Podcast: How to decarbonise your investments
As the world races towards net zero, we discuss the strategies investors could use to decarbonise their portfolios.
Profily autorov
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The full transcript is available below:
[00:00:00.12] - David Brett
Welcome to the Investor Download, the podcast about the themes driving markets and the economy now and in the future.
[00:00:14.15] - David Brett
I'm your host, David Brett. Despite the flip-flopping of some governments and companies on their net zero ambition, the world is on the road to decarbonisation. That means investors are having to make decisions, too. In this show, we speak to two investors dealing with the challenge of decarbonising their portfolios and how they go about creating a decarbonisation strategy.
[00:00:47.04] - Announcer
On Apple Podcasts, Spotify, or wherever you get your podcasts, you're listening to the investor Download.
[00:00:53.21] - David Brett
As the world speeds towards net zero, investors are playing their part, too.
[00:00:58.23] - Simon Webber
Many people have a personal objectives or morals and values that they want to align with their investing objectives.
[00:01:06.15] - David Brett
That's Simon Webber, Head of Global Equities at Schroders. He sees investors taking an active role in decarbonising their portfolios to help businesses and governments meet their targets. But it's not just about moral obligation or desire. This is about opportunity, too.
[00:01:24.10] - Simon Webber
Many investors, like myself, believe that there is huge potential for alpha generation on the opportunity side in the transition to a net zero world, and avoidance of risk by being less exposed to companies that are laggards or industries where stranded assets are a major risk.
[00:01:43.08] - David Brett
Generating alpha refers to investments' ability to outperform their market, thereby generating positive risk-adjusted returns. We'll come back to risks shortly. Stranded assets refer to investments that become economically unviable or obsolete due to factors such as changes in technology, environmental regulations, or market conditions.
[00:02:04.17] - Simon Webber
There could be many reasons why investors want to embed sustainability and decarbonisation in their portfolios. But I think the key thing is that investors want sustainable outcomes, not just sustainability.
[00:02:19.16] - David Brett
What's the difference between sustainability and sustainable outcomes, I hear you ask.
[00:02:25.05] - Simon Webber
Sustainability is obviously quite a general word. It may mean different things for different people, but in investment, it's tended to be about benchmarking, comparing investments to one another, or what one fund or index is doing against another.
[00:02:39.16] - David Brett
Benchmarking can be a bit subjective, to say the least. It comes with its issues.
[00:02:44.22] - Simon Webber
Sustainable outcomes is about measuring funds, portfolios, against specific targets. For example, if a company or a fund has a target being carbon-neutral by 2030 or perhaps net zero by 2040, that can be measured. It could be tracked against, and investors can hold their portfolio managers accountable for delivering against that target. The key point is it's measurable and it's much more objective.
[00:03:10.23] - David Brett
That's a critical factor if investors truly want to decarbonise their portfolios. For many investors, decarbonisation simply means reducing emissions. For most, that needs to be achieved by a certain date. Sounds simple, right? Well, not quite. Lowering emissions in a portfolio isn't just about divesting from fossil fuels or reducing investments in the highest emitting assets.
[00:03:34.18] - Ben Popatlal
As investors, our portfolios don't operate in a vacuum.
[00:03:38.03] - David Brett
That's Ben Popatlal, a Multi-Asset Analyst at Schroders.
[00:03:42.10] - Ben Popatlal
Our portfolios operate within the bounds of an investable opportunity set, which is ultimately set for us by the world at large.
[00:03:50.23] - David Brett
There's a bigger theme at play here: from truly caring about how we treat the planet to recognising where countries and companies have set targets to achieve net zero by a certain day. It's going to happen.
[00:04:02.14] - Ben Popatlal
Decarbonisation for us also means that we need to understand the world that we operate in, different parts of the world, regionally, different parts of the investable universe, about sectors and different companies, will decarbonise at different speeds. And so for us, as active managers, decarbonisation means operating within that universe, in line with the universe, but hopefully in a manner that avoids the risks associated with climate change and takes advantage of opportunities.
[00:04:34.05] - David Brett
Risks can include anything from businesses not following through on their net zero commitments to supply chains being disrupted by climate events to countries reneging on their climate promises.
[00:04:44.03] - Ben Popatlal
So governments and policymakers can be a headwind. I think probably the uncertainty that comes with policy can be a headwind. The red tape that comes with policy, wondering when policy is going to be enacted, whether there'll be a change in government and a massive structural change in the way that the government is going to be pointing their objectives. And I think when governments are clear about what their targets are and what their priorities are, that sets the scene for individual companies. It gives companies a licence to set their own targets and align their targets with their governments. And all we're really doing, especially in multi-asset for our decarbonisation strategy, all we're doing is aligning our target with the general target of net zero by 2050.
[00:05:33.23] - David Brett
Managing those risks, dealing with companies and governments flip-flopping on their commitments, or moving the goalposts is a hazard that comes with the territory for investors. It means they have to be versatile when it comes to decarbonising their investments.
[00:05:47.09] - Ben Popatlal
There's always a trade-off with everything, basically. I think that's true, not just an investment, but pretty much in all walks of life. But we found that the trade-off with decarbonisation is nonlinear. That sounds like a technical term, but what I mean by that is you can reduce emissions in your portfolio, or you can improve the climate profile of your portfolio to a certain extent without taking on additional investment risk, without taking on tracking area relative to a benchmark, and you can push that to a certain amount. But then if you push it too far, too fast, if you like. If you're going much faster than the universe will allow you to go, then you'll start to take on a lot more active investment risk. The key thing is that where you've taken on that active investment risk, you haven't taken it on because you expect to be financially rewarded.
[00:06:36.12] - David Brett
Helping investors make the right decisions and avoid taking on too much risk requires businesses and governments to play their part and to be as transparent as possible.
[00:06:45.22] - Simon Webber
We are now getting more and more data from companies, and the disclosure is improving. It's not perfect, but it's improving.
[00:06:54.06] - David Brett
That's Simon Webber again.
[00:06:56.04] - Simon Webber
We're getting better data to be able to report on current emissions. We're getting better data around targets that companies are setting so we can build profiles of where... If companies deliver on those targets, their mission profile will be going in the future, and we can aggregate that up to a portfolio level.
[00:07:14.18] - David Brett
But it's not perfect, which represents a challenge. What happens if a company isn't living up to its side of the bargain?
[00:07:21.22] - Simon Webber
We get more and more questions around individual companies, around the engagement that we're doing with laggards, not just leaders with laggards. If they're a laggard, are we comfortable with that? Are we engaging with the company? If they remain a laggard, how does that affect our investment view of the company and the equity? Clients like to see what it means for them and the portfolio as a whole, what the trajectory is, what the history has been, and it ends up in good conversations. You get a lot of insights about your investments from this as well.
[00:08:00.17] - David Brett
So we have our net zero target. We're looking at the data. We know the amount of risk we're willing to take, and we know we can engage businesses failing to live up to their commitments. But how do investors go about creating a strategy to meet their decarbonisation objectives? That's coming up after the break.
[00:08:18.07] - Announcer
Get in touch with us by email at schroderspodcasts@schroders.com or visit our website, schroders.com/theinvestordownload.
[00:08:29.23] - David Brett
So much information and so many pitfalls can make it difficult to know where to start when creating a strategy to decarbonise your investments. But Popatlal says the best place to begin is probably the most obvious place to look, and that's with policy.
[00:08:44.20] - Ben Popatlal
On the fiscal side or on the government side, the policy will create winners and losers. It will create winners and losers across sectors, but also companies within sectors. And so I think for us, I mentioned earlier on about emissions and trying to reduce those. But to some extent, it's about companies just aligning their business models with the future state of the world that governments are trying to encourage. So for us, it is about future proofing your portfolio going forward. That's probably the main priority. One proxy for that is emissions or just a simple metric, something like climate change related metrics that we can track in our portfolios, and we can see them in our dashboard. Those are proxies to help us understand whether a company or whether a sector or a region is aligned with some... Or is future proofed against government regulation.
[00:09:40.01] - David Brett
If you followed the policy, then there's certain leavers you can pull as an investor, particularly if you're a multi-asset investor?
[00:09:46.22] - Ben Popatlal
Multi-asset investors are fortunate in being able to pull lots of different levers. You would expect a multi-asset investor to pull the lever of asset allocation, your equities versus bonds. That's something they've always done. But then I think becoming more important is the strategy type within the asset class. Given strategy types within your equity portfolio can do different things for you, given the objective that they have both on the investment and sustainability side. So we pull the asset class lever, we pull the strategy type lever, but then also pull the kind of what we call the levers for change, which are trying to drive real-world improvement. Because as the real-world improves, so we can build a better portfolio within that world. So in a way, you can see that as being refreshingly selfish way to think about the planet, which is that we want the planet to improve so that we can build a better portfolio within the planet. And the levers there are engagement. We've already mentioned that. We think that's the most potent tool for equities. We can do it in a credit portion of the portfolio as well. But in the equity space, you're an actual owner of the company.
[00:10:58.14] - Ben Popatlal
The provision of capital and use of proceeds. That's something that we think you can do in the fixed income portion of your portfolio. So things like green bonds that you can use. And then finally, impact is the third lever, and we think that's a high bar.
[00:11:12.19] - David Brett
But what if you're not a multi-asset investor? What if you focus on one asset class, say equities, for instance? What do you do then? Here's Simon Webber again.
[00:11:21.17] - Simon Webber
Well, there are two main lenses as equity investors we can look at. One is the carbon footprint, or perhaps more correctly, the financed emissions of a portfolio. We can look at the weighted average of those financed emissions, and we can look at how it declines over time. Lots of clients and some portfolios are setting targets to decarbonize, and you can align that with the trajectory that the world needs to be on to meet the Paris Agreement. Of course, that's what institutions like Schroders have as a whole, is we have targets as a business to align. But that's just one way of looking a carbon footprint of a company. That's just one way of looking at it. A carbon footprint of a company can be very different depending on the industry they're in. But two businesses in different industries with different carbon footprint could still be aligned if they have the right investments and decarbonisation trajectory ahead of them.
[00:12:21.06] - David Brett
An important tool available to equity investors to help them align targets and companies' delivery on those targets is something called implied temperature rise or ITRs.
[00:12:30.23] - Simon Webber
These ITRs are essentially temperature scores that you turn company targets and company delivery on those targets into. Each investment we make will have an implied temperature rise, and then there's a formula for looking at that at the portfolio level. For active management of equities, this is really important because at a big asset owner level, you might want to be looking at the overall emissions because you will still be investing right across the market over time. But for one portfolio, like some of the ones I manage, in a year's time, the really attractive investment opportunities might be in a higher carbon sector. The carbon footprint or financed emissions of one portfolio, if it's actively managed, should be able to rise if you're finding opportunities in these other parts of the market. But if you're still investing in companies that are aligning themselves with the Paris Agreement, they should still have an implied temperature rise, and the portfolio as a whole could still have an implied temperature rise that is consistent with the Paris Agreement.
[00:13:40.11] - David Brett
Papatlal has three pieces of advice to investors creating a decarbonisation strategy. First, be aware.
[00:13:47.17] - Ben Popatlal
Understand that your portfolio doesn't operate in a vacuum. The extreme example, as you've already gone to, is that we probably can get to net zero or very close to net zero in the next few years. But there's a huge cost associated with that, and that is possibly taking on massive concentration risk, kicking out entire sectors of the economy, missing out on loads of opportunities.
[00:14:08.18] - David Brett
Second, don't be afraid.
[00:14:10.24] - Ben Popatlal
Pull every lever that you can. Those are the leavers for driving real-world change that I mentioned. If you are a multi-asset investor, recognise that there's engagement within equities and credit, possibly with sovereigns too. And then also real-world impact decarbonisation solutions, rather than just looking at the profile of the asset. And think about what that asset is doing for the real world. Is it offering solutions for the real world? So that's what those are the higher impact parts of the portfolio that we look at.
[00:14:40.21] - David Brett
Finally, be vigilant.
[00:14:42.21] - Ben Popatlal
Put in place a monitoring framework and keep the monitoring framework quite simple. And put everything in one place if you can. So have a dashboard in front of you that can look at the emissions profile, the intensity profile, the footprint, implied temperature rise, and any other metrics that matter to you as the investor. Try and get them all into one place or into a small number of tools so that you can have a monitoring framework that helps you keep on track of your portfolio. Again, don't over complicate it. Keep it simple, but be on top of it all the time.
[00:15:14.11] - David Brett
That was the show. We very much hope you enjoyed it. You can subscribe to the Investor Download wherever you get your podcasts. And if you want to get in touch with us, it's Schroders podcasts@schroders.com. And you can find out much, much more at schroders.com/insights. New shows drop every other Thursday at 05:00 PM UK time. In the meantime, keep safe and go well.
[00:15:38.07] - Announcer
The value of investments and the income from them may go down as well as up, and investors may not get back the amounts originally invested.
[00:15:45.05] - Announcer
Past performance is not a guide to future performance. Information is not an offer, solicitation, or recommendation of any funds, services, or products, or to adopt any investment strategy.
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