Asset owners must demand bold climate action from asset managers
Asset managers must oppose outcomes that generate short-term alpha at the expense of reducing market beta, argue Allianz’s Patrick Peura and Wespath’s Jake Barnett
The financial sector has sounded the alarm: climate change threatens the foundation of the global financial system. From Mark Carney’s call to prevent “the tragedy on the horizon” to Larry Fink plainly stating that “climate risk is investment risk”, leaders are recognising climate change as the greatest destabilising force of our time.
The global response to the climate threat must centre on limiting the global temperature increase to 1.5°C and transitioning our economies to Net Zero greenhouse gas emissions. The recently-launched Glasgow Financial Alliance for Net Zero (GFANZ), representing $70tn in assets, marks a clear re-orientation toward Net Zero across the breadth of the financial services industry. Net Zero commitments from countries representing approximately 70% of global GDP reinforce this commitment.
Despite this momentum, there remains a significant gap between long-term commitments and actionable intermediate targets in both finance and public policy. The latest UN Nationally Determined Contribution (NDC) Synthesis Report demonstrates that the latest round of NDCs (the climate targets established to help countries support the Paris Agreement) put the world on track for less than a 1% reduction in emissions by 2030—a far cry from the Intergovernmental Panel on Climate Change’s call for a 45% global reduction this decade, with significantly higher reductions needed from developed economies.
For asset owners, climate risk is more than just a financial risk; it is an existential risk to our core businesses
Likewise, the Net-Zero Company Benchmark created by shareholder engagement network Climate Action 100+ earlier this year exposes major gaps at the biggest emitters. While more than half the initiative’s focus companies have stated their intent to achieve Net Zero by 2050 at the latest, none have detailed plans to align future capital expenditure with a 1.5°C scenario. The International Energy Agency (IEA) has also acknowledged the step-change in action needed: in its recent special report, Net Zero by 2050, the agency stated the pathway to Net Zero is “narrow and requires an unprecedented transformation of how energy is produced, transported, and used globally”. Despite the narrow pathway, this is still practically feasible today because, as the IEA report states, “most of the global reductions in CO2 emissions between now and 2030 in the net zero pathway come from technologies readily available today.”
Our next steps in addressing the climate threat are critically important and it is clear that long-term goals without well-defined intermediate targets will be insufficient. Further, something like GFANZ - a voluntary coalition of sector leaders - is not enough, unless it sparks a major shift in the financial and economic incentives that drive our economy.
As members of the UN-convened Net-Zero Asset Owner Alliance, we believe asset owners must play an important role in this shift. For asset owners, climate risk is more than just a financial risk; it is an existential risk to our core businesses. In addition to lessening the financial security of our beneficiaries, climate change creates a more inequitable, resource-scarce and conflict-prone society, threatening the viability of today’s insurance offerings and jeopardising our pension participants’ hopes for a comfortable retirement.
But all is not bleak: asset owners possess powerful tools that can influence the transition to a net-zero economy, build support for the intermediate targets needed and incentivise smart climate action. It all starts with entrusting our money to asset managers with strong approaches to climate in their stewardship and policy activities.
Asset managers are powerful stewards of asset owners’ long-term interests. They choose the companies in our portfolios, conduct corporate engagements, cast votes on directors and climate-related resolutions, and influence the economic system through lobbying and discourse.
The clearest way asset owners can enhance our side of this partnership is by increasing the ambition and scope of what we require from our asset managers, while supporting those taking our interests most seriously. This must include the management of systemic climate risks, which itself must include moving beyond the narrow lens of seeking company-specific “alpha” and addressing the undiversifiable, market-wide “beta” associated with unabated climate change.
As an example, let us imagine an energy company lobbying against sensible climate regulation in hopes of maintaining a short-term competitive advantage. While success in this effort may indeed reward the company today, it simultaneously contributes to a regulatory mispricing of climate risk in the economy. In the long term, this mispricing would adversely affect society and, in turn, negatively impact the global economy and the diversified investment portfolios of global asset owners. Therefore, in such a situation, asset managers must oppose outcomes that generate short-term alpha at the expense of reducing market beta.
Unlike most traditional approaches to alpha and beta, this new way of thinking appropriately identifies the existential risk of climate change as something that cannot be offset, hedged out or made up elsewhere—rather, it must be addressed head on, in the real economy. This offers a new contextualisation of an asset manager’s fiduciary duty. Failure to act now—through portfolio realignment, lobbying for net-zero policy, corporate engagement and targeted investments—is failure to act in the best interest of asset owner clients. Put simply, if an asset manager is not supporting bold climate action, it is not fulfilling its fiduciary responsibilities. In turn, asset owners must hold their managers accountable to this elevated expectation.
We commend groups like Principles for Responsible Investment (PRI) for building momentum toward this more beta-forward form of stewardship through initiatives like Active Ownership 2.0 and Investing with SDG Outcomes. The Alliance’s new resource for asset owner evaluation of asset manager climate-related proxy voting is also a valuable example of how to build stronger asset owner-asset manager relationships in the context of voting proxies.
Still, we must do more to prioritise our approach to fiduciary duty and beta stewardship in the selection, evaluation, and engagement of asset managers.
The transition to a global net-zero GHG emissions economy is on the scale of the great transitions of human history; however, unlike the industrial revolution or the electrification of our energy system, we do not have the benefit of time. To achieve Net Zero by 2050 and limit global warming to 1.5°C, we must take immediate action.
We call on all asset managers to elevate their climate-related proxy voting programmes in alignment with the Alliance’s guidelines. Furthermore, all asset managers that have yet to do so should publicly commit themselves to stewarding their portfolios in line with a Net-Zero-by-2050 world. This should include action plans with intermediate reduction targets, strategies for addressing climate-related market beta, and commitments to hold companies accountable for the change they must drive in the real economy.
As stated above, asset owners must make a habit of holding their asset managers to these new expectations. Bold climate action today is our expectation of what’s needed tomorrow. We invite all asset owners - especially sovereign wealth funds whose countries have committed to Net Zero - to join the Net-Zero Asset Owner Alliance and state their intentions clearly.
Through partnership and collaboration, it is possible for asset owners and asset managers to navigate the transition to a just, prosperous, and net-zero future. Doing so is not a competitive advantage—it is a competitive necessity.
Patrick Peura is ESG Engagement Manager at Allianz
Jake Barnett is Director of Sustainable Investment Stewardship for Wespath Benefits and Investments