This article was sponsored by State Street Global Advisors.
Commitment to the 2016 Paris Agreement and the momentum from COP26 makes it imperative for investors to plan their journey to net zero. We outline the key steps you can take to implement a Net Zero investment strategy.
Key Steps for an Effective Transition
- Asset Allocation
1. Engagement – The Primary Tool to Drive Alignment
Investment strategies should prioritize engagement and stewardship as a mechanism to drive alignment. Direct engagement may be difficult for investors – there may be a lack of expertise or a significant learning curve required – and for most asset owners such engagement is often implemented by their asset manager.
Our Climate Stewardship Approach
2. Exclusions – Divestment Can Be Useful
Engagement and stewardship actions are recommended as the main tool to achieve alignment. However, divestment and exclusion may be considered where there is climate-related financial risk, to escalate after unsuccessful engagement or where the company’s primary activity is no longer considered permissible in terms of credible net zero pathways.
Exclusions appear simple in terms of implementation but can rapidly become complicated as these are driven by strong visions where the route to engagement has been cut off. As climate change is a new and evolving topic it renders exclusion criteria difficult and may need to be revisited and reviewed over time.
Other custom divestments can be made based the volume of CO2 emissions (in millions of tons) owned by a company, indirect ownership of companies involved with fossil fuels, or other particular metrics or indicators. However, determining appropriate thresholds for some of these metrics can prove complicated.
3. Asset Allocation – Public and Private Markets
Strategic asset allocations for liquid portfolios encompasses asset classes ranging from sovereign bonds to equity markets. The weighted allocation will typically be derived risk return assumptions for a given horizon.
In addition the asset owner’s climate change policy will need to be implemented which requires the definition of measurable parameters at the underlying company level which can be aggregated, evaluated and monitored at the total portfolio level. Climate change parameters can be characterized as being linked to mitigation or adaptation, or alternatively said as being historical or forward looking.
The asset owner may decide to allocate some investment to illiquid alternative vehicles. This can be for example private debt, private equity, direct real estate or infrastructure. Evaluation of climate change alignment for illiquid investments is still much a work in progress. Reporting is typically not standard and not necessarily transparent, engagement has a central role.
4. Reporting – An Essential Element
Reporting is a vital component in a successful Net Zero strategy. State Street Global Advisors can provide reports and assessments of clients’ investment portfolios that include several ESG components, including TCFD metrics and climate profiles such as:
- Carbon intensity
- Weighted average carbon intensity
- Scope 1 and 2 carbon emissions
- Total reserves of carbon emissions
In the event that additional climate metrics such as green revenue and brown revenue share and/or climate adaptation scores are integrated, we can report on these as well. Lastly, we are also able to provide climate scenario analysis results via specialized third-party analytics tools. In summary, we are able to provide covering the following areas:
- Carbon emissions-related data (including TCFD aligned metrics)
- Climate data (including fossil fuels, brown/green revenues, adaptation score)
- General ESG scoring using our proprietary R-Factor framework
- Engagement highlights
- Climate scenario analysis via third-party reporting tools
State Street Global Advisors Worldwide Entities
The returns on a portfolio of securities which exclude companies that do not meet the portfolio’s specified ESG criteria may trail the returns on a portfolio of securities which include such companies. A portfolio’s ESG criteria may result in the portfolio investing in industry sectors or securities which underperform the market as a whole.
Responsible-Factor (R Factor) scoring is designed by State Street to reflect certain ESG characteristics and does not represent investment performance. Results generated out of the scoring model is based on sustainability and corporate governance dimensions of a scored entity.
All information is from SSGA unless otherwise noted and has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such. Past performance is not a reliable indicator of future performance.
The information contained in this communication is not a research recommendation or ‘investment research’ and is classified as a ‘Marketing Communication’ in accordance with the Markets in Financial Instruments Directive (2014/65/EU) or applicable Swiss regulation. This means that this marketing communication (a) has not been prepared in accordance with legal requirements designed to promote the independence of investment research (b) is not subject to any prohibition on dealing ahead of the dissemination of investment research.