I need a zero. I’m holding out for net zero till the climate is right

Alex White - Redington

Alex White

Managing Director, ALM
(Monday, Jun, 21, 2021)
|   5 mins

The first step in Redington’s 7-point climate action plan is ‘objective setting’: helping our clients articulate their own climate-related objectives – allowing them to achieve their investment goals while having a real-world impact. Here’s how we plan to do this:

Climate change is a vast global problem; keeping temperature rises even remotely manageable will require significant action from a range of stakeholders – this is what the Paris Agreement sets out to achieve. The Paris Agreement aims to limit global temperature increases to well below 2°C (ideally 1.5°C) by 2100. To realise this, recognised scientific thought is that the global economy needs to halve emissions by 2030, reaching net-zero greenhouse gas (“GHG”) emissions by 2050 at the latest.

By definition, net zero is achieved when anthropogenic emissions of greenhouse gases are balanced globally by anthropogenic removals over a specified period. The result being no new emissions entering the atmosphere.

Unfortunately, delivering real economy net-zero emissions is a monumental challenge. Not least because the entire global economy must reconfigure business-as-usual, the lives of every individual on the planet will need to change and adapt. There’s no quick fix to this challenge; given the state of technology, it’s impossible to achieve the transition today. Reaching net zero will require massive amounts of spending on infrastructure and innovation over the next three decades, as well as a paradigm shift in the way governments, society and corporations value the sustainability of planetary ecosystems.

With investors becoming more alert to the threats of climate change, and regulators increasing the pressure on asset owners in tandem, there’s considerable demand for portfolios to meet emission reduction targets.

But how do you turn good intentions into clear, measurable objectives?

We’re proposing three potential climate-related objectives for our clients which will drive strategic asset allocation decisions:

  1. Risk management

An investor may want to protect their portfolio against climate risk – this could be realised in numerous ways. It could involve managing the transition risk arising from the necessary upheaval of the economy, or the physical risk deriving from the direct effect of higher temperatures, rising sea levels, and so on, or perhaps a combination of the two. Whilst these risks may be very different, general de-risking processes (such as moving higher up the capital structure, reducing credit duration, switching from emerging markets to developed markets etc.) are likely to remain effective in managing both.

  1. Portfolio decarbonisation

If every investment portfolio had zero emissions, it’s likely that the world would have already transitioned to net zero. Reducing emissions is measurable and, as a consequence, harder to greenwash (although there are a number of complications around how – and whether – to allow for indirect (scope 3) emissions). Portfolio decarbonisation is therefore a tangible, definitive action investors can take which should at least create pricing incentives for green investments. For example, investors might consider establishing exclusionary benchmarks (e.g. ex-energy or ex-fossil fuels), selling credit and buying a smaller (return-equivalent) equity allocation and moving from beta to alpha.

The downside is that there’s a risk of ‘passing the buck’. In the extreme case, while a 100% cash portfolio wouldn’t have any emissions, it would also be unlikely to achieve much in the way of reducing global warming. Similarly, while gas power stations are high GHG emitters, coal plants emit roughly twice as much carbon and carbon-equivalents. This means, in a country that burns a lot of coal, building a gas power station may actually achieve a greater reduction in global emissions (if it replaces a coal plant) than building a renewable power plant in a country with an already relatively green energy mix.

  1. Real-world impact

This approach recognises the global nature of climate change and looks to achieve a reduction in real economy emissions, not just at the portfolio level. The most obvious example of this is renewable power: building solar panels means less fossil fuels are burned to generate electricity, so the solar panels have a wider impact on emissions than simply the (small but non-zero) emissions produced in building and running them. Stewardship, specifically where investors use their power to drive greener decisions on company boards, is another example.

The downside here is that the impact is vaguer and more indirect; it’s far less measurable and therefore more vulnerable to greenwashing. This is particularly the case in green tech, since some form of innovative green tech is likely to be a vital part of the solution; but like any new technology, it’s unlikely that any specific solution will prove most important.

Surely there are more than three potential climate-related objectives to choose from?

There are of course alternative objectives to the three mentioned above, however, we generally see these as being less useful. For example, ‘percentage of green revenues’ is not only open to greenwashing, but it also fails to account for how green or how brown the green and brown revenues are. This distinction can be critical since distributions amongst revenue types can be heavily skewed, with a handful of holdings producing the majority of a portfolio’s emissions. Adding in this extra detail brings us back to measuring emissions and targeting portfolio decarbonisation.

So, where does that leave us?

No objective or metric is perfect: all of them approach a problem from a different angle and therefore result in different conclusions. Sometimes these can even be directly opposing; for example, an offshore wind farm may have a high emissions reduction impact, but it may also be exposed to a high level of physical risk in the face of rising sea levels and more extreme weather events. For many investors, a combination of all three objectives may be the best approach.

Our team at Redington can work with you to help define, quantify and measure your climate objectives, converting these good intentions into a framework that drives strategic asset allocation decisions.


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