Institutional investors need to plot their route to net zero, no matter how complex the journey, writes Jennifer Anderson, co-head of sustainable investment and environmental, social and governance at Lazard Asset Management.
The goals of the framework — “to ensure investors can decarbonise investment portfolios and increase investment in climate solutions, in a way that is consistent with a 1.5C net-zero emissions future” — have significant implications for participating portfolios.
Some investors have already begun to put this framework into practice. Of course, even though the goal is clear, the road there will be long and unyielding for many. For numerous other large pension funds and their asset managers, the question currently dominating every meeting agenda is: how do we begin?
Asset owners face numerous challenges
Achieving a net-zero portfolio today is quite difficult. Indeed, there are almost no listed companies globally that are emission free (although many purchase credits to achieve net zero).
Time is running out for those investors still contemplating how to begin — the time to act is now
The closest are largely concentrated in the technology sector, which would present major diversification challenges to portfolios. Even owning these names in concentrated strategies would be too risky to be viable for most institutional investors.
Beyond that, a wide variety of hurdles remain to be overcome by any solution purporting to begin a credible journey towards a net-zero portfolio — from data and engagement, to the broader social and environmental context of carbon reduction.
Data currently available, such as scope 1 and 2 emissions, while providing an important benchmark for a company’s current activities, do not consider progress nor look forwards to a path towards carbon neutrality.
Forward-looking scenario analysis is at its early stages of development, but it will ultimately be critical to determining if a portfolio is genuinely invested in companies on a feasible pathway to net-zero carbon emissions.
Another challenge is that green solutions providers tend to be more concentrated in private hands or are smaller companies, complicating portfolio construction designed to enable a green transformation in the wider economy.
Investors also face the complex balancing act between excluding high emitters and using active and rigorous engagement to improve real-world outcomes, or a mix of both.
Active strategies have an advantage when using voting and engagement to support companies building net-zero carbon business strategies, yet they face difficulties when it comes to evidencing, attributing, and quantifying real-world/economic outcomes.
Where to begin?
Given the challenges, the question for asset owners and managers is deciding how and where to begin constructing an investment solution aligned with the 2050 goal.
For large, complex mandates, we believe a viable route to achieving net-zero goals could include several core elements.
First, portfolios must be bespoke. A ‘one-size-fits-all’ approach is unlikely to meet the broad and often complex objectives around environmental, social and governance, risk, return, liability-matching characteristics, impact-oriented outcomes and adherence to policies such as Paris-aligned portfolios.
Second, avoid greenwashing. Asset managers will have to demonstrate deliberate designs and the application of real intellectual capital in constructing portfolios for client mandates.
Portfolio construction must achieve tangible outcomes that move beyond empty slogans claiming to adhere to sustainable investment through ESG integration and exclusions, when the reality is quite different.
Third, employ quantitative/data science expertise and practices, supported by rigorous fundamental analysis. Integration of geographic data to provide financial insights, particularly around environmental analysis, will increase.
The availability of larger and newer data sets will present challenges and opportunities for asset managers to extract actionable information from otherwise nebulous sources, unlocking the potential to generate returns, enhance capital allocation decisions and optimise portfolios.
Lastly, asset owners and managers need to engage in meaningful ownership. Increasingly they must be able to engage with companies to accelerate the pace of change towards a more sustainable future by leveraging their fiduciary duty.
Stewardship engagement and proxy voting decisions should be led by investment decision-makers rather than separately, as so often is the case when this is done by ESG specialists alone.
The quantitative plus fundamental analysis approach, with integrated ESG considerations, offers but one of the possible paths to a net-zero carbon portfolio.
In any case, the direction of travel towards investing in, and for, a more sustainable future is clear. Time is running out for those investors still contemplating how to begin – the time to act is now.
Jennifer Anderson is co-head of sustainable investment and ESG at Lazard Asset Management
