A panel of investment practitioners discussed during a Responsible Investor webinar last week how their firms are involved in the fight against climate change, with most saying the industry must step up action if we are to meet the Paris Agreement goals.
The online event, entitled ‘Taking Temperature for 2021: Investment solutions for challenging climate change,’ was hosted in partnership with Qontigo. Moderator Daniel Brooksbank asked all participants to give their perspective on, and experience with, the integration of climate as a guiding objective in investment portfolios.
Act now
Viola Lutz, deputy head of climate solutions at ISS ESG, opened the presentations with an overview of current action and an outlook for the near future. ISS ESG is a leading provider of sustainability data and analytics.
Lutz said that following a dip in carbon emissions during the COVID-19 crisis, latest monthly emissions readings have bounced back to pre-pandemic levels.
“Essentially, we are in a business-as-usual scenario,” she said. Meanwhile, “the costs of climate change are rising. What it means is that we are collectively still falling off the proverbial cliff when it comes to climate change.”
On a more positive note, government and industry initiatives continue apace, she said. There are more than 10 international bodies that are looking into sustainability in the financial sector, she noted, and more than 42 countries with at least one national program on sustainable finance, in addition to regional endeavors.
In 2021, Lutz forecast, we can expect more heat records and increased regulation. She urged investors to adopt climate considerations now, rather than wait for rules and guidance from policymakers.
“We do not know exactly what the various green taxonomy initiatives will look like,” she said. “But, we don’t need to. The direction for action is actually very clear: and that is becoming net zero as fast as possible.”
Lutz highlighted three initiatives that exemplify the financial industry’s strong push towards a low-carbon landscape: the Net Zero Investment Framework, Science Based Targets (SBTi) and the United Nations-convened Net-Zero Asset Owner Alliance.
“In 2021, we will see net-zero goals for investors and companies gain more prominence,” she added.
The asset-owner experience
Laurent Deborde, head of equity portfolio management and fund selection at Groupe Caisse des Dépôts, took his slot to report on a recent project as the French asset owner seeks to align portfolios with a low-carbon pathway.
In November 2019, Caisse des Dépôts led nine other investors in a search for managers for three funds with a climate-aware focus. As Deborde explained, the move was planned to find and test investment methodologies that could in time be expanded to the rest of the group’s portfolio.
The funds were launched last December. One of them is an active fund run by Sycomore Asset Management, and the other one is an index fund managed by Amundi that tracks the Euro iSTOXX® Ambition Climat PAB Index.
“The goal is two-fold,” Deborde said. “Both to earn money and to try a financial management methodology that will take into account climate change and orient investments towards a net-zero world, while keeping our standards of returns and risks.”
Analyzing the relative risk of a climate strategy
Investors planning on making similar transitions from traditional to climate-aligned portfolios have usually had concerns about related costs and implied risks. Melissa Brown, managing director for applied research at Qontigo, presented a study from Qontigo’s Applied Research team that may help assuage those concerns.
First, Brown showed how the STOXX® Europe 600 Paris-Aligned Benchmark (PAB) Index has had, in data going back to 2018, lower volatility than the benchmark STOXX® Europe 600 Index. The lower volatility was accompanied by relatively low active risk for the PAB compared to its standard index counterpart.
Secondly, she showed the results of a series of ‘stress tests’ on Paris-aligned (PAB) European, US and global portfolios and compared them with their capitalization-weighted brethren. One set of tests replayed historical instances of market stress while the other one looked at ‘what-if’ scenarios such as big declines in specific sectors.
Here the findings showed that the average difference in expected returns between the PAB portfolios and their standard counterparts throughout all historical instances was close to zero. In almost all scenarios, the portfolio pairs moved in the same direction. Only in few cases was the magnitude of the moves noticeably different, some in favor of the PAB portfolio and some not.
“Am I taking on more risk by getting climate awareness into my portfolios?” asked Brown. “The answer is clearly no.”
In a second part of the analysis, Brown looked at the cost of transitioning to a low-carbon portfolio. The data showed that trading costs rise in percentage terms the larger the pool of assets and the higher the volatility of the market. For a look at her team’s research on the topic, please click here.
With time, the regular portfolio and its climate-aligned counterpart will drift wider apart, because of increased demand for ‘green’ assets and of heightened regulation, Brown said. This suggests that transitioning costs may increase over time, she added.
“The active risk and the turnover involved in these transitions are going to increase year on year,” she said. “If you are considering a move to a climate-aligned benchmark, you probably want to do it slowly to mitigate costs, but you may want to do it sooner rather than later.”
Supporting net-zero strategies
Rodolphe Bocquet, global head of sustainable investment at Qontigo, closed the round of presentations. He told the audience that during the pandemic, global gas emissions fell as much as 7%, matching the annual decarbonization target required under the Paris Agreement. Sadly, as lockdowns were eased, emissions have quickly bounced back.
“Replicating that emissions decrease on a yearly basis going forward is quite a challenge,” Bocquet said. Moreover, between 2010 to 2019 the emissions gap didn’t narrow at all, but it actually widened, he added. “Such is the drastic and daunting challenge that lies ahead of us.”
This calls for an urgent shift of capital towards green assets.
Here, passive investing has a key role to play, said Rodolphe. He put the focus back on the recently introduced family of STOXX Paris-Aligned Benchmark Indices (PABs),1 which were mentioned early in the webinar. The indices are designed to exceed the requirements in the European Union Climate Benchmarks regulation and use science-based targets to encourage companies and investors to work towards global targets.
Bocquet explained that the PABs were specifically designed so that they keep exposure to high-emission industries and avoid lowering the carbon footprint by simply switching to ‘greener’ sectors. Instead, they allocate capital to companies that are doing best across the sectorial board.
The indices top the regulatory criteria in several points. Firstly, they aim for a higher carbon reduction threshold than established by law. The indices also include Scope 3 carbon emission data from day one. Finally, they adopt a minimum green-to-brown ratio that was not part of the final EU regulation.
The indices will progressively invest only in companies that have committed to approved science-based climate targets published by the (SBTi). These are targets that are aligned with what climate science deems necessary in terms of carbon emissions reduction to meet the goals of the Paris Agreement. The SBTi helps companies set and achieve such goals.
Bocquet called this last criterion “a very strong commitment from our end, and a very powerful way to make sure that the indices will support net-zero investment strategies.”
The STOXX Paris-aligned benchmarks are already used in exchange-traded funds managed by Amundi and Franklin Templeton.
The clock is ticking
In summary, the presenters agreed that the clock is ticking when it comes to climate. There are plenty of initiatives where investors are engaging to bring change and halt global warming, and indeed momentum seems to be gathering pace. In 2021, it’s up to every participant to build on this trend.
1 The Paris-Aligned benchmarks are part of Qontigo’s Climate Benchmark Indices, which also include the STOXX Climate Transition Benchmark Indices (CTBs). Both comply with, and exceed, the requirements laid out in the EU’s Climate Benchmark Regulation. The indices are based on liquid securities from a selection of STOXX Benchmark Indices. The PABs track a portfolio whose greenhouse gas (GHG) emissions are aligned with the long-term global warming target of the Paris Climate Agreement. The CTBs form a portfolio that is on a decarbonization trajectory.