Asset owners need to focus on achieving real world decarbonisation rather than just focusing on numbers and targets that may only superficially decarbonise portfolios

Many asset owners around the globe are setting long-term net-zero targets and trying to steadily decarbonise their portfolios over the next few decades, and the companies they invest in are following suit.

However, well intentioned asset owners should avoid focusing too much on simply hitting quantitative targets for risk of disserving the complex climate web of considerations that no purportedly suite of metrics can claim to neatly capture.  Instead, they should use these science based targets as guiding a more holistic assessment of their portfolio’s climate transition possibilities and pathway with the intent to contributing to a meaningful real economy wide decarbonisation.

In a multi-asset diversified portfolio, the ability of different asset classes to contribute to decarbonisation varies, and each has a different starting point, so the task is not a simple one.

At Mercer, when we talk about net-zero and its implementation from a portfolio perspective, our intent is to stay focused on achieving real economic decarbonisation and alignment to the Paris Agreement. Our net-zero commitment sits at the total portfolio level and is not limited to any specific asset classes. We look at how all the different sectors and asset classes collectively equate to net zero through quantitative and qualitative considerations that are also expected to further evolve.

Beyond portfolio decarbonisation

While investors can achieve portfolio decarbonisation by divesting or screening high emitting assets, this alone may not meaningfully contribute to real economic decarbonisation. Further, it is achievable to optimise portfolios for reduced carbon exposure - 20% to 45% less carbon intensive than benchmark- whilst preserving risk return characteristics as a cheer win for being on track for targets. These are largely emissions based re-weightings that penalise companies with high emissions profile and can effectively contribute towards portfolio decarbonisation. However, solving for real economic decarbonisation and an orderly transition through managed diversified portfolios, requires a carefully designed approach that is capable of looking beyond simply reducing emissions quantitatively to hit net zero targets.

We work closely with our investment managers to constructively challenge and explore climate risk management strategies and new opportunities. We are open to looking closely at examples where high emitting companies of today can also have a strong case for investment looking out into future through climate lens, when qualitatively reviewing their transition readiness. 

Fossil fuels are often likened to tobacco until we understand that many fossil fuel intensive companies are in fact capable of changing spots, bringing about real economic decarbonisation as well portfolio decarbonisation. Asset owners play a privileged role in the investment value chain to effect influence that can be meaningful for real economy decarbonisation through tools such as advocacy, engagement and voting. 

We spend a lot of time sitting down with management to understand such asset-specific decarbonisation pathways. Complicated carbon calculations are only possible through engagement with managers and company boards. We harness this information to help our clients with their investment decisions.

Learning from the past

All climate labels are not sustainable, they also need to go through the same ESG due diligence. For instance, windfarms are great for decarbonisation, but care must also be taken not to impinge on the flightpath of migrating birds that are critical to the surrounding ecosystem. We must avoid creating a second problem while solving the first. Climate analysis should evolve to systematically include biodiversity factors as well as the social impacts of physical and transition risks.

We should also learn lessons from past ecological disasters. For example, the 2015 rupture of the Fundao tailings (iron ore mining waste) dam in a town in Brazil, which killed 19 people, polluted rivers and harmed agriculture. Carbon sequestration and storage are new climate solutions that we need to ensure for safety from leakage before fresh disasters unfold.

If we achieve Paris alignment, we have a better chance to protect portfolios and help to achieve better risk-adjusted returns. Asset owners can lead the ripple effect on asking the right questions along their investment value chain that’ll progress real economic decarbonisation.  Rather than just focusing on numbers and targets around net-zero, it is time to walk the talk if investors want to drive real change. 

Komal Jalan
Komal Jalan
Sustainable Investment Manager

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