Align goals Refine strategies Optimise decisions Escalate physical risk Key takeaways

Is your decision-making optimised?

Asset owners are still accountable to beneficiaries from a fiduciary perspective. So you need to model the impact that decarbonisation strategies will have on your returns, then factor this analysis into decision-making.

If you are investing in green bonds, would this mean accepting a yield discount for the assets?

What would switching to a climate-tilted equity benchmark mean for portfolio diversification?

How could decarbonisation strategies help identify or minimise the impact of climate risks on future returns?

Asset owners have a balance to strike – and communicate

Asset owners need to assess the trade-off between an investment’s impact on returns in the short term and its effectiveness as a decarbonisation measure in the long term. And you need to be able to explain this decision to your beneficiaries.

“If we've taken a strategic decision to take a long-term underweight to the energy sector, considering the impact of fossil fuels, potentially, there will be times when we will underperform,” says Brunel’s Faith Ward. “The important thing is being able to explain the underperformance. If we can attribute and demonstrate that we didn't hold X, because its long-term climate impact, that's an acceptable underperformance if your stated objective is to invest in a climate aware way.”

LCP’s Claire Jones argues that analysis of performance impact should be at the underlying asset level.

“I think some of the modelling we're doing around climate change is causing clients to think twice about how long they want to retain exposure to higher risk assets,” she says. “But I also think that the conversation, when we invest in a growth asset class, is going to increasingly be about how we mitigate the risks within it, rather than choosing a different asset class altogether. Within real assets, it could be focusing on low-carbon infrastructure rather than ordinary general infrastructure.”

"I think some of the modelling we're doing around climate change is causing clients to think twice about how long they want to retain exposure to higher risk assets”

Claire Jones

Partner and Head of Responsible Investment, LCP

Asset owners have a balance to strike – and communicate

Asset owners need to assess the trade-off between an investment’s impact on returns in the short term and its effectiveness as a decarbonisation measure in the long term. And you need to be able to explain this decision to your beneficiaries.

“If we've taken a strategic decision to take a long-term underweight to the energy sector, considering the impact of fossil fuels, potentially, there will be times when we will underperform,” says Brunel’s Faith Ward. “The important thing is being able to explain the underperformance. If we can attribute and demonstrate that we didn't hold X, because its long-term climate impact, that's an acceptable underperformance if your stated objective is to invest in a climate aware way.”

LCP’s Claire Jones argues that analysis of performance impact should be at the underlying asset level.

“I think some of the modelling we're doing around climate change is causing clients to think twice about how long they want to retain exposure to higher risk assets,” she says. “But I also think that the conversation, when we invest in a growth asset class, is going to increasingly be about how we mitigate the risks within it, rather than choosing a different asset class altogether. Within real assets, it could be focusing on low-carbon infrastructure rather than ordinary general infrastructure.”

"I think some of the modelling we're doing around climate change is causing clients to think twice about how long they want to retain exposure to higher risk assets”

Claire Jones

Partner and Head of Responsible Investment, LCP

There is progress on frameworks

Asset owners now have more resources to draw on, such as the Task Force for Climate-related Financial Disclosures (TCFD), the UN Environment Programme Finance Initiative (UNEP FI) for financial services, the Institutional Investors Group on Climate Change's (IIGCC) Net Zero Investment Framework, and the Carbon Risk Real Estate Monitor (CRREM) for real estate.

Jones encourages her clients to use the IIGCC’s Paris Aligned Investment Initiative, which is geared towards asset owners and includes considerations at a strategy as well as a portfolio level, so it can be applied to most portfolios.

“The IIGCC framework has the advantage of being open access and credible,” Jones says. “A lot of work has gone into it, drawing on collaboration with some of the best people in the industry.”

And investment managers can help

To compensate for the lack of coverage across all asset classes, Jones suggests that asset owners rely on investment managers to implement the framework across assets in the portfolio. This can be as simple as engaging with investment managers about existing products, but it can also extend to the development of new products and solutions.

“If one of our clients wanted to invest in a buy-and-maintain credit fund, for example, but couldn’t find one that we thought was suitably climate aware, we would look to start a conversation with investment managers to see if there were appetite for them to launch something new,” she says.

Phil Cliff, Head of Climate at M&G, puts forward three key measures to get ahead:

Develop a thermal coal policy to distinguish between corporates aligning with 2030 and 2040 phasing-out timelines.

Evaluate your portfolio according to the Net Zero Investment Framework:

◦ Starting position and emissions exposure

◦ Forward-looking indicators of decarbonisation alignment

◦ Exposure to climate solutions

◦ Climate and net-zero engagement

Develop a climate scenario modelling roadmap to add perspective to risk and investment allocations.

With respect to real estate, Nina Reid at M&G Real Estate believes that asset owners should develop a sustainable development and refurbishment framework that sets out operational targets as well as embodied carbon targets.

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