How are you combining and informing your net-zero strategies?

Decarbonisation strategies differ across asset classes

• Real estate involves mapping refurbishment and whole-life carbon decisions and engaging with corporate tenants.

• Equities focus on the assessment transition process of each corporate and widespread engagement with company boards, while identifying opportunities in climate solutions.

• Debt markets support corporate transition plans and there is also strong growth in green bonds, which finance real-world decarbonisation.

Each strategy has its own strengths and weaknesses. Within equities and debt, asset owners might tilt the allocation towards green revenues and divest assets linked to coal, but exclusion alone has limitations. When exclusion is based on existing emissions data – that is, by looking in the rear-view mirror – companies that are transitioning rapidly can miss out on funding opportunities. Businesses often require large amounts of green-bond finance to transition, which can distort emissions data upwards in the short term, before falling.

Equally, if you do not hold a stake in a transitioning company, it reduces your influence in the real world, even though the threat of divestment can spur corporates into improving their transition plan.

“If you exclude something, someone else will buy it,” says Mark Thompson, an investment expert with roles at a number of major pension funds. “You want your asset manager to be engaging and pushing the management team to make the company more sustainable. If the company doesn’t play, exclude it – but that needs to happen at the end rather than at the beginning of the process.”

Missing information has unintended consequences

To agree on decarbonisation strategies, you need reliable and timely emissions and performance data. But that kind of data is not readily available.

LCP’s Claire Jones says there are two issues: variations in data availability across asset classes, and the need to rely on investment managers gathering information from investees. For listed equities and corporate bonds, the available data is relatively accessible. For other classes, information is scarce.

“The data is patchy enough in listed markets, but once you get on to private equity, private debt, infrastructure and property, it becomes even worse” says Jones.

In private markets, you can use machine learning tools to estimate scope 1 and 2 data, covering direct emissions, but there are wider gaps and unreliable estimates when it comes to scope 3 data (measures of a corporate’s upstream and downstream supply chain emissions).

This lack of visibility, as well as a tendency to rely too heavily on one metric, leads to unintended consequences. The lack of data about private market investments, for instance, means they are often identified as high climate-risk assets. An asset owner might therefore divest high emitters and not provide green finance needed to enable replacement of capital and a transition to a lower carbon future.

Carbon data is not everything

Focusing too much on current carbon-emissions data and footprinting – based on self-reported disclosures rather than absolute impact – can be counterproductive.

“If you look at a wind-turbine maker, you will see the manufacture, transportation and construction of the turbine in the carbon metric,” says Faith Ward, Chief Responsible Investment Officer at Brunel Pension Partnership. “It wouldn’t account for the turbine’s net positive, as part of a long-term transition story, and would make it look worse than it really is.”

It also means that so-called clean sectors such as banking and technology are included in a portfolio regardless of their ultimate real-world impact – because there is an assumption that they will not need to go through a decarbonisation process. “Their true carbon footprint is not evident,” says Ward. “Because it's just so difficult to get hold of.”

Meanwhile, carbon-heavy sectors such as electricity need significantly greater financing if they are to transition to net zero. The IEA’s recent ‘Net Zero by 2050’ report, for example, highlighted that annual investment in clean energy worldwide would need to more than triple by 2030 to around $4 trillion to support the transition to a low-carbon system.

There are limits to scoring systems

Simplify this data into a metric that reduces the nuances of an asset to a single score, and it can become even less useful.

“Emissions information should just be the start of the journey,” says Jones. “You have to ask about the short-, medium- and long-term targets, and about the management structures in place around that. It’s about qualitative disclosures, which are quite labour-intensive to provide, but which are supported by initiatives like the Climate Action 100+ and the Transition Pathway Initiative.”

Faith Ward recommends developing a balanced scorecard that combines several metrics to form a clearer picture of an asset’s real climate impact, determine how it can be decarbonised and analyse its carbon performance relative to the sector.

“If you distil everything to a backward-looking number, and if everything gets framed and focused on that footprint number in isolation, then it can create spurious data,” she says. “It only captures certain types of emissions, in certain places. There is a need for greater nuance.”

Will Nicoll, CIO of Private and Alternative Assets at M&G Investments, also warns about the “naivety” of many established scoring systems. “Some are based on a large number of ticked boxes, which a machine could do,” he says. “To make a judgement, you need a more holistic view of what the company is trying to do and whether it’s even going to exist in the future even if it’s attractive today.”

It is time for better data

So asset owners should strive to develop a qualitative picture of an asset’s carbon profile, without relying exclusively on scores.

Qualitative insight from a long-term engagement programme enables you to assess complex decarbonisation strategies, reinforcing transparency and highlighting real-world impact. The engagement process is time-consuming, so many will need asset managers to do the ‘legwork’.

Mark Thompson urges asset owners to become more demanding. “Climate change risk isn't going to wait for better data,” he says. “And the only way it gets better, is if asset owners put pressure on fund managers and the issuers of equity and debt to publish.”