Net zero is now one of the most popular portfolio aspirations for investors as they respond, either willingly or by regulation, to climate change.
But while it might be easy to sign up to net zero pledges, investors need to work hard to keep the promise, according to Emily Steinbarth, Russell Investments head of ESG research and development.
In a webinar for NZ clients last week, Steinbarth laid out a four-step program to take net zero from whoa to go for investors and asset owners.
Firstly, Steinbarth said net zero requires a firm commitment to the process at all levels of the organisation. Investors should develop a clear understanding of why they’re adopting net zero targets – expected higher returns or better risk management, for example – and the costs involved (governance, engagement, risk-return trade-offs etc).
“And then investors can leverage a target-setting framework,” she said, noting three possible models covering emissions at the portfolio- or sub-portfolio-levels, or other goals such as portfolio temperature rating.
Decisions at this stage may include which global pact to sign (there are several) or whether science-based targets would be more appropriate.
Turning theoretical models into practical portfolio management is, perhaps, the more difficult challenge and Steinbarth said investors probably have to make compromises.
For instance, scrubbing thermal coal from portfolios might seem an easy way to fast-track net zero goals but dogmatic exclusions need to be considered within the wider picture.
Steinbarth gave the example of a utilities company that earned 10 per cent of its revenue by burning coal and also 25 per cent from renewables.
Real portfolio decisions, she said, are nuanced while investors and asset owners also have to weigh up the “tolerance for nuance” among their clients.
Finally, net zero also implies a new monitoring and reporting responsibilities, which typically involves taking on more technology and data-based analysis.
Net zero, however, is just one element in the broader sustainable investment reporting process now lumped under the Taskforce on Climate-related Financial Disclosures (TCFD) regime.
TCFD has emerged as the global climate-reporting standard, forming the basis of new laws in several jurisdictions including NZ.
Steinbarth highlighted scenario analysis – a requirement to map various temperature-based climate outcomes against portfolio holdings – as a particularly complex part of TCFD reporting.
She said Russell had marshaled both internal and external analytical firepower to produce climate models to test portfolio robustness in the face of different global temperature changes.
“You have to interpret with caution but modeling can show how different sectors may be impacted by climate change,” Steinbarth said.
Somewhat counterintuitively, in the ‘hothouse’ scenario (or out-of-control temperature rises) current portfolio financial risks are lower than either an orderly, or disorderly, energy transition that would see costs imposed now to lessen any forecast planetary disaster.
World leaders are meeting in Egypt over November 6-18 to nut out the latest global policy response to climate change in the COP27 conference. COP27 is hosted this year in the Red Sea resort town of Sharm El-Sheikh, which is expected “to see nice weather all week”, according to the Egyptian Meteorological Authority.