How can investors support the transition to net zero?
Addressing greenhouse-gas emissions is an urgent and critical task and charities are coming under increasing pressure from stakeholders to play their part.
It can be tempting for investors to carry out portfolio decarbonisation – reducing the emissions of investments by investing only in companies with the lightest emissions at the expense of those with the heaviest. It could be argued that this has a limited impact on emissions in the real world. Greenhouse gases are still being emitted by these high-emitting companies whether they are in the portfolio or not.
An alternative approach focuses on real-world decarbonisation. The shift towards a greener world offers, we believe, two key opportunities in supporting companies benefiting from real-world decarbonisation. One is investing directly in companies offering the low-emissions solutions that will replace legacy technologies. These companies need capital to grow quickly. The other is investing in companies running legacy higher-emitting technologies but which have robust and credible plans to replace them and become greener themselves. We think this second group is critical; these are companies earnestly planning to be a part of the future green economy, not burying their heads in the sand and pretending the transition will not happen.
What are the benefits of real-world decarbonisation?
Achieving net zero via “real-world” decarbonisation means investing in the companies we believe are best placed to deliver the low-carbon transition, representing the growing part of the economy in providing solutions and turning high-emitting businesses into low-emitting ones. Real-world decarbonisation focuses on a company’s pathway of emissions, and the likelihood of it achieving reductions consistent with a 1.5-degree path to net zero by 2050.
We consider that companies with robust transition plans will be more resilient to transition risks because it is easier to accelerate your decarbonisation plans in response to energy-price volatility than to form plans on the hop.
Retaining investments in higher-emitting companies with robust transition plans also supports the just transition – the need to move and retrain the labour force to participate in the low-carbon economy. Companies within heavy-emitting sectors with robust approaches to the transition will necessarily be considering evolving their workforces.
In contrast to portfolio decarbonisation, this approach does not introduce unintended sectoral and regional biases, which would lead to the exclusion of large companies making energy-intensive products which enable future energy efficiency, like batteries.
How can investors assess the robustness of companies’ emission-reduction plans?
Assessing whether companies are mobilising their businesses well to reduce their emissions is like assessing whether someone is keeping a new year’s resolution. It is one thing to make the promise, but have they actually considered what needs to be done in detail?
Are they monitoring their own performance? Are they sharing that with others who can help?
We have developed a clear and consistent methodology to identify companies with what we believe to be robust climate transition plans. It enables the portfolio manager of net-zero aligned mandates to identify and invest in companies that have set and are implementing good plans to decarbonise their operations (Scope 1 and 2 emissions) in line with net zero, and where Scope 3 emissions are a material part of their climate impact, setting out plans for those too.
A proprietary quantitative-based score evaluates the quality of companies on net zero by assessing three crucial elements:
- The strength of a company’s emissions targets – are they externally validated by the Science-Based Targets initiative (SBTi)?
- The historic company performance relative to its targets – is there evidence the company has followed its plans?
- The alignment of a company’s products and governance to net-zero targets – is there evidence the company is organised to achieve its targets?
We will continue to evolve our methodology to ensure it becomes more granular over time as data improves.
How can charities align their portfolios to net zero?
According to the 2023 Newton Charity Investment Survey, almost half of charities have committed to a net-zero target, so trustees may be exploring how these targets can be achieved in practice. We have been through a phase where net zero-committed asset owners have had little choice but to go down the route of portfolio decarbonisation. We think the additional volatility from portfolio decarbonisation may have put charities off committing to net zero in their investments, but better reporting and clarity from companies across many sectors is making real-world decarbonisation a plausible alternative.
Seeing net-zero alignment as meaning only investing in those companies which are assessed to have robust transition plans improves the chances that emissions reductions can be organic outcomes of the investment process rather than requiring ongoing divestment of higher-intensity industries. Investments are eligible across sectors and the number is increasing all the time as more companies improve their transition plans.
Above all of this is the reminder that achieving net zero is the responsibility of everyone. Governments, society and companies all have to follow through on their commitments to stop increasing global greenhousegas concentrations in the atmosphere. No individual actor can achieve net zero alone, but aligning portfolios to net zero is a critical step to reducing the physical risks from climate change to our portfolios, and our world.
Alison El-Araby is a portfolio manager at Newton Investment Management
Fast facts
Newton has a long and proud history of investing on behalf of charities through the management of both pooled funds and bespoke portfolios
Our investment research platform is our key differentiator. We harness both fundamental and quantitative analysis, which includes responsible investment and thematic research
Our focus on performance and service has helped us become one of the UK’s leading charity investment managers
What we do
Our purpose at Newton is to unlock investment opportunity so that our charity clients achieve their goals in the vibrant world we all want to see. We seek to deliver strong outcomes to our charity clients by taking an active, multidimensional and engaged investment approach. It’s a future-facing approach – designed to manage the realities of today’s fast-evolving investment landscape, and to resist outdated assumptions. We manage a range of strategies for charities, including charity-focused pooled funds, sustainable strategies, and segregated portfolios. We work closely with clients to create strong long-term partnerships that build the foundation for success over many years.
