This is the final blog in a series examining the steps portfolio managers need to take to reach the goal of net zero carbon dioxide emissions in their investment strategies by 2050. Previous blogs defined net zero, looked at the creation of a carbon footprint, optimized a portfolio to make it carbon sensitive, and took further steps to improve optimization by selecting companies that are on track to meet the goals of the Paris Agreement. We wrap up the series by looking at the need for corporations to adopt science-based targets and be more transparent about their ESG strategies to be on the radar screens of investment firms.
In our first blog, we mentioned several investment industry organizations that are committed to transitioning their portfolios to net zero greenhouse gas (GHG) emissions by 2050. This included the UN-convened Net-Zero Asset Owner Alliance, launched in September 2019, and the Net Zero Asset Managers initiative, launched in December 2020. In the short time since we published that blog, support for these two organizations has grown tremendously. The Net Zero Asset Managers initiative alone now has a total 87 global signatories, representing $37 trillion in assets under management.1 The breadth of signatories shows the market’s strong commitment to achieving a sustainable future.
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To meet the growing demand of portfolio managers for carbon-sensitive strategies, our blog series highlighted a number of datasets and approaches that can be used to zero in on companies that are lower carbon producers. We started by creating a carbon footprint for the S&P Global 1200 and then used a mean variance-based optimizer, where Scope 1+2 carbon emissions were used as an optimization constraint, to lower the overall carbon emissions of the portfolio by under/overweighting high/low Scope 1+2 carbon companies. This was done while still maintaining the sector, country, risk, and return characteristics of the underlying index.
We then went further by using additional data to diversify the portfolio even more by selecting companies that are on track to meet the goals of the Paris Agreement over the next five years based on the Trucost Paris Alignment dataset. This represented an additional reduction of 8.2% in 2025 from the initial carbon-sensitive portfolio we created, and a total reduction of 19.8% from the original S&P Global 1200. Since data is updated annually, we will continue to produce rolling five-year forecasts.
The Demand for Disclosure
Asset management firms continue to be pressured by investors, consumers, and regulators to develop and manage appropriate ESG strategies. They are looking to dig deeper on a range of ESG factors that are expected to have an impact on a company’s growth, profitability, capital efficiency, and risk exposure. Many are also taking steps to be well positioned for expected new regulations regarding ESG disclosure, and are looking for additional insights that can help support portfolio optimization and capital allocation towards companies with superior ESG performance. This has enormous implications for corporations around the world, especially as investors increasingly shift their money into ESG funds. Flows into sustainable investment funds in the U.S. in 2020 reached $51.1 billion, which was more than double 2019 levels and a nearly 10-fold increase from flows into ESG funds in 2018, according to Morningstar Inc.2 Establishing science-based targets and being more transparent about current carbon emissions and future plans is essential if corporations are to get the attention of portfolio managers.
Capital Markets Take the Lead on Change
The efficient market hypothesis says that new information coming into the market will immediately be reflected in stock prices. As more asset managers focus on net zero, companies that show both a commitment to lowering their GHG emissions and science-based targets on how to get there will be favored.
Fortunately, there are strong signs that change is taking place and that corporations are assessing their current ESG stance and developing strategies for improvement. Net zero and carbon neutral commitments are on the rise in 2021, as companies, financial institutions, and countries assert their alignment to global climate goals.3 In addition, the S&P Global Corporate Sustainability Assessment (CSA), an annual evaluation of companies’ sustainability practices first established in 1999, saw the strongest level of corporate participation in 2020 — up 19% from 2019, with 238 companies participating for the first time. Given its growing importance for asset managers, it seems that disclosure is becoming an essential component to attract investment.
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1 “Net Zero Asset Managers Initiative”, home page as of May 12, 2021, www.netzeroassetmanagers.org.
2 “ESG funds beat out S&P 500 in 1st year of COVID-19; how 1 fund shot to the top”, S&P Global Market Intelligence, April 6 2021, www.spglobal.com/marketintelligence/en/news-insights/latest-news-headlines/esg-funds-beat-out-s-p-500-in-1st-year-of-covid-19-how-1-fund-shot-to-the-top-63224550.
3 “Informing the journey to net zero and carbon neutrality”, S&P Global, as of May 12, 2021, www.spglobal.com/esg/insights/informing-the-journey-to-net-zero.