ENVIRONMENTAL INVESTING: Facing the challenge of climate change

Funds Europe asked a range of asset owners and asset managers what they are doing, as responsible investors, to tackle the biggest risk facing the world right now.


How are you addressing climate change in your investment portfolio?
We have about 2,800 companies in all countries and in all sectors. Our view on ESG is from the universal owner perspective and we basically do two things: we are active owners in every way we can, so we do everything from voting to shareholder resolutions to engagement to blacklisting and also securities litigation. All of these with a purpose to have an impact on company behaviour, so we want them to change in a more sustainable direction.

The governance, the active ownership, that is one part, and the other part is impact investing. In our view, we have this in all our asset classes, so we have a cleantech portfolio within private equities, we have green bonds within our fixed income and now we also have, within listed companies, a mandate divided in two parts.

One is related to SDG [Sustainable Development Goal] 6: clean fresh water and sanitation. The other is towards SDG 13: climate; but also some environmental things. To give it a simple definition, we invest in companies that are contributing solutions to sustainability problems and preferably within climate. So basically, companies that solve climate issues.


How are you addressing climate change in your investment portfolio?
The Legal & General appointment [in April 2018, Brunel Pension Partnership announced it had awarded a £4 billion (4.5 billion) passive equity mandate to Legal & General Investment Management] includes an allocation for low-carbon-tilted index mandates. Both Avon Pension Fund and Environment Agency Pension Fund already had allocations in this space and we have provided the opportunity for other clients to use this option as part of their own strategy in the future.

In active equities there will be a sustainable equity sleeve that is likely to include specific low-carbon investment opportunities. In private markets we are seeing exciting opportunities in low-carbon investments, particularly in infrastructure.

Our approach is to be 100% climate-aware, so the first step is to understand the carbon emissions and fossil fuel exposure in listed equities and bonds. The data is improving all the time and this is a very useful process to raise awareness of some supply chain-related risks. The next step is to evaluate, more qualitatively at present, physical and adaption risks. We are hoping to develop more quantitative measures going forward. Physical and adaption risks from climate change are very pertinent within our private markets space.

So it is just coming up with mechanisms to evaluate that. We will be looking for things like GRESB [the Global Real Estate Sustainability Benchmark] within our real estate portfolio and also the GRESB infrastructure to help us manage and report on some of those issues within those sectors and then factoring them into the due diligence and ongoing fund monitoring. We also look to see where we can apply this expertise to manager appointments elsewhere within private markets.

But we expect it to be 100% climate and carbon-aware. So everybody will know the level of risk (and opportunities). It does not mean to say that we can realistically remove the risks out of all the mandates, but it is about risk and reward, and asking: is the risk appropriate? Are you being rewarded for those risks?


How are you addressing climate change in your investment portfolio?
Since 2012, we have invested in different strategies to lower climate risk of the portfolio. We have two focus areas: one is on climate and environment and the other one is corporate governance.

We view climate risk as a material risk to the fund and we try to reduce the exposure to it while at the same time having a broad, globally diversified portfolio of equities.

We have three ways of reducing climate risk currently in the global equities portfolio. One is that we have decarbonisation strategies, where we tilt the portfolio in each sector where companies that have a large carbon footprint will be down-weighted relative to the ones that have a lower carbon footprint when we measure it in relation to sales and in relation to fossil reserves.

The second thing is something we did quite recently across the portfolio. We exclude investments in coal companies – those where 20% or more of the turnover is based on thermal coal.

Thirdly, we have a fairly large home bias and the Swedish equity portfolio is less carbon-intensive than a broad global index portfolio, so these three all contribute to a lower footprint.

Our footprint is roughly a little bit north of 50% in relation to a broad global equity index.

What action would you like to see from an institutional investor’s perspective?
Apart from actually adjusting our portfolios we also engage with companies, we vote on specific initiatives at annual general meetings and we also cooperate with other investors to sponsor more transparent reporting.

Investors can do a lot but it will very much be dependent on politicians to set policies that will promote or incentivise a transition. We would like to see a global carbon tax and when that has material financial implications, the investment community will act much more rapidly than we do today.

It very much has to do with the fact that we have to decrease the carbon emissions and you need a pricing mechanism for that that will be applied internationally.


Can you give a practical example of how a major global investor can play a key role in addressing climate change?
We announced a while ago that we would have a climate impact pledge. So we pieced 84 of the largest companies in the world [together], we own them and we are big investors in them.

Those 84 are in the sectors that we think are more exposed to climate change, and then we said we will meet and rank them with public information.

We understand oil and gas companies are oil and gas companies, but you can be a company that is looking to transition to a low-carbon economy, or one that says: “I’m not sure I even believe in climate change.” And that is how we try to rank them – with lots of things including governance and diversity. We spent a year speaking to these companies, reading their reports, listening to other investors, and we ranked them.

When we announced the results, we also said who was doing a great job on climate in those sectors – because you can still do a good job. We also announced at the back of the report some of the eight companies that we thought were doing the worst job out of the 84, and we named them. We publicly named those laggards and that has caused quite a lot of publicity and has helped bring this debate mainstream. It is not the sort of thing that LGIM does very often, and I thought it was that important on climate change that we did that.

Of those eight companies, you can say: “What does that mean, just naming them?” Well, we are going to vote against them – the chairman, a named director, on those eight companies in every single stock that we own in this firm, not just on the climate change funds because we think this is a material issue for all our clients.

There are some clients who say: “I want to go further, I want to have funds that don’t own stocks like that.” We have a range of Future World Funds where our clients have chosen for us to rank and divest those eight companies. So we have gone further where we can, but because this is mainstream, it is much more important that we name those companies both positively and negatively and vote against the chairman because we want them to change.

If we get the largest companies in the world to change, then we are more likely to get to keep within two degrees than if we did not, and I think that is where our role within this investment chain sits.


Can you give a practical example of how a major global investor can play a key role in addressing climate change?
We engage around 200 companies a year on E, S and G topics and you see that the environmental dialogue is very important and a lot of these dialogues centre around climate change and the challenges that companies face.

If I describe the engagement that we have related to climate change, of course we focus on the sectors with the highest carbon emissions, sectors where this is most relevant. That means that we have scope and engagement with the oil and gas sector, with the utilities sector, with the automotive industry and also with the real estate industry.

We are very active in the collaborative engagement programme Climate Action 100+. This was launched last year and it is really an initiative where 289 investors from 29 countries [with some $30 trillion in assets under management] have joined forces with the aim to really get into a dialogue with the biggest emitters worldwide.

The aim of that engagement is first to encourage companies to set carbon-reduction targets and do that in line with two degrees scenario planning, so to act in line with the Paris Agreement.

That is the first focus area, the second is board commitment to climate action – so, to what extent are boards really involved and committed, or is climate change something discussed by a department on the third floor?

The third objective is transparency – be transparent on your current emissions, on your targets and on the progress. Those are the focus areas for that Climate Action 100+.
In Climate Action 100+ there is a lot of collaboration with investors, many companies are targeted and for every company there is a lead investor, so we take the lead on several of those companies and having a joint dialogue is very helpful.

Engagement is not a one-off process: you do not approach a company, have a nice conversation and that’s it. Our engagement approach is very structured. We start with the research – what is the current status in the sector, what are the relevant objectives that we have to focus on and how are the companies that we will start engaging with doing it? Once we have those insights, then we start engaging.


What are some of the most effective ways to tackle climate change and what company engagement and data do you need?
The best way to reduce further climate change is by reducing energy use and also to switch to non-polluting energy consumption and generation, so that breaks the opportunities down firstly into energy efficiency and secondly into clean energy and particularly renewables.

We have been orienting our investments in those two directions, so in energy efficiency we are really looking at four areas: transportation energy efficiency, which is for example, the move to electric vehicles. We are looking at buildings, which would include efficient lighting and smart ways of insulating properties. We are looking at electronics and reducing electricity consumption in mobile phones and handheld devices; and finally, we are looking at the power grid and how you can reduce energy losses through distribution.

So that is energy efficiency; and then in renewable energy, it is the obvious ones of solar and wind power. We are investing to build new solar power stations and wind projects and we have also started to invest in the hydropower sector as well.

If you want to broaden the scope and look at some of the adaption questions or opportunities, then there is a huge opportunity in the water sector to build new infrastructure that is resilient and efficient for new populations, growing populations in developing countries.

There is also the opportunity to repair water infrastructure in Europe or North America which was built 150 years ago and is not working very well. And then there are plenty of opportunities to improve water quality through, for example, better filtration or better membrane-type technologies.

It very much has to do with the fact that we have to decrease the carbon emissions and you need a pricing mechanism for that that will be applied internationally.

©2018 funds europe



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