The investment case for a low-carbon portfolio

The transition to a low-carbon economy and society is one of the biggest challenges facing financial markets – but it also means investment opportunities. Our panellists discuss what the transition means for investors and how it is likely to impact business.

With greater momentum to tackle climate change building, there will be considerable changes to the global economy in the years ahead.

Decarbonisation of the global economy means there will be winners and losers emerging and, therefore, some interesting investment opportunities.

Whatever form it takes, decarbonisation will need to take an inclusive approach, said Faith Ward, chief responsible investment officer at the Brunel Pension Partnership and chair of the Institutional Investors Group on Climate Change (IIGCC). This will prevent anybody from being left behind in the transition to a low-carbon global economy and society.

“From a broader policy perspective, we need policymakers to be smart,” Ward said. “We’ve seen incidences and occurrences of not well-thought-through policy that has then had knock-backs. We won’t make this transition unless we make it socially inclusive and make sure we balance some of those impacts that are inevitably going to happen – in terms of increased costs – and get the right behaviours incentivised. And make less attractive behaviours that aren’t compatible with decarbonisation more expensive.”

Investors have a critical role to play in decarbonisation, said Ward, by engaging with carbon-emitting companies and help them lower their carbon output.

“We can’t make investment returns by exhausting the people or the planet on which we depend,” she added.

However, it will require a different way of thinking about investing, said Luke Greenwood, co-head of global fixed income at Invesco.

“As portfolio managers, we’re assessing businesses and we’re looking to see if they have prepared for the inevitable policy response to climate change,” he said. “Because if they’re not aligning or not prepared to change, then they pose a source of risk.”

Greenwood said a more traditional approach to decarbonisation, such as tilting a portfolio to lower carbon-emitting companies, would not necessarily help solve the problem.

“This kind of portfolio really does nothing to address what we’re trying to achieve in terms of climate change or reducing emissions because a low-carbon portfolio is based on current emissions and investing in companies that aren’t the problem,” he said.

“We’re trying to get over to these other corporates, to engage with them and get them on a pathway to help solve the broader problem that we all face.”

Additionally, a more exclusionary portfolio would starve some areas of the market of financing, disrupting economies and stalling the energy transition, Greenwood argued.

For investors to make informed decisions, they need accurate and relevant data. Jason Eis, executive director at Vivid Economics, said that while the quality of data disclosed by companies had improved over the years, it was still “incomplete”.

“There’s just no place you can go today to get a full and clear picture of all ESG factors in a comparable format, even just for listed companies,” he said.

Eis continued: “Parallel to that, there is also a question about what we know about how ESG risk is changing over time. So much of ESG analysis is in the past.

“We know that the fact that you might be exposed [to ESG risk] today isn’t necessarily a good indicator of how big that exposure might be tomorrow.”

Information such as Scope 3 emissions – indirect carbon emissions that come as a result of activities in a company’s value chain – is important for investors to make sure capital is allocated to those companies that are actively trying to reduce their carbon footprint.

Christopher Mellor, head of EMEA exchange-traded fund (ETF) equity and commodity product management at Invesco, said indexing strategies would play an increasingly important role in decarbonisation as more cash flows into thematic ETFs aimed at tackling climate change.

While there are more products to tackle climate change and high carbon emissions, it will be hard to design strategies that take a more scientific approach to decarbonisation without more sophisticated data.

“When we look at the ETF business and the flows, they do tell you something: there is very much a broad acceptance of the need to do something in a sustainable sense,” Mellor stated. “We are seeing an increased coalescence around the need to take more specific and explicit steps towards decarbonisation.”

The above article was drawn from ‘Designing investment solutions for a low carbon economy’ session at our ESG@Invesco digital client event on 17 June 2021. Please click here to watch the session.