Investors need to look for carbon ‘footpath’

From

Kathryn McDonald

Investors should move to a forward-looking view on a company’s commitment to future emissions reduction or its carbon footpath, according to AXA Investment Managers (AXA IM).

As concerns surrounding climate change continue to intensify, equity investors increasingly need to understand how this could impact their investment portfolios. Climate data makes clear the urgency to address carbon emissions, and investors must consider the obvious financial concerns related to future fundamentals.

AXA IM has found listed equity companies are globally responsible for an estimated 18 gigatonnes of direct emissions from owned or controlled sources[1] and would need to reduce their emissions by at least 30% from current levels – or almost 50% if revenue growth is accounted for – to meet the baseline scenario of a 2⁰C increase in global temperatures by 2030.

However, if considering the elimination of investments in top polluters based on current point-in-time emissions – or carbon footprint ­– investors need to take into consideration the impact on the diversification of their portfolio.  Hence AXA IM is advocating moving from carbon footprint to carbon footpath investment strategies.

“Many asset owners and investors are divesting from the largest polluters to reduce the carbon footprint of their portfolios. In practice, this approach, also known as ‘de-carbonisation’, has meant excluding investments in companies that exhibit high point-in-time emissions tied to company activity,” said Kathryn McDonald, Head of Sustainable Investing, AXA IM Rosenberg Equities.

“But a divestment-led approach can pose unintended problems for core equity investors in the form of increased active risk, and also means they have less leverage to use with respect to engagement with the goal of encouraging a transition towards greener and more sustainable products, technologies or activities.

“In addition, from a purely investment returns perspective, the divestment-led approach targeting point-in-time, absolute carbon intensities ignores the potential winners of a future low-carbon economy. It treats all polluters the same instead of seeking out those that are evolving.”

AXA IM believes investors need to take a holistic measure of a company using multiple data inputs.  For example, by analysing companies through the E score lens – a multi-dimensional view of a company’s environmental commitment – it is possible to identify the leaders and laggards within a sector in order to shed light on a company’s carbon ‘footpath’.

“Using our ‘E’ scores instead of carbon intensity to ‘de-carbonise’ a basket of stocks is just one way we can identify the companies that have done more to improve emissions by beginning to transition before others in their respective industries”, said Ms McDonald.

“We can, for example, find electric utilities that have shown a higher propensity to invest in renewable energy and storage solutions and divest from thermal coal.  In addition to E score, other data on company products and services, as well as transition behaviour is necessary in order to develop a full picture of ‘footpath’.

“Using this approach may not reduce portfolio point-in-time carbon intensity at the same rate, though the research did show a decrease.  But importantly, this ‘footpath’ approach means investors can manage investment risk by maintaining representation in all sectors and also potentially benefit from the upside of investing in the climate change leaders that are better able to navigate the rapidly tightening regulatory landscape.”

In January, Lonsec* upgraded the AXA IM Sustainable Equity Fund to “Highly Recommended” noting the Fund’s explicit inclusion of ESG considerations which it stated differentiates the Fund from similar factor-based quantitative peers. For the three years to December 2019, the Fund outperformed the MSCI ACWI ex-Australia index by 1.6% net of fees.

Ms McDonald added that, “As investors look to address the impact of climate change risk on their investment portfolios, it is important to note that aiming to reduce point-in-time carbon footprint through a divestment-led approach is an effective but blunt tool that may not be sophisticated enough for such a complex issue. Instead of leading with divestment, we need to incorporate several types of information to form a more holistic view of a company’s behaviour towards tackling the need to reduce global carbon emissions and protect the environment so that we can more concretely anticipate their pathway towards transition.”

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