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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Kylie Porter

The United Nations-affiliated Global Compact Network Australia has urged CEOs to become more outspoken on issues such as climate change, or risk reputational damage to their business and long-term decline in revenue.

“The time for quiet is over,” according to the GCNA’s 2020 Pressures Report. “Leaders who speak up, who authentically match words with action and drive societal change will reap the benefits.”

“Authentic public action will raise a leader’s visibility, reinforce social licence to operate and demonstrate action beyond business as usual,” the report says.

Conversely, business leaders who remain quiet will find themselves “outcompeted by purpose driven leaders and companies.”

“Their silence will likely lead to reputation damage, loss of customers and long term decline in revenue.” The report says Australian business leaders could learn from those who had already spoken out such as BHP’s former CEO Andrew McKenzie, who publicly described climate change as “an escalation towards a crisis”.

Those leading the charge internationally included Starbucks CEO Andrew Johnson who closed all of the company’s stores to conduct racial bias training in order to tackle systemic racism. GCNA executive director Kylie Porter said that while pressure on CEO’s to take a public stance on social and environmental issues had been mounting, the impetus was growing due to increasing public awareness and activism.

“There is a real opportunity for businesses to tap into the public groundswell and take the lead where governments have fallen short,” she said.

“Shareholders, consumers and employees want to trust the organisations they engage with and they expect their leaders to have views on issues such as climate and human rights and be prepared to voice those views publicly.”

Climate change and its impact on human rights heads the GCNA’s list of key pressures facing Australian business.

Other key pressures facing corporate leaders are:

• Compliance with the Commonwealth Modern Slavery Act with businesses being judged on how they are responding to the risks of modern slavery and human trafficking in their supply chain.
• Effective water governance and management to ensure “mature stewardship of vital water resources.
• Adequately managing the risks associated with the transition to a net zero carbon economy by 2050.
• The need to rebuild trust through effective communication, particularly with influential Generation Z, estimated to account for 40% of global consumers by the end of 2020.

“Businesses no longer have the luxury of time,” the report says. “They must step away from a business as usual approach and reposition themselves as more responsible and sustainably savvy.”

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Joshua Kendall

A record $234bn in green bond issuance was added to the market in 2019, an increase of more than 50% on the $150bn issued in 2018. While issuance in 2018 and 2017 was relatively flat, 2019 saw a significant jump up in issuers joining the market, when compared to previous years. This watershed moment marks a turning point in the depth of opportunities available to investors, according to Insight Investment, a leading asset manager.

The core sectors for these instruments – financials, governments, utilities, energy and industrials – all experienced significant growth in issuance with financials leading the charge, adding more than $78bn in green bonds over the course of the year. Diversity improved with the telecommunication sector now part of the market. The Netherlands issued its inaugural green bond in 2019 and Germany said it intends to issue a green bond later in 2020.

Josh Kendall, senior ESG analyst at Insight Investment, said: “Green bond issuance in 2019 reached record levels, deepening the universe to more than $747bn. This strong momentum in support of climate transition indicates a turning point for investors.  We expect 2020 to be another record year for green bonds with early indications suggesting a total close to $300bn in issuance.”

Bruce Murphy, Insight Investment Director of Australia and New Zealand, said: “We hope to see increased issuance of green bonds from Australian corporates in 2020. Its issuance last year remained largely level with 2018 ($4.5bn in 2019 vs $4.3bn in 2018), which suggests issuers may be missing out on the swell of demand from a global investment community actively seeking diverse and impactful opportunities. A deeper investable universe will help speed the transition to a low carbon economy and hopefully create jobs and boost productivity along the way.”

>Social and sustainable impact bonds issuance increased, adding $35bn in 2019, which, together with green bonds, brought total issuance of impact instruments over the year to almost $300bn ($299.8bn). The market also saw the evolution of new types of impact instruments, for example Enel’s transition bond, which may present a model for further issuance from petroleum companies in 2020.

Kendall said: “The overall growth in impact instruments is encouraging but in too many instances we are finding that the targets set out by issuers lack conviction and ambition. We want to see far more attention paid to the quality of the underlying propositions. Insight has awarded ‘green flag’ status to only 27% of the more than 120 impact bonds we have reviewed. This is because the market still struggles with transparency reporting and a clear demonstration of positive impact.”

Insight Investment manages A$30 billion for Australian investors and A$1.2 trillion globally^[1].

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[1] Figures shown in USD. All data sourced from Bloomberg.

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Sylvia van Waveren

A partnership between companies and investors is essential if climate change targets are to be met. And investors must themselves band together through collaborative initiatives if real progress in decarbonizing the energy sector is to be made.

That’s the message from engagement specialist Sylvia van Waveren and Head of Active Ownership Carola van Lamoen ahead of the annual World Economic Forum, at which the issue of tackling emissions has top billing.

The main topic to be discussed at Davos on 21 January is “How to address the urgent climate and environmental challenges that are harming our ecology and economy.”

Becoming carbon neutral

Making the world carbon neutral by 2050 is seen as essential to meet the goals of the Paris Agreement, which seeks to limit global warming to 2 degrees Celsius or less above pre-industrial levels by the second half of this century.

Much of the focus has been on reducing the carbon emissions by oil and gas companies in the transition from fossil fuels towards renewable, net zero carbon energy.

Three-year engagement

Robeco had a three-year engagement program with eleven listed oil and gas companies that ended in 2019. Engagement was conducted with six international and five national oil and gas companies which combined account for one quarter of global oil and one fifth of gas supply.

“Looking back on three years of engagement, our work with the oil and gas companies have in general led to successful outcomes,” says Van Waveren, who covers the global energy industry in Robeco’s Active Ownership team.

“Of the 11 companies within the peer group, we have been able to close seven successfully, based on their progress on the underlying objectives set at the beginning of the engagement. That’s a success rate of 64%.”

Stunning success with Shell

The engagement formed part of collaborative work with the Climate Action 100+ initiative, a grouping of more than 370 investors with more than USD 41 trillion in assets collectively under management. Launched in December 2017, the initiative has identified more than the 100 companies that emit the most carbon, including the biggest names in the oil and gas sector.

It achieved a stunning success in December 2018 when Shell agreed to set short-term targets for the carbon emissions, including those of the used products, and said it will link executive pay to meeting these objectives for the first time. The Shell engagement was co-led by Robeco and the Church of England Pensions Board.

“The Shell example shows how important it is to form partnerships, both with the companies that need to lower their carbon footprints, and with other investors,” says Carola van Lamoen, Head of the Robeco Active Ownership team.

“Initiatives like the Climate Action 100+ have laid the foundations for the unprecedented partnerships that are needed going forward in high-emitting sectors such as aviation, automobiles, shipping, energy and steel.”

Public/private partnerships

The Davos summit is itself a public/private partnership at which the world’s largest corporations meet in the Swiss ski resort every January to discuss global issues. This year the main topics under discussion by business leaders are sustainability, the ‘fourth industrial revolution’ and the demographic and social trends reshaping entrepreneurship.

Van Waveren says investors can build on the collaborative successes of 2019, at which three major moves forward were seen. “The first and most important was the firm establishment of the umbrella-style partnership model to drive ambitious change, as seen with what Climate Action 100+ achieved working collectively,” she says.

“The second was the concept of aligning companies’ business models with the Paris Agreement, helped by organizations such as the Transition Pathway Initiative, which looks at carbon emissions. Thirdly, attention has been – very logically – shifting away from energy supply and towards energy demand, since many decarbonization solutions lie with the use of the energy products by consumers. One example is the high carbon industries such as transport.”

More ambition needed

In 2020, investors and companies can build on this success, Van Waveren says. “While 2019 marked a watershed in terms of emerging practice and in terms of changing investors’ attitudes and views, we do not yet have the level of ambition needed if we are to succeed,” she says.

“This is why 2020 has to be the time a new partnership is formed between the company board room and institutional investors. This should be a partnership that is based upon systemic change and practical outcome that can work across the full value chain and across all asset classes, to develop net-zero carbon paths for aviation, autos, shipping, steel and cement, to name but a few.”

Van Waveren says that at a governmental level, Nationally Determined Contributions – the emissions that countries are committed to mitigate under the Paris Agreement – will rise up the agenda. Many governments including Robeco’s home nation of the Netherlands are already setting targets. Some companies are also formulating their own Determined Contributions to similarly try to become Net Zero Carbon– the new buzz phrase in sustainable investing – by 2050.

By Sylvia van Waveren and Carola van Lamoen

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Nicolette Rubinsztein

Within the lifetime of Australia’s millennials, the occurrence of heatwaves will triple and they will be longer leading to increased deaths among the nation’s elderly, an Actuaries Institute Dialogue paper on the widespread impacts of climate change has found.

The paper states that heatwaves, which have killed more Australians than any other natural hazard, will at least triple by 2060-2080. More frequent, longer and hotter days will drive a significant increase in mortality, with Australia’s ageing population amplifying the number of people who will die as a result of climate change.

*The Dialogue paper, The Impact of Climate Change on Mortality and Retirement Incomes in Australia, has been written by Ramona Meyricke and Rafal Chomik. Dr Meyricke is a Senior Actuary and Associate Investigator, and Mr Chomik is a Senior Fellow, at the Centre for Excellence in Population Ageing Research at the University of NSW.

“Understanding the potentially significant implications of climate change is crucial to Australians’ wellbeing,” said Actuaries Institute President Nicolette Rubinsztein. “Many Australians understand the physical risks posed by climate change but few appreciate the impacts it could have on their mortality risks and their retirement savings.”

The Dialogue examines how climate change will affect Australians in broad ways including the impact on economic growth, health and mortality, government spending and investment returns. It says there are consequences for individuals and businesses including health, general and life insurers, pension providers, investors, and emergency services and governments. The Dialogue represents the views of the authors and builds on significant work done by the Actuaries Institute on climate change and its impacts, including the launch of the Australian Actuaries Climate Index.

It states that climate change and ageing populations are key global megatrends of the 21st century, interacting to create “a perfect storm”.

“Without proper risk management, these megatrends have the potential to overwhelm individuals, private companies and government balance sheets over the course of this century,” the authors state.

“In terms of public policy, the wide-ranging consequences of climate change on mortality, public health and the economy mean that system-wide policy responses are necessary to mitigate the risks posed.”

Heatwaves have killed more Australians than bushfires, cyclones, earthquakes, floods and severe storms combined and are the main threat to Australians’ mortality from climate change. The heatwave in Victoria in 2009 is estimated to have caused 374 more deaths than otherwise would have been expected. Mortality arising from future heatwaves could increase by 12% among over 65s by 2060-2080 in some regions.

The forecast is even more significant given predictions about Australia’s ageing population. Australian Bureau of Statistics figures project that by 2050 the population of over 65s and over 85s will nearly double and triple respectively.

“Population ageing will amplify the burden of heat related mortality and health risks in a warming climate; an interaction that policymakers and insurers have not yet fully taken into account,” the report states.

The potential impact of climate change on people’s lives could also extend to lower superannuation contributions and investment returns. Increased periods of under- or unemployment, driven by economies around the world transitioning to net zero emissions and/or a higher frequency of natural disasters, could lead to lower superannuation contributions. In addition, climate change has negative long-term return implications for investors who are not diversified at a total portfolio level to climate change, which could lead to lower superannuation balances. Illustrative scenario modelling suggests that an individual earning around $75,000 pa could retire with 11% to 18% less, or a superannuation balance of $40,000 to $70,000 less, because of lower contributions and/or lower investment returns.

The impact would be greater for those who experience both reduced contributions and investment returns. The predictions have major implications for individuals, superannuation funds and pension providers, including the federal Government. Two material cost drivers for life insurance and pensions (annuities) are mortality and investment returns,” the paper states. “Climate change is expected to impact on both.”

There may be a greater reliance on the Age Pension if climate change seriously diminishes superannuation balances, and a higher cost of provisioning for future Age Pension liabilities if investment returns are lower.

The present value of extra Age Pension expenditure on the median earner, if investment returns were 1% pa lower over that person’s life, is estimated to be around $30,000, the paper states. Failure to address climate change has been identified “as one of the largest socio-economic risks to modern society”. “There is mounting pressure on all financial institutions from investors and regulators to improve transparency and the disclosure of climate-related risk,” it says.

Key points:

• Heatwaves, which have killed more Australians than any other natural disaster, are expected to become more frequent and last longer.
• Deaths from heatwaves could rise by 12% among over 65-year-olds by 2060-2080 in some regions.
• Climate change may have negative long-term return implications for investors.
• For individuals, it may mean lower super balances; illustrative modelling suggests reductions of 11-18% for the median earner.

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Jonathan Bailey

Global investment manager Neuberger Berman has been shortlisted for ESG incorporation initiative of the year at the upcoming PRI awards for systematically analysing the potential investment implications of climate change across portfolios.

The firm was also awarded top scores across all categories in the latest United Nations-backed Principles for Responsible Investment (PRI) assessment report which measures Environmental, Social and Governance (ESG) integration efforts among 1,100 investment firms worldwide.

Neuberger Berman obtained the highest score, A+, for its overarching approach to ESG strategy and governance. It also earned an A+ for ESG integration across every asset class, and is rated above the peer median on every category.

Head of ESG Investing at Neuberger Berman, Jonathan Bailey, noted the firm’s top score and shortlisting reflects the firm’s overall approach to ESG across all investment practices.

“Both industry recognitions reflect the work of our analysts and portfolio managers in integrating our ESG philosophy and proprietary ESG ratings systems across asset classes,” said Mr Bailey.

As part of Neuberger Berman’s integrated ESG approach, portfolio managers analyse and review which securities are likely to financially benefit or suffer from changes in weather patterns, regulation or technology shifts.

By systematically analysing the potential investment implications of climate change across portfolios, the firm has developed a resource to enhance long-term value creation for clients.

For example, Neuberger Berman runs a range of climate change scenarios, including those aligned with a 2° Celsius and a 1.5° Celsius transition. The results allow the firm’s analysts to focus on engaging with companies and management teams who appear to be particularly at risk and provide bottom-up insights to further enhance understanding of climate risk.

“As the world transitions to a lower carbon economy, it is important for us to understand how best to position our portfolios to serve our clients’ objectives,” said Mr Bailey.

“No scenario will be perfectly accurate, but by systematically modelling climate-related risk and opportunity, our portfolio managers are better informed about how their portfolios are positioned. They can then choose how best to apply all the tools of active management, whether that is to engage or ultimately to sell a security when it no longer offers an attractive risk-adjusted potential return.”

In recent years, the employee-owned investment manager has made improvement in its score, most notably in Fixed Income (Corporate Non-Financial) and Private Equity. This year, the firm improved its score to A+ for its approach to Active Ownership in Listed Equity—a grade that only 13% of asset managers with >US$50b in AUM received.^[1]

Neuberger Berman was also shortlisted for ESG incorporation initiative of the year at the upcoming PRI awards. Winners will be announced on 10 September.

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Observations on the Responsible Investment Sector

While it was a fairly unremarkable year in terms of product development, there were a number of significant team movements impacting on the sector. ‘Offerings from AMP Capital, Australian Ethical and Challenger all experienced significant personnel change,’ said Steve Sweeney, Lonsec’s Senior Investment Analyst responsible for reviewing the sector.

The lack of new entrants highlights the Responsible Investment sector’s continuing adjustment to subdued post credit crunch appetite for equity products. “There are a few exceptions (e.g. emerging market funds) but generally this trend is consistent with product development across most equities categories as fund managers continue to consolidate product lines,” said Sweeney.

Sweeney also attributes the lack of new Responsible Investment product development in some part to the failure of last year’s UN Climate Change Summit in Copenhagen to produce a meaningful outcome on achieving global emission reduction targets.

“Responsible Investment proponents were hopeful that a positive agreement committing economies to material emissions reduction would significantly progress the climate change agenda boosting the sector with some positive regulatory developments for key industries and companies,” said Sweeney.

Despite the lack of product growth, Lonsec observed an increased integration of ESG (assessment of environment, social and governance practices) into the mainstream company research process.

Sweeney noted that this trend has not been exclusive to funds in the traditional ethical or SRI sector but across other sectors including Australian equities, global equities, Asian and emerging market funds.

Although this trend is blurring the lines between the Responsible Investment sector and mainstream equity funds, Sweeney commented that there still remains “considerable grounds of distinction between ethical and sustainable or ESG style funds, including philosophical approach, that are likely of material interest to investors in these funds”.

Lonsec noted that while the sector’s Australian equity peer universe is modest (7 funds) there has been a wide variance in performance for the past 12 months and that this highlights that it is not a ‘one size fits all’ investment approach.

‘It’s important to recognise the structure of these funds can have a significant performance impact either through restricting the investment universe (e.g. no exposure to resources) or introducing increased volatility compared to mainstream large cap Australian equity funds due to greater exposure to smaller companies” said Sweeney.

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