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A 3°C warming scenario will be dire for member outcomes
According to our new narrative-based scenario analysis detailed in now:pensions 2024 TCFD report, the economic consequences of a 3°C or higher warming scenario are likely to be dire and bad for our members’ investment portfolios. It is easy to paint a picture that a 3°C warmer world would impact global economic growth negatively and lead to higher inflation which consequently would be detrimental to the majority, if not all, of the asset classes we invest in today. We call this the systemic risk of climate change that cannot be diversified away as it affects all assets, in all regions and all sectors around the world.
A 1.5°C or 2°C scenario is likely to be much more favourable to members’ investment portfolios. It is why our Trustee board has decided it should aim to deliver results focused on three Rs: Return, Risk and the Responsible Investment of our investments – all of which should be achieved in tandem.
Does this mean investors should decarbonise as quickly as possible?
In our portfolio, we are currently on track to achieve net zero by 2050, and a 50% reduction by 2030 based on 2019 levels, which is consistent with the Paris Climate Agreement to limit temperature increases to 1.5°C. We’d like to see the world decarbonise even more quickly than this, but the reality is that global greenhouse gas emissions have yet to peak, let alone decrease in-line with the pathway we’ve set out.
We do not believe investors can help achieve this goal by indiscriminately disinvesting carbon intensive industries and companies. It might present an artificially positive picture of our progress, but it will not help the world decarbonise any faster, as there are plenty of other opportunistic investors with different objectives willing to buy the shares of companies we would have sold.
Instead, we want the companies we invest in to reduce their greenhouse gas emissions as quickly as possible and set themselves targets to do so. To have a real-world impact on limiting global warming, we prefer to stay invested and engage with those ‘high emitters’ of today, whom we believe can develop credible plans to achieve net zero by 2050.
How do we manage our equity assets to make a real-world difference?
Our new equity portfolio implemented at the start of 2024 is managed with an aim to achieve a return in line with a global market cap index (including emerging markets). This could be considered aligned to a passive index management approach but with an enhanced element – the enhanced element being with reference to the ability of companies to contribute to the net-zero transition.
All our investee companies are categorised with reference to their contribution to net-zero carbon transition by 2050. We automatically exclude companies with exposure to thermal coal, and oil sands as these are completely incompatible with the transition. Companies that are not adapting quickly enough, and have not responded to our engagement, may also be excluded. Those companies which have credible plans to adapt to the transition – even if they are carbon intense today – remain as holdings in our portfolio. As a result, we have excluded a substantial number of oil and gas energy companies but continue to own shares and engage with others where we think there is more potential for the transition.
Once the exclusions are established, the portfolio is reweighted so the sector, country and factor exposures align with the global market cap index and returns will be broadly in-line with it. Through this process, companies that make a positive contribution to the transition or are adapting to it will have an overweight allocation.
Because the assets in the portfolio are managed directly by our in-house investment manager, Cardano, they are then stewarded in-line with the Trustee’s key priorities which include climate change. We actively engage with companies about their plans to transition to net-zero in line with the Paris Agreement. As well as engaging with them, as share owners we of course vote on key resolutions relating to climate change. To increase the impact of engagement and voting, we collaborate with other investors with a similar mindset to drive change. If companies are not making sufficient progress, we may escalate our concerns by voting against management and directors or co-filing shareholder resolutions.
Conclusion
Investors have a massively important role to play in limiting the warming of the planet and therefore mitigating the impacts of climate change. In our view, exclusions should not be the first response – this presents a false picture of real-world progress. Investors should invest in a way that supports carbon intense companies’ transition to net-zero. Alongside government policy, investor engagement and voting to influence corporate behaviour is vital to support the transition. Only if a company is unable or unwilling to adapt to the transition should they be excluded.
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