As global climate change continues to pose a significant threat, many asset owners are shifting towards adopting net-zero investment objectives as a strategic approach to mitigate climate change risks. A net-zero investment objective aims to achieve a balanced portfolio with zero greenhouse gas (GHG) emissions by 2050. This aligns with the global goal outlined in the Paris Agreement to achieve zero real-world GHG emissions growth.
- Strategies for Net-Zero Investment Objectives:
- Reducing Portfolio Emissions: Asset owners are focusing on reducing portfolio emissions to minimize transition risks associated with climate change.
- Investing in Climate Change Solutions: Investing in climate change solutions presents opportunities to capitalize on macro trends and drive positive change.
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Engagement and Advocacy: Engaging with companies and advocating for sustainable practices are essential methods to reduce systemic risks associated with climate change.
Challenges Faced by Asset Owners:
The integration of a net-zero objective into a traditional investment program poses challenges for asset owners:
- Balancing Fiduciary Duties: Asset owners must balance their fiduciary responsibilities with the net-zero objective.
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Climate Risk Policy: Setting clear climate risk policies and benchmarking net-zero investment strategies are critical considerations.
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Benchmarking and Incentives: Determining suitable benchmarks, incentivizing managers, and establishing performance horizons are key challenges faced by asset owners.
A well-executed net-zero investment program should enhance an asset owner’s risk, return, and actuarial objectives, without compromising fiduciary duties. Climate risk should be carefully considered while aligning with financial risk and return objectives.
- Addressing Climate Risk Policy:
- Traditional risk metrics like tracking error and volatility may not capture climate change risk adequately.
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Portfolio climate change risk is multi-faceted, including transition risks, physical risks, and systemic risks.
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Transition risk factors, such as company emissions reduction targets, play a crucial role in managing climate risk.
- Utilizing Benchmarks:
- Decarbonizing benchmarks like Paris-Aligned Benchmarks (PAB) and Carbon Transition Benchmarks (CTB) provide valuable metrics for net-zero investing.
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Asset owners may leverage scorecards to measure financial performance and net-zero objectives effectively.
- Establishing Incentives:
Asset managers need suitable incentives to align with net-zero objectives:
- Asset owners can structure compensation systems to motivate managers to achieve net-zero targets.
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Emerging net-zero incentive compensation structures are expected to evolve as the industry progresses.
- Time Horizons for Net-Zero:
Achieving net-zero targets necessitates setting short- and intermediate-term goals:
- Interim targets with five-year time horizons offer better engagement opportunities and emissions reduction strategies.
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Setting diverse target dates allows for a flexible approach in achieving net-zero objectives.
In Conclusion:
As the globe undergoes significant climate transformations, the future of net-zero investing appears promising. The industry is witnessing a shift towards sustainable practices and innovative investment strategies to combat climate change risks. With evolving tools and improved skills in climate risk management, net-zero investing is poised to grow further and contribute towards a more sustainable future.
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