Step by step: Reducing the carbon footprint of investments

Key Takeaways:
  • Accurate measurement of the carbon footprint of investments is vital for keeping pace with the global objective of +2°C.
  • Responsible investor Mirova teamed up with experts to develop an innovative methodology that calculates both induced and avoided emissions on a lifecycle basis, providing a roadmap for reorienting investments.
  • Passively managed funds won’t do – most indices represent an economy in step with a 4.5°C - 5.5°C climate scenario, indicating severe, adverse effects to come.
  • Climate-conscious active management can reduce long-term risk, encourage innovation and create further opportunities towards a transitioning economy.
Hervé Guez,

Global Head of Research and CIO of Equities & Fixed Income Mirova

Only climate-conscious, active management investment strategies are fit for a 2°C world.

The world is changing. Investors can no longer look to existing strategies and indexes – clearly representative of the “old” economy – to be sufficient during the current transition towards the “new”. This is especially true regarding environmental issues in light of the Paris Agreement, the recent UN Sustainable Development Goals becoming standard for investment strategy assessments, and increasing public and regulatory pressure.

Over the past year for instance, the French Article 173 has required investors to report on the non-financial impacts of their investments. The public, made up of none other than final investors, is becoming increasingly exigent in its calls for action to combat climate change. No matter whether rooted in a moral calling to protect the environment or a desire to avoid the risks associated with this economic transition, it is time for institutional investors to look at the ESG impacts of their investments.

The trajectory is clear. But, before setting a goalpost, it is important to assess the starting point; a robust and reliable carbon footprinting methodology serves as the basic tool for assessing and improving climate impact.

The art of interpreting carbon footprints

There are several methods for measuring carbon footprints of investments, but they generally do not consider a company’s entire business model. Some rely only on a company’s direct emissions and the emissions from its energy use. Others do not consider the benefits of products through measures like avoided emissions. Both are essential for understanding a company’s, and consequently a portfolio’s, climate impacts.

First, looking only at direct and energy use emissions does not take into account supply chain or use-phase emissions. Most of oil and gas extraction companies’ carbon footprint comes from the use of their products by the final consumer; this is not captured unless use-phase emissions are estimated. Though simple, this example illustrates by itself that an issuer’s direct emissions alone can inadequately depict its climate impacts, potentially misrepresenting the company’s risk exposure.

Then, consider a company that manufactures cosmetics and a company that manufactures wind turbines. Looking at direct and energy-use emissions alone, their carbon footprints are the same. But this is counterintuitive: doesn’t a turbine manufacturer contribute far more to the energy transition? For this reason, it is essential to also consider the emissions avoided by the companies’ activities relative to the regional energy mix. The turbine company’s avoided emissions will be far higher than the cosmetics company’s, demonstrating the far greater magnitude of its positive climate impacts.

As an investment manager, we believe that measuring the carbon footprints of our investments is a crucial issue. Unsatisfied with existing methods, we decided to team up with experts to develop an innovative methodology able to calculate both lifecycle and avoided emissions. This data is translated into a telling climate scenario indicator, which helps us to understand the relative impacts of our strategies and provides a roadmap for reorienting investments.

Following indexes: are we on the wrong track?

We believe that recognising the need to invest in a way compatible with the international consensus of limiting global warming to 2°C is the first step forward for investors. Understanding the various approaches to carbon accounting, looking at both climate opportunities and risks, the second. Then comes the most important step: acting on it.

Indexes still have a long way to go as far as climate issues are concerned. Most represent an economy on track to achieve a 4.5°C-5.5°C climate scenario, indicating severe, adverse effects. Sectors most exposed to climate change (energy, resources, buildings, and mobility) make up a substantial part of the major indexes, and large companies in these sectors have yet to sufficiently develop innovative solutions to compensate for their presence in and contributions to the fossil-fuel reliant economy. This reflects the richness of large industrial groups in the world economy, as well as the lack of risk capital for new companies. And, as a result, passively-managed funds that track traditional indices are in line with the “old” economy rather than seeking to balance it with the “new”, low-carbon economy.

Therefore, strategies relying on the major market indexes are not sufficient to mitigate the diverse risks associated with climate change. Passive management, which is nothing more than the choice to not choose, will not do it this time. But, there remain several potential paths for making investments more climate-friendly, namely carbon-conscious active management strategies that are not closely linked to indexes.

Next steps for investors

Active managers can allocate the capital at their disposal in ways that address the environmental, social, governance, regulatory, and repetitional risks ahead. If these strategies are well designed, they fuel themselves: seizing new investment opportunities generates better medium-term profits while mitigating climate change, which will in turn ensure better profits over the long-term. Not only does this carbon-conscious active management approach reduce long-term risk, but it encourages innovation, which can lead to even more opportunities related to the transitioning economy.

So, investors looking to reduce the climate impacts of their investments and perform over the long-term can seek out asset managers which have thoroughly assessed and begun to tackle the task at hand. Until carbon footprinting methodologies for creating low-carbon indexes are developed and applied, offerings mainly consist of actively-managed strategies that take carbon impacts into account, though methodological differences could lead to differing levels of impact. At Mirova, we have worked to decrease our strategies’ carbon impact, to line up with the 2°C objective, without hindering their performance. Today, our consolidated equity funds are compatible with a 1.5°C scenario, compared to 2.9°C two years ago. This was achieved by looking for investment opportunities beyond the obvious: not just renewable equipment manufacturers but throughout the entire value chain of renewable energy and energy efficiency solutions. And not just large companies present in indexes, but also mid-cap companies with sound business models proposing innovative solutions. Through this active, carbon-conscious management of both diversified and thematic strategies, Mirova has substantially reduced the climate profile of its investments – and thus its exposure to the associated risks – all with a view to generate sustainable, long-term performance.

The world is changing and so are we. Finance can and must play a role in transitioning to the “new” economy and staving off the worst effects of climate change by providing investment solutions designed to address the associated opportunities and risks. Step by step, investors’ carbon footprints can become lighter.

Published in September 2018

MIROVA
Affiliate of Natixis Investment Managers
Limited liability company
Share Capital: €8 322 490
Regulated by the Autorité des Marchés Financiers (AMF) under n° GP 02014.
RCS Paris n° 394 648 216
59 avenue Pierre Mendès France
www.mirova.com

Natixis Investment Managers
RCS Paris 453 952 681
Share Capital: €178 251 690
43 avenue Pierre Mendès France
75013 Paris
www.im.natixis.com

This communication is for information only and is intended for investment service providers or other Professional Clients. The analyses and opinions referenced herein represent the subjective views of the author as referenced unless stated otherwise and are subject to change. There can be no assurance that developments will transpire as may be forecasted in this material.

Copyright © 2018 Natixis Investment Managers S.A. – All rights reserved



Enhanced Beta Video

Ostrum AM is used his long standing expertise in managing fixed income products and developed his enhanced beta strategies which combines the advantages of the active management and the smart beta approach.

Emerging Equities

Ostrum AM focuses on stockpicking and avoids market “noise”.

Energy Transition

Renewable energy is one of the fastest growing segment within the infrastructure market

Blockchain

The Blockchain is on the verge of revolutionising asset management

What is natural capital?

VIDEO (3’19) – Gautier Quéru, Director of the Land Degradation Neutrality Fund Project at Mirova

Aviation Letter

Annual outlook of aircraft industry

2018 Market Outlook

Natixis Investment Managers’ affiliates share their thoughts on what might be on the horizon for investors in 2018.

Indices in Hot Water

The carbon footprint of the major equity indices exceeds the +2°C objective of the Paris Climate Agreement (COP 21).

US Municipal Bonds

Non-US investors could benefit from allocating to US municipal bonds

Finance and climate change

French institutional investors are bound by the Energy transition law to take action.

Aviation Letter

Annual outlook of aircraft industry

French Election

What does the outcome mean for global financial markets?

It’s Time for Real Assets

Private debt can be a lower-risk, higher-yielding alternative to traditional bonds

Real Estate Debt

An alternative to conventional fixed income investments

Green Bond Principles

Mirova discusses market standards and the lack of a regulatory body for Green Bonds

Real Estate Alchemy

Transforming non-core assets into prime property requires skill and resources

Referendum in Italy

Our expert’s insights into the 4th December's Italian referendum and its impact on financial markets.

Crisis Alpha

Managed futures may provide shelter from storms and diversified returns in calm markets

Active Share

How passive is your active manager?

Hop Aboard the U.S Growth Engine

Mid-market private companies have the potential to expand rapidly while avoiding high exposure to volatile public markets

2016 Global Retirement Index

4 key trends shaping the future of retirement security: access, incentives, engagement and economics.

Insurance Survey:

companies grapple with new regulatory constraints, capital rules and increased risks

Diversified Growth Funds

Seeking to respond to rapid shifts in markets while reducing risk.

Institutional Investors Outlook:

Institutional investors bullish on stocks, alternatives in 2016, wary of global political tensions