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How to select companies for net zero portfolios

The aim of the Paris Agreement, to limit global warming to 1.5 degrees Celsius, is now a well-established benchmark for companies. But up to 75% of companies are nowhere near achieving this goal1. This presents a fundamental problem for investors trying to deploy capital with a net-zero mind-set.

That’s why at Lombard Odier, we have developed a unique methodology where we not only align portfolios to temperature but we also assess if companies are on the right decarbonisation trajectory. 

On the face of it, this may appear counterintuitive. Investing in a highly polluting company could appear contrary to the aims of the Paris Agreement but if that company is pursuing an ambitious and – in particular – credible decarbonisation trajectory, then it may just be a sound investment.

Assessing the companies

In recent years, the most popular strategy to selecting “sustainable companies” for net-zero portfolios has been low carbon strategies. These are strategies that simply avoid the most polluting sectors such as steel, concrete, chemicals and heavy industry and focus on so-called ‘clean’ sectors or companies such as solar panel companies or education and health services.  

While such a strategy might have intuitive appeal, it fails to take into account the wider investment universe, or the real nature of the transition. As part of the transition to net zero, many high-emitting industries will remain essential, and the challenge therefore is not to exclude them, but to identify the transitioning leaders that have ambitious and credible plans to remain part of the future.

To be considered credible, we believe a company must have committed to long-term and mid-term targets. It must have identified key technologies and investment requirements needed, and to be tying executive remuneration to the achievement of these goals. Independent verification of commitments, for instance through the Science Based Targets initiative, is also key. 

At Lombard Odier, we assess companies using a forward-looking assessment that we call Implied Temperature Rise, indicative of the level of global warming that would result from a given level of ambition

At Lombard Odier, we assess companies using a forward-looking assessment that we call Implied Temperature Rise, indicative of the level of global warming that would result from a given level of ambition. Using this assessment, we estimate that today only 25%2 of public companies are on track to keep warming below 2°C, and only 6% are aligned to 1.5°C.

The destination is the same for all companies, but those that have plotted a clear path are the companies that will thrive. By being able to identify these companies, we can begin to get a sense of where investable opportunities might lie.

Read also: Sustainable investing in five easy questions

Preserving nature

The natural world that surrounds us is the very heart of our economy. Some 50% of all economic activity derives from the world's geology, soil, water and air.3 It is vital that we work to ensure that this vast natural resource is protected.

From an investment point of view, this means focusing on companies that look at every facet of their operations with the natural world in mind.

This could be dematerialising their supply chains. It could mean ensuring that their waste is treated properly and reduced to appropriate levels. It could mean that they implement the circular economy far more in their business model. 

Some 50% of all economic activity derives from the world's geology, soil, water and air. It is vital that we work to ensure that this vast natural resource is protected

We frequently hear the word ‘climate’ used as shorthand for the multitude of issues at stake. But according to researchers at the Stockholm Resilience Centre, there are in fact nine key planetary boundaries which keep the Earth’s systems stable, along with our economy. Of these there are four – climate, land use, bio-diversity and air and water pollution – where we have now crossed the natural limits in which we can safely live.

We believe these to be both economic and environmental issues. As part of our scrutiny of companies, we ensure we also look at how they are committed to the other environmental dimensions as well as decarbonising. When Lombard Odier signed a commitment to prevent deforestation at the last UN Climate Change conference, we reduced the number of companies linked to the practice in our portfolios.  

It is because of this absolute commitment to the world around us that we are so focused on incorporating planetary boundaries into our investment process.


The only alternative

Since COP26, an increasing number of countries have been setting targets to reach net zero. As a result, their economies will follow. Otherwise they will be at a competitive disadvantage. At the same time, consumer sentiment is shifting firmly towards companies which are more focused on sustainability. 

We believe that investing with sustainability at the core is the only way to do it. And by including high-emitting companies in our portfolios, we ensure that we focus on the journey as we all move towards destination net zero. 

 

1 Lombard Odier source
2 https://am.lombardodier.com/contents/news/investment-viewpoints/2021/november/only-14-of-large-caps-are-on-tra.html
3 Lombard Odier source

Important information

This document is issued by Bank Lombard Odier & Co Ltd or an entity of the Group (hereinafter “Lombard Odier”). It is not intended for distribution, publication, or use in any jurisdiction where such distribution, publication, or use would be unlawful, nor is it aimed at any person or entity to whom it would be unlawful to address such a document. This document was not prepared by the Financial Research Department of Lombard Odier.

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