Net-zero targets revolutionise investment opportunities

investment insights

Net-zero targets revolutionise investment opportunities

Stéphane Monier - Chief Investment Officer<br/> Lombard Odier Private Bank

Stéphane Monier

Chief Investment Officer
Lombard Odier Private Bank

Key takeaways

  • Major economies reinforced pledges to decarbonise at a virtual climate summit
  • A lack of common standards and data disclosure complicates sustainable investing. In-house carbon expertise allows us to assess a portfolio’s alignment with the Paris accord
  • Investing in already-sustainable technologies is not enough: we need to focus on best-in-class firms transitioning to carbon-neutral business models
  • The transition to a net-zero economy offers unprecedented opportunities for investors.

Last week’s US-hosted virtual climate conference saw the world’s biggest polluters pledge strengthened cuts to their greenhouse gas emissions on the road to a net-zero economy. This shift in the global economic model is prompting the fastest revolution in investment history, with opportunities for portfolio returns.

“We have to step up,” create a sustainable economy and “overcome the existential crisis of our time,” President Joe Biden said in his opening remarks. One of his first acts in office was to re-join the 2015 Paris accord, and to commit the US to a target of net-zero carbon emissions by 2050. At the conference last week, the US pledged to cut carbon dioxide (CO2) emissions by between 50% and 52% by 2030, based on 2005 levels.

Others also stepped up their ambition. Japanese Prime Minister Yoshihide Suga for instance told the meeting that his country will cut emissions by 46% by 2030, relative to 2013 levels, and Canada increased its 40% reduction target to 45% by 2030, using 2005 levels.

US emissions have been in decline since 2007, thanks to switching from coal to natural gas, and action by individual states, such as California. In addition, companies have driven market forces to the point where cleaner simply becomes the cheaper option.

However, last week’s new pledges require a significant increase in policy support. The Biden administration already has a goal of generating net-zero electricity by 2035 by expanding reliance on renewable sources such as wind and solar energy, and last month unveiled a programme to spend USD 2.25 trillion on overhauling the country’s infrastructure, one third of which directly targets climate-related investment.

The two-day virtual summit included Chinese president Xi Jinping, as well as heads of state from India, Germany and Russia. China has expressed doubts about the US commitments, since the US made pledges under the Kyoto protocol that it failed to deliver without Senate ratification. China, the world’s largest emitter of CO2 is responsible for more than one quarter of global greenhouse gas emissions. It plans to be carbon neutral by 2060 and announced it will phase down coal consumption from 2026 onwards.

An average… office worker’s 121 emails per day is the equivalent of driving 13.4 kilometres

Last chance, new chances

Bill Gates has explained the urgency of net zero emissions through the analogy of a running bath that will eventually overflow. Net emissions have to stop – not just be curtailed - as even a trickle of water from the tap will inevitably be disastrous. Last week, a study by Swiss Re found that if no mitigating action is taken, global temperatures could rise by more than 3 degrees Celsius and the world economy could shrink by 18% in the next 30 years.

From a positive perspective, these political targets are technologically and economically achievable, though time is of the essence. We have already warmed our environment by 1.2°C. The Paris Agreement seeks to limit such warming to no more than 2°C, and work to limit global warming to no more than 1.5°C. At current annual emission rates of 52 billion tonnes, we would exceed this target in less than a decade. Meeting the target no later than 2050 means halving emissions every decade.

The challenge is vast. Carbon emissions from energy generation, industrial production, transport and farming affect every aspect of our lives. Even the CO2 pollution from email is quantifiable. At an average 1,652 grams of CO2 per day, an office worker’s 121 emails is equivalent to driving 13.4 kilometres at 2019 levels of new car emissions in the European Union.

 

Quantifying net-zero fitness

Although the objective is clear, understanding what a net-zero economy might look like and how we might invest in it is more complex. Simplistic approaches that merely seek to shift capital to lower carbon industries have dominated the market. Such strategies fail to recognise that to get to net-zero, we will need to find solutions across all sectors of the economy. Higher-emitting, hard-to-abate sectors are among the most relevant in terms of climate change. This raises the question of how we compare the sustainability of investing in a company in a high-emitting sector, such as steel, to investing in a company that is already lower carbon, but is also of less relevance to the transition ahead.

Our in-house carbon expertise seeks to understand the specific shape of the transition in each sector, region and industry

To address this, we have developed in-house carbon expertise that seeks to understand the specific shape of the transition in each sector, region and industry. We have sought to define the technologies and behavioural changes that may transform more than 160 industries, potentially exposing firms to new risks, as well as new growth opportunities linked to the transition to a net-zero economy. Through this analysis, we have assessed more than 20,000 companies’ alignment to the transition ahead, measuring their current carbon footprints, and whether these are falling quickly enough. To meet the Paris accord’s objectives, each company’s emissions must follow the transition path for their respective industries.

These approaches enable us to identify the companies best positioned to capitalise on investable transition opportunities while identifying specific or systemic risks for businesses that are not taking action. This is fundamental for investors to spot valuable opportunities. An assessment of financial risk has to take account of more than just a firm’s carbon footprint and factor in specific costs, market and environmental changes resulting from the transition.

The goal of a carbon-neutral economy set out in political commitments will not be accomplished over the next three decades simply by investing in already-sustainable technologies. It is a mistake to shy away from investing in sectors that are high carbon today, but will remain essential in a net-zero economy. Our economies will continue to depend on the energy, food and infrastructure that they provide. Rather than excluding them from portfolios, investors should focus on solution providers and best-in-class companies who are transitioning and can form a sustainable part of a carbon-neutral future.

 

Meeting or missing targets

The crucial question then, is not whether an industry is currently polluting, but whether it is positioned to transition to a clean future, and whether a company is on a credible and viable path to decarbonise.

Markets will increasingly drive change as they start to penalise those without a plan in place. Behavioural changes are already underway. Regulatory and legislative changes are slower, and will not in themselves, be enough to achieve the results we need, but may catalyse and accelerate transitions. Investors, too, can accelerate the transition as we can encourage companies to set more demanding targets, along with faster implementation.

Change is unlikely to be linear as technological developments render some parts of specific industries redundant, while boosting others. That means industries will experience sudden shifts. Within a decade, every major car manufacturer, for example, has overhauled its business model as stricter CO2 emission targets force automakers to embrace carbon-free alternative technologies, such as battery electric vehicles. BMW and Volkswagen, for example, plan to have half of their fleets running on batteries by 2030, while Volvo prepares to be fully electric by then.

Investors’ portfolios will need to reflect simultaneously all these evolutions and ambitions while being resilient to shocks

Overall, analysts expect electric vehicles to account for 35% of the market by 2030, driven by better-than-expected sales and the US infrastructure bill. The Biden administration is planning to multiply its network of charging stations five-fold as part of its eight-year infrastructure spending programme.

Investors’ portfolios will need to reflect simultaneously all these evolutions and ambitions while being resilient to shocks that occur over relatively short timeframes, taking advantage of placing capital in public and private opportunities.

A first step is assessing a portfolio’s ‘value at risk’ from climate-related threats and opportunities. Our goal is to align portfolios with the transition to net-zero economies and so benefit from this revolution. That demands an approach that spots where there is progress by paying attention to the engineering and scientific solutions underlying the evolutions. Investors can then choose solutions that place capital with those companies best positioned to make this transition.

As this transition plays out, investment approaches taking account of these revolutionary changes should provide superior risk-adjusted portfolio returns.

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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 marketing communication.
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