Komal Jalan

Towards the end of 2021, the climate change outlook seemed clearer than ever before as science-based decarbonisation was becoming mainstream for investors and companies alike with an overwhelming surge of net-zero target commitments.

This year, however, has brought fresh woes to a pandemic-strained global economic scenario, with the Russia-Ukraine war tipping major economies toward an energy crisis and higher inflation. Rescue attempts have seen rising interest rates and, more alarmingly, a rush for new fossil fuel production and infrastructure to supplement energy needs. The recent energy stock rally has seen the carbon intensity of some portfolios rise whilst benefiting return outcomes.

Staying the course on net-zero is being tested and, without careful consideration, could threaten investment and environmental performance alike. But investors should not be discouraged if, at this early stage of a long-term commitment, the numbers aren’t moving in their favour. Short-term macro-economic forces are outside an investor’s control and the path to net-zero should never be assumed to be neat or linear. A quantitative and qualitative mix will be critical to achieving medium and long-term net-zero success.

With Mercer Australia making its own commitment to  a net-zero by 2050 target last year for its Australian Funds and the Mercer-managed investment options within Mercer Super, we share our observations and some steps investors can take.

Staying the course

We believe having a clear intent and time horizon that guides an investor’s strategy are key to staying the course on the complex path to net-zero. It is important to solidify the motivation for committing to net-zero in the first place – is the commitment guided by trend or pressure? Or is it driven by a strong investment belief on climate risk and opportunity?

It is also important to undertake actions that go beyond simply tracking year on year portfolio emissions intensity reductions. Portfolio emissions reduction may not always result in real economic decarbonisation. For instance, when an investor simply sells their carbon intensive assets to another investor who may care less about climate transition. Further, simply pursuing real economy emissions reduction alone will not take us far, unless we also consider the interconnected ecosystems, biodiversity, natural capital as well as social impacts along the climate transition journey.

Shortening the value chain

As an investor with a commitment to net-zero, the buck stops with you. Ultimately, you are accountable for whether or not you reach your target. But, you are dependent on the climate actions of those in your investment value chain, particularly your underlying investment managers and the companies themselves. For this reason, we believe investor collaboration across the value chain is vital to meeting climate goals.

This can be achieved with investment managers through a robust engagement program that seeks alignment with an investor’s climate ambition. For companies, investors should strengthen their active ownership approach with direct corporate engagement and public policy participation, where their involvement is in the best interests of their investors.

Being closely engaged with investment managers and companies directly may also help identify new climate investment opportunities that may be the return drivers of tomorrow. The decarbonisation of the aviation industry, for example, relies significantly on sustainable aviation fuel, which is 60 per cent to 80 per cent less emissions intensive, as an alternate to conventional jet fuel. This will need many market participants to make it a scalable solution.

Looking beneath the hood

As investors get closer to the assets themselves in their climate engagement, it is important to look beneath the hood. We believe this is critical when one of the major challenges on the net-zero journey is there is no standardised way yet for companies to disclose their progress.

When the successes of an investor’s net-zero ambitions are interconnected with those of the assets they invest in, we must ask – how credible are the decarbonisation pathways of companies that have committed to net-zero? Investors must dig deeper beyond headline commitments. Has the company clearly outlined key enablers such as its climate strategy, interim targets and capital expenditure requirements?

Recognising real progress

While portfolio emissions may not track a linear downward decline in certain periods, there is real progress to be demonstrated for investors with genuine intent. There is much investors can do to influence the real economy and report positive progress on net zero – from embedding climate alignment with investment managers, to strengthening one’s active ownership approach, collaborating across the investment value chain and allocating capital to return drivers of tomorrow including climate solutions.

Measurement is important, but as we chart our path towards net-zero, setting up the right qualitative engagement frameworks now should only strengthen our ability to achieve runs on the board in the face of uncontrollable events in the future.

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