By Andrew Howard, Global Head of Sustainable Investments at Schroders

Climate change isn’t something investors can choose to get exposure to – it is not a theme you can dip in and out of. We are all exposed to climate change. The real question is: Are we managing that proactively or reactively?

Despite – in many ways because of – waning climate change ambition from governments, companies and investors – climate risk is accelerating and every investor across the globe is exposed to some extent. The question is not whether climate change should be a consideration in a portfolio, but rather how to manage the disruption.

A new era where objective-setting won’t cut the mustard

Since climate change started to appear on company and investor agendas in the early 2000s, we have seen cycles of pessimism and optimism ebb and flow. We believe we are on the brink of a new era where – despite a recent flatline in ambition from various stakeholders – the acceleration of climate risk will necessitate a step change from establishing climate-related objectives toward deliberate strategies for reaching them within portfolios.

And the way asset allocators do this needs to be cognisant of the shifting environment in which we operate. In the five years following the signing of the Paris Accord, government ambitions and policies strengthened, which trend many investors expected would continue.  However, in practice since then they have stalled – the long run temperature rises implied by aggregate global commitments or policies haven’t budged in recent years.  Investors need to consider how they are assessing climate risk and building portfolios in the context of a slower pace of change than many expected, and the increased long term impacts physical climate changes will have as a result.

Pulling the right levers: three strategies for decarbonising portfolios

A journey to a low-carbon world is more important in many ways than a commitment to reaching that world. We have identified three primary strategies that can be used to move beyond objective setting to reduce carbon intensity in your portfolio.

Firstly, you could invest in companies that are low carbon today, and mathematically, that will reduce the carbon intensity of your portfolio. We call these “Climate Leader” companies. Secondly, you could invest in companies delivering sustainable solutions – those developing and deploying clean technologies that support the transition to a low-carbon economy. We call these “Climate Solution” companies. Thirdly, you can invest in companies that may have high carbon emissions today but are committed to reducing emissions quickly. These we’ve titled “Climate Improver” companies.

At Schroders, we have found that those companies which have high carbon emissions today but are achieving the fastest rate of change in terms of reducing emissions (“Climate Improvers”) have consistently outperformed their competitors.

Source: Schroders. Past performance is not a guide to future performance and may not be repeated.

These are also the companies that have been able to deliver the most change and returns

“Climate Improver” companies have been responsible for the greatest reduction in real world emissions. But identifying those companies well placed to decarbonise and encouraging those organisations to transition is no easy feat. At Schroders, we are able to bring together quantitative analysis, the perspectives of our fundamental investment teams and our active ownership capabilities– and the results are surprisingly positive.

Since 2021, we’ve engaged with over 2,000 companies globally on climate topics. Looking at constituents of the MSCI ACWI global benchmark, the companies we engaged with have been about twice as likely to set new emissions targets, and have cut their emissions twice as fast as those we have not engaged. These companies aren’t just reducing emissions faster, but also deliver – on average – about 4% annual outperformance to companies we didn’t engage from that same peer group.

The value of active ownership in understanding who these transition winners will be

The integration of forward-looking analysis and active ownership are critical to delivering the opportunities climate transition presents, by identifying the companies able to transition to a low-carbon world where the greatest exposure and performance will come from.

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