Forum Institutional

The zero that every investment portfolio needs

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System change not climate change. Image: Photo by Scott Evans on Unsplash

Günther Thallinger
Member of the Board of Management, Investment Management, Environmental, Social and Governance (ESG), Allianz SE
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Long-Term Investing, Infrastructure and Development

This article is part of: The Davos Agenda
  • To address climate change effectively, investors must steer their entire portfolios towards climate neutrality.
  • Portfolios that do not evolve in the right direction risk becoming unattractive to beneficiaries in the long run.
  • Sustainability, especially climate change impact, must be considered in investment decision-making. Investors have to change their objectives and decision processes.
  • The UN-convened Net-Zero Asset Owner Alliance (AOA) has set its first defined target of reducing emissions in its own portfolios in the range of 16-29% by 2025.

Climate change is the defining risk of the 21st century. Changes in economies, and consequently in the behaviour of individuals, need to be driven through concerted efforts.

One such effort is the Net-Zero Asset Owner Alliance (AOA), a United Nations-convened alliance of large institutional investors, established in 2019. Back then, the 12 founding members, including Allianz, had taken a bold pledge to facilitate the decarbonization of the world economy, by making their own portfolios carbon-neutral by 2050.

The AOA, which has now expanded to 33 members managing more than US$5 trillion of assets in total, took a definitive step last year towards this goal by setting up its first defined target of reducing greenhouse gas emissions in own portfolios of 16-29% by 2025.

The AOA 2025 Target Setting Protocol, detailing the Alliance’s approach, was developed in collaboration with experts from asset owners, the UN and the Principles for Responsible Investment (PRI) as well as civil society (WWF, Global Optimism) and scientific organizations.

Why did these investors accept the target of net-zero emissions for their portfolios? And why should more investors join the pledge?

The case for net-zero portfolios

Climate change and more broadly, sustainability (“ESG”), must be considered by all economic actors: not only because of the impact of increasing risks or changing expectations and behaviour of stakeholders but also because of the economic opportunity. And finally, because all business activity should safeguard the common good.

Long-term investment action requires integration of ESG aspects into decision-making processes.

  • It addresses potentially stranded or otherwise underperforming assets and opens up new investment opportunities and therefore, interprets anew the “classical” risk/return profile.
  • Both retail and institutional customers are increasingly demanding climate-friendly/ESG-compliant products and services. More and more are aware that they need to change their activities and hence, want financial partners to “help”.
  • To retain their “license to operate” provided by broader public, politics and regulators, financial service companies need to consider societal and political developments.

So, to answer the question on why investors should be concerned with the holistic integration of ESG in investment decisions: Doing well and doing good are not contradictory. If done right, they complement each other.

A multi-pronged development

To reach the ambitious target of net-zero GHG emissions by 2050, investors need to actively develop their portfolios – that means, every single asset.

1. Dedicated climate/ESG investments

In recent years, new investment opportunities like “green buildings”, ESG-compliant infrastructure and impact funds have emerged. These kinds of investments will play an important role but they alone will be not sufficient to steer portfolios to net-zero.

2. Develop individual assets

Asset owners always need to have their investments evolve. Such evolution must incorporate an approach towards sustainability; in particular, a path to reduce climate impact (ideally in full compliance with the IPCC scenarios).

Currently, the most promising approach for asset success is “engagement”. An asset owner or a group of asset owners have a dialogue with a company (“the asset”) about the development of its carbon footprints, for example. The AOA fully supports engagement (many of the AOA members are very active members of Climate 100+).

In the future, mandatory reporting of companies (the assets) needs to be established for all business activities. This reporting will help to replace most of the work covered by today’s engagement dialogues with information provided in standardized, regularly updated and publicly available information. Ideally, it will also begin to be audited soon.

3. Reduction of exposures

Investors reconsider allocation from time to time. If certain assets no longer fit strategies or prove not to develop as planned, reallocation decisions need to be made. In that sense, it could become necessary to reduce assets with a non-satisfactory sustainability approach. In the extreme case of non-existence of such approaches, divestment is the ultima ratio.

Given the possible investor actions, the AOA has developed a GHG-measurement for portfolios and an interim target-setting approach. Such target-setting ensures that investors change their own profiles by integrating climate neutrality into investment decision-making (equivalent to financial targets).

The AOA 2025 Target Setting Protocol carefully balances scientific ambition, active owner engagement and divestment constraints.

Image: World Economic Forum, Dashboard for a New Economy

The AOA’s approach divides its targets into four broad categories.

Sub-portfolio targets are the most quantitative element and ensure that the members’ portfolios develop overall in line with the 1.5°C ambition. Members start with listed equity and corporate bonds as well as real estate assets, targeting a reduction of 16-29% by 2025.

Sector targets account for the differences among sectors in technologically feasible emission reductions. The intention is to orientate expectations towards the highest-emitting sectors, starting with energy, steel and transport, using sector-specific performance indicators.

Engagement targets provide a common and productive lever for members to drive change in the real economy. The alliance promotes collaborative engagement efforts towards companies and sectors and emphasizes the responsibility of asset owners towards asset managers and their stewardship actions.

Financing transition targets reflect the role of asset owners in providing capital for the necessary transformation of the global economy. Large amounts of public and private capital are needed and the members are committed to providing this capital.

Being a founding member of the AOA and based on the Target Setting Protocol, Allianz has started with concrete targets for its listed equity and corporate bonds portfolio – a 25% reduction in absolute emissions until 2025. Furthermore, based on climate science, Allianz will align its real estate portfolio with a net-zero pathway by the latest in 2025.

Investors collaborating through initiatives such as the AOA can achieve much. However, investors need the support of governments, in particular, with measures like mandatory ESG, and especially climate impact reporting and the establishment of carbon pricing mechanisms.

Fighting climate change requires persistence and decisive action. The AOA invites other asset owners to commit to net-zero, set a 2025 interim target and join the challenge.

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