09 Jun 2021
Climate change is one of the biggest issues facing the world today. Many governments, countries and industries have recognised the threat and are taking measures to try to counter it. Much depends on their success or failure. As asset managers, however, our primary interest is in the investment implications. Our recent White Paper uses a scenario-based approach to examining the subject in depth. You can also read a series of other short articles on related topics here.
Below, we focus on how our climate change scenario analysis is changing the way we invest from the bottom up.
For portfolio managers, climate change risks and opportunities are not new considerations. Often, however, managers have had to rely on public and backward-looking data when it came to including them in investment decision-making. Carbon-emission trends are an example of this type of information. They might be useful to help us understand a given company’s historic and current exposure to carbon risk. What they don’t do is help us to answer the biggest question – how well-positioned is its business for the future?
Enter our climate scenario analysis, which has helped us to shed some light on the matter. Using its outputs, we can more rigorously consider climate change in context when we are actively selecting stocks. Our results showed us that we need to ask a number of key questions as part of the research process. We summarise some of them briefly below, but you can find the full list on page 41 of the paper. We also provide illustrative examples, based on the mining sector.
When we evaluate climate change risks or opportunities for companies in a particular sector, our analysis shows that we should think about impact drivers. What creates or destroys value in that sector? Which companies will be affected most positively or negatively by these drivers? Do the drivers vary between the ‘winners’ and ‘losers’ inside the sector?
From here, we go on to consider questions at the individual stock level and how impacts compare to close peers. In our research process, we would choose to assess a particular stock based on our exposure or because it stands out among the companies most impacted (whether positively or negatively) by climate change.
We must also look at any mitigation actions and transition strategies that the company is taking or employing. Are they captured by the climate scenario analysis? While the modelling takes account of abatement actions, we know that dynamic transition strategies and company-specific emission reduction targets are not yet well captured in the analysis. We therefore need to complement the outputs with our active research view on credible transition plans. Could they be material enough to change our view of the biggest climate change impacts on that company?
One of our core responsible stewardship activities is engaging with companies for which climate change is a material risk. The results of the analysis will feed into our discussions with companies. Identifying the most material climate risks for a given company will help change our engagement priorities. Our approach will vary depending on whether or not that company already carries out its own scenario analysis.
One of our core responsible stewardship activities is engaging with companies for which climate change is a material risk.
If it does, we can challenge its assumptions and compare its analysis with our own. More importantly, we can also find out how it includes the results in its decision-making. If the company does not carry out its own analysis, we can highlight the key messages of our own scenario analysis outputs. Here, we are likely to focus on three questions related to climate change exposure, resilience and management.
After our engagement, we would like to see companies take steps to undertake climate-scenario analysis. We would also like them to build resilience in areas where we have identified material climate risks. We will reflect this in our written stock research and include it in our investment decision-making. Ultimately, this could lead to further engagement, escalating the issue, reducing our exposure or eventually even exiting our position in the company.
In short, our climate scenario analysis gives us a robust way with which to include climate risks and opportunities in our research, engagements and investment decisions. By asking the right questions, we can feed our results into bottom-up investment decisions and complement our broader company research. The output from our analysis also forms a critical component of our approach to stewardship. It leaves us in a stronger position to assess the credibility of firms’ transition strategies and it may lead to allocation changes where we think that risks are not being well managed.