Strategy two: invest

Integration of ESG factors is “the systematic and explicit inclusion by investment managers of environmental, social and governance factors into traditional financial analysis” in order to enhance investment decision-making30. Integrated analysis of climate change can assist in understanding sector- and company-specific risks. Although not in itself a way to reduce emissions in the real economy, this is essential to informing investor engagement and investment decisions. Integration is a more suitable strategy for actively managed than passively managed funds, given the latter do not involve stock-picking or under/over-weighting companies compared to a benchmark. Integration practices within equities are presently more advanced than in other asset classes such as fixed income.

• Actively managed equities: integration can involve identifying and analysing material climate changerelated issues, quantifying these to adjust value driver assumptions, and as a result making betterinformed investment decisions. Climate change can be considered within different stages of investment decision-making, including idea generation, company analysis , the investment case, and portfolio construction. As integration practices become embedded, asset owners can work with portfolio managers to measure the impact of ESG factors on valuations. For example, one manager, Robeco, has calculated that on average, ESG factors account for 5% of the target price, with the impact on valuation ranging from -23% to +71%.
• Fixed income: integration can involve analysing issuer exposure to material climate change risk and financial implications, pricing the risk and determining whether the bond represents good investment value, and as a result having a more informed assessment of issuer credit risk and creditworthiness. Climate change can be considered for corporate bonds at a sector and company level. It can also be considered for government, municipal and supranational bonds, focusing on exposure and resilience to climate change impacts, for example. Credit rating agencies such as S&P have work underway on sovereign risk and climate change see the Appendix for other asset classes.

PRI evaluation

Pros: Systematically include evaluation of climate change risks and opportunities in the investment decision.

Cons: effective in identifying carbon risk at the company and sector level, but challenging to aggregate this meaningfully across an entire portfolio and some data challenges too.

Timeframe: developing a robust process for integrated analysis can be resource-intensive initially, but will likely bring better-informed investment decisions on an ongoing basis.

Tracking and measuring performance: Performance indicators can focus on how a portfolio manager actively incorporates climate change factors into core decisionmaking processes, including idea generation for actively managed equities, and credit worthiness for fixed income. Indicators may include evidence of specific investment decisions or analysis adjusted as a result of integration of climate change risks and opportunities, at a sector, company or issuer level.

Possible actions

Portfolio managers could be encouraged, through discussions in performance review meetings, surveys or formal wording in mandates, to take the following actions:

• Integrate climate change risk and opportunities within sector analysis;
• For actively managed equities: integrate climate change factors into idea generation; including assessment of company strategy, management quality including innovation, financial reports and valuation tools;
• For fixed income: integrate climate change risk factors into credit risk assessment, and
• Report on the portfolio manager fs evaluation of the fund fs exposure to climate change risks and opportunities.

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  Developing an asset owner climate strategy

  November 2015

Invest in low-carbon solutions

Investing in solutions to climate change helps finance the transiton to a low-carbon economy, and is essential to addressing ongoing global emissions. Priority areas include:

• Transportation
• Electricity generation
• Property
• Industrial process
• Sustainable agriculture and forestry

Investment opportunities exist across asset classes and investment approaches. These include renewable energy projects, low-carbon indices, thematic funds, climate-aligned bonds, green infrastructure, real estate and private market opportunities.

• Low-carbon indices: aim to reflect a lower carbon exposure than the broad market by overweighting companies with low carbon emissions. This may involve investing in best-in-class companies in carbon intensive sectors, or companies with positive environmental impact, such as those leading in mitigating the causes of climate change.
• Thematic funds: aim to focus investment ideas on environmental themes, typically solutions to environmental problems. Thematic funds focused on climate change may invest in renewable energy, energy efficiency, clean technology, water and waste management.
• Climate-aligned bonds: aim to finance or re-finance projects to address climate change, ranging from wind, solar, hydropower to rail transport. New issuance is often multiple times subscribed and athe total climatealigned bonds universe stands at US$597.7 billion (as at July 2015), a 20% year-on-year increase32. The Climate Bond Standard, supported by the Climate Bonds Initiative33 assists in demonstrating such bonds are genuinely ggreen.
• Green infrastructure: an estimated US$57 trillion new investment in infrastructure is needed between 2013 and 2030 (see figure below), while infrastructure planning needs to be aligned with a 2 ‹ objective. GRESB Infrastructure assessment offers asset owners an assessment tool for evaluation and industry benchmarking of infrastructure assets, including specific indicators for climate change risk and resiliency34. In the longer-term, asset owners may need to work with stakeholders on investment grade green infrastructure investment opportunities.
• Real estate: Buildings generate 40% of global primary energy consumption35, with significant opportunities to reduce emissons in new buildings and existing property, particularly through energy efficiency. Tools such as The Global Real Estate Sustainability Benchmark can assist asset owners in understanding performance in energy and greenhouse gas emissions. Other tools such as in-house ESG assessment of property assets may also be developed.
• Private market opportunities: these can include funds investing in clean tech, energy efficiency and water, for example. They can invest in infrastructure and private equity.

PRI evaluation

Pros: Investment in low-carbon solutions significantly assists financing the transition to a low-carbon economy and uses the portfolio to address emissions.

Cons: Concerns exist about how low-carbon investments can demonstrate a genuine contribution to solving climate change. There are also concerns about liquidity, diversification, the investment pipeline, and the specialist skills and resourcing needed for low-carbon investments.

Risk-return profiles must be acceptable to investors compared to the normal thresholds they seek, in order for sufficient scale to be achieved. Engagement with companies is important to achieve this, along with engagement with policy makers to develop adequate investment vehicles for institutional investors.

Resourcing and screening is needed to assess previously unseen opportunities, such as new technologies, which can be a barrier for many asset owners. Asset owners could collaborate to identify and work with specialist intermediaries on this.

Timeframe: Direct investment and asset allocation can start having an impact on climate change relatively soon, especially if achieved at a meaningful scale.

Tracking and measuring performance: A fund could commit to having a particular percentage of its total assets under management in low-carbon, energy-efficient and other climate mitigation investments. The UK Environment Agency Pension Fund published such a target in 2015. Further performance metrics have yet to be developed.

Possible actions

• Review opportunities in line with asset allocation and other investment objectives, and factor climate change into asset allocation decisions. This can include requesting portfolio managers and consultants consider investment opportunities.
• Resources include the Low Carbon Investment Registry, a new global public online database of low-carbon and emissions-reducing investments made by institutional investors, including the type and value of investment, destination region and manager.