Net zero in practice: Insights from equity investors

Starting in mid-2022, we held a series of workshops for 40 investment managers and asset owners who belong to the Net-Zero Listed Equity Practitioners Group. Many participants submitted case studies that now feature on the PRI website (links to individual case studies below).

The case studies explain how investors set portfolio targets, how they measure alignment with targets and decarbonisation pathways and how they use the levers available to them to bring portfolios into alignment. The case studies explain which metrics and methodologies investors use and why, providing hypothetical as well as real world examples.

This report consists of two parts. The first provides links to, and brief descriptions of, the case studies. The second summarises key findings from the workshops and subsequent drop-in sessions.

The practitioners group mainly focused on implementing the recommendations of the frameworks as set out by the Net-Zero Asset Owner Alliance (NZAOA) and the Net Zero Asset Manager (NZAM) initiative. At the time of writing, some of the more detailed aspects of net zero – such as the various sector pathways, and measurement and reporting of upstream and downstream Scope 3 emissions – are still under development and subject to debate. Signatories demonstrated that discussion and idea sharing are important to net-zero portfolio target setting, measurement, alignment and reporting.

It is clear that there is no one-size-fits-all net-zero portfolio process and that different investment strategies will require different approaches, depending on the nature of the entity (asset owner or asset manager) and on where on the investing spectrum the investor is (fundamental, quantitative or passive). We have, however, observed the emergence of a set of common steps and decision-making points that investment managers and asset owners need to go through once they have decided to commit to net zero. This report highlights these steps.

Not surprisingly, asset managers and asset owners have a good understanding of where in their portfolio one finds most of the GHG emissions, certainly those of Scope 1 and 2. For those wishing to decarbonise quickly, divestment appears to be a quick, achievable solution. As the case studies show, however, the approach most widely used to achieve decarbonisation is engagement.

About this paper

Overview of case studies

Signatory	Example	Description
Allianz (Asset owner)	Managing climate risk at aggregate portfolio level using portfolio tilts, exclusion and other levers.	The insurer’s approach to decarbonisation is applied to core and satellite portfolios, which determine the degree of asset owner involvement, the level of standardisation of processes across different investment strategies and the use of backward- and forward-looking GHG emission metrics and trajectories.
Signatory:  Allianz (Asset owner) Example: Managing climate risk at aggregate portfolio level using portfolio tilts, exclusion and other levers. Description: The insurer’s approach to decarbonisation is applied to core and satellite portfolios, which determine the degree of asset owner involvement, the level of standardisation of processes across different investment strategies and the use of backward- and forward-looking GHG emission metrics and trajectories.
ClearBridge (Asset manager)	Assessing a utility and a shipping company for net-zero alignment and engagement.	Issuers are sorted into four categories on the alignment spectrum, using SBTi and Climate Action 100+ criteria as well as proprietary research. The categorisation is used to prioritise engagement.
Signatory:  ClearBridge (Asset manager) Example: Assessing a utility and a shipping company for net-zero alignment and engagement. Description: Issuers are sorted into four categories on the alignment spectrum, using SBTi and Climate Action 100+ criteria as well as proprietary research. The categorisation is used to prioritise engagement.
Mirabaud (Asset manager)	Engaging with a south European utility to address shortcomings in its climate strategy.	Explains the asset manager’s categorisation of existing and potential fund holdings into temperature-alignment-status categories based on the issuers’ climate targets and historical emission pathways. Provides a sample of an actual scorecard listing relevant criteria used to inform investment decisions and engagement.
Signatory:  Mirabaud (Asset manager) Example: Engaging with a south European utility to address shortcomings in its climate strategy. Description: Explains the asset manager’s categorisation of existing and potential fund holdings into temperature-alignment-status categories based on the issuers’ climate targets and historical emission pathways. Provides a sample of an actual scorecard listing relevant criteria used to inform investment decisions and engagement.
Robeco (Asset manager)	Adjusting target baseline to account for changes in asset mix and portfolio values.	Re-baselining makes it possible to discern the extent to which asset managers’ choices are leading to decarbonisation, after controlling for the effects of shifting asset values on carbon intensity calculations.
Signatory:  Robeco (Asset manager) Example: Adjusting target baseline to account for changes in asset mix and portfolio values. Description: Re-baselining makes it possible to discern the extent to which asset managers’ choices are leading to decarbonisation, after controlling for the effects of shifting asset values on carbon intensity calculations.
RBC GAM (Asset manager)	Using six metrics to measure net-zero alignment of global equity fund.	Metrics are both forward- and backward-looking and are adjusted for sectors with lower carbon intensity. Alignment status informs investment decisions and engagement with investees.
Signatory:  RBC GAM (Asset manager) Example: Using six metrics to measure net-zero alignment of global equity fund. Description: Metrics are both forward- and backward-looking and are adjusted for sectors with lower carbon intensity. Alignment status informs investment decisions and engagement with investees.
Danica Pension (Asset owner)	Setting a decarbonisation target for the utility sector using inputs from One Earth Climate Model and Transition Pathway Initiative.	Shows how the most recent scientific knowledge on sectoral decarbonisation can be used in a pragmatic way to inform portfolio measurement. Holdings are evaluated against sector targets; results are used in engagements with laggards to support company efforts on climate-related issues.
Signatory:  Danica Pension (Asset owner) Example: Setting a decarbonisation target for the utility sector using inputs from One Earth Climate Model and Transition Pathway Initiative. Description: Shows how the most recent scientific knowledge on sectoral decarbonisation can be used in a pragmatic way to inform portfolio measurement. Holdings are evaluated against sector targets; results are used in engagements with laggards to support company efforts on climate-related issues.
Invesco (Asset manager)	Constructing a temperature-aligned factor portfolio by narrowing a global developed markets universe of 3,000 stocks into a portfolio of 200 stocks in a two-step process.	This quantitative equity model uses implied temperature rise to develop an anchor portfolio aligned with 1.5°C, then a factor overlay optimisation to harvest premia arising from quality, momentum and value.
Signatory:  Invesco (Asset manager) Example: Constructing a temperature-aligned factor portfolio by narrowing a global developed markets universe of 3,000 stocks into a portfolio of 200 stocks in a two-step process. Description: This quantitative equity model uses implied temperature rise to develop an anchor portfolio aligned with 1.5°C, then a factor overlay optimisation to harvest premia arising from quality, momentum and value.
La Francaise (Asset manager)	Using a Portfolio Temperature Ratings Tool at a security and portfolio (global impact fund) level.	Tool combines proprietary and open-source methodologies to determine individual company temperature scores and portfolio temperature ratings. Results inform portfolio construction and engagement priorities.
Signatory:  La Francaise (Asset manager) Example: Using a Portfolio Temperature Ratings Tool at a security and portfolio (global impact fund) level. Description: Tool combines proprietary and open-source methodologies to determine individual company temperature scores and portfolio temperature ratings. Results inform portfolio construction and engagement priorities.
Trillium (Asset manager)	Setting and pursuing a 2030 target for equity holdings that already have a low-carbon footprint.	The asset manager’s target is that 75% of in-scope holdings set credible targets for GHG reduction, as approved by the Science Based Targets initiative. Proxy voting policy includes voting against/withholding support at AGM if the company has not set or committed to set an SBTi-approved target.
Signatory:  Trillium (Asset manager) Example: Setting and pursuing a 2030 target for equity holdings that already have a low-carbon footprint. Description: The asset manager’s target is that 75% of in-scope holdings set credible targets for GHG reduction, as approved by the Science Based Targets initiative. Proxy voting policy includes voting against/withholding support at AGM if the company has not set or committed to set an SBTi-approved target.
Victorian Funds Management Corporation (Asset owner)	Engaging with construction materials producer to address significant Scope 3 emissions.	During engagement with this Australian holding, the asset owner reviewed industry pathways, peer comparisons and approaches to decarbonisation for the portfolio company’s end customers in the construction materials industry. The portfolio company engaged with its customers in the steel value chain and committed to working with them to develop the technologies to decarbonise production.
Signatory:  Victorian Funds Management Corporation (Asset owner) Example: Engaging with construction materials producer to address significant Scope 3 emissions. Description: During engagement with this Australian holding, the asset owner reviewed industry pathways, peer comparisons and approaches to decarbonisation for the portfolio company’s end customers in the construction materials industry. The portfolio company engaged with its customers in the steel value chain and committed to working with them to develop the technologies to decarbonise production.
Eurizon Capital (Investment manager)	Setting engagement objectives and an escalation strategy for use with cement companies with higher emissions.	The investment team sorts cement companies in its investment universe into three categories, partly based on their offering and promotion of low-carbon cement products. The categorisation process informs stewardship activities.
Signatory:  Eurizon Capital (Investment manager) Example: Setting engagement objectives and an escalation strategy for use with cement companies with higher emissions. Description: The investment team sorts cement companies in its investment universe into three categories, partly based on their offering and promotion of low-carbon cement products. The categorisation process informs stewardship activities.

Key findings

The first step in setting a target

During the workshops, presenters and signatories referenced guidance from the various net-zero initiatives (e.g. NZAM, NZAOA) to make the point that work must be undertaken before setting a net-zero target. The most common starting point is identifying and measuring emissions of portfolio holdings. Investors need to understand the existing assets under management, their exposure to carbon emissions, and establish in which direction those emissions are heading. This is typically done with the help of pathways – likely forward trajectories of portfolio holdings and, if relevant, the benchmark. Investors can only set specific targets once they understand the portfolio’s positioning with regard to emissions and the likely future direction.

The Partnership for Carbon Accounting Financials (PCAF) has illustrated some of the core steps in implementing net-zero portfolios, putting target setting into a broader perspective (see Figure 1). PCAF recognises that current data coverage and quality present challenges when setting comprehensive targets at the asset level. That is why the arrows suggest an iterative approach.

Figure 1: Global GHG Accounting and Reporting Standard for the Financial Industry

Source: PCAF (2022). The Global GHG Accounting and Reporting Standard Part A: Financed Emissions. Second Edition, p9.

As the case studies illustrate, target setting goes hand in hand with considerations of which strategies should be used to decarbonise portfolios and which levers are available to managers. In its Net Zero Investment Framework (NZIF) guidance, the Institutional Investors Group on Climate Change explains how the target-setting process facilitates action. Once investors have identified key sources of data, they can assess and monitor the alignment of portfolio assets to establish a baseline and set an initial target: 

Investors should use the alignment data to develop and inform a stewardship and engagement strategy and to inform portfolio construction, as two key tools to drive the alignment of assets. Over time, investors should be able to broaden the coverage of the target and include a more comprehensive set of data points as data availability improves.

NZIF Target setting guidance (p6, section 3.1)

 

Metrics and methodologies

Workshop participants acknowledged the many metrics available and discussed the advantages and drawbacks of each. Portfolio carbon metrics should ideally be agnostic to both stock price and changes in exposures, a difficult challenge to overcome.

The most common metrics referenced during the workshop include:

• Weighted average carbon intensity (WACI) – Metric tons of CO₂ equivalent per million dollars of revenue, which captures a portfolio’s exposure to emissions-intensive companies. Expressed as tCO₂ e/€M or tCO₂ e/US$M.
• Economic emissions intensity – The amount of financed emissions divided by the portfolio value. A common carbon footprint measure that is normalised for the total size of the portfolio. Comprehensively described in the PCAF Standards (p61-63).
• Implied temperature rise (ITR) –- Indicates how well the portfolio’s holdings align with global climate goals. This metric assesses the collective carbon budget allocated to portfolio companies, and their undershoot or overshoot of that budget during the reporting period. This undershoot/overshoot is then converted to a degree of temperature rise (see CDP temperature ratings).
• Financed emissions – Absolute tonnes of CO₂ financed (owned) by investors for each holding. Usually attributes ownership based on the percentage of enterprise value including cash (EVIC) that is attributed to an investor. These are added to create an aggregated portfolio figure.

It is not the purpose of this report to provide detailed explanations of the metrics – relevant links to guidance are provided.

Group members cited the following resources for assessing portfolio GHG emissions:

• IIGCC: Net Zero Investment Framework 1.5°C Implementation Guide
• IIGCC: The Net Zero Investment Framework: Supplementary target setting guidance
• Task Force on Climate-related Financial Disclosures (TCFD) Guidance on Metrics, Targets, and Transition Plans (including Appendix 1 on metric categories)
• Partnership for Carbon Accounting Financials (PCAF) Financed Emissions Standard

Investors new to this topic may find the PRI’s Introduction to responsible investment: climate metrics  guide useful.

Some asset managers combine open-source methodologies with their own techniques (see La Francaise Asset Management). Investment managers rely on both external data providers and internal, proprietary solutions.

Footprint vs. intensity metrics

While there is a range of possibilities for emissions metrics, what is being measured can dictate the best choice. When setting portfolio decarbonisation targets and measuring progress against them, participants favour economic-emissions-intensity measures. When assessing emissions of individual issuers, especially relative to their sector peers, WACI is more common. Both measures are useful when reporting on performance against climate targets. A useful summary of the pros and cons of different carbon metrics is provided by Abrdn.

Forward- and backward-looking measures

When discussing measurement and reporting options, it became clear that very few asset managers rely on a single measure. To gain a broader perspective, both forward- and backward-looking approaches are used. Reported GHG emissions intensity provides a backward look while ITR is used to project future emissions (see CDP-WWF temperature rating methodology). The consensus was that backward-looking footprints and intensity measures give a good snapshot of where the portfolio stands, while forward-looking assessments of decarbonisation commitments and capex plans (which are also captured by ITR metrics) provide a more comprehensive view of the alignment, progress and transition risks of the issuer and aggregate portfolio. Signatories clearly recognise that best practice requires monitoring of both the backward-looking and forward-looking metrics. Inevitably, metrics based on recently disclosed carbon data may contradict what ITR data shows – given that ITR data captures companies’ future plans.

Aggregate portfolio considerations

Aggregate portfolio metrics are calculated in several established ways, as noted above. In the case of portfolio ITR, the metric is sometimes calculated by going beyond a simple weighted average reflecting each holding’s weight in the portfolio. Investors have shown a preference for weighting methods that reflect individual issuers’ emissions levels, how much of those the portfolio “owns” and how those owned emissions compare to the overall portfolio emissions (see CDP-WWF temperature rating methodology – CDP).

Data sources and data quality

Investors’ data sources include open-source tools; issuers’ disclosures, statements and commitments; and commercial providers that include TruCost, ISS ESG, MSCI, Sustainalytics, Vivid Economics, Carbon4 and Planetrics.

Participants see availability, reliability and consistency of data as a major hurdle. Where there are gaps in GHG emissions data, a widely used proxy is to use estimates based on the issuer’s physical or economic activity, as explained by the PCAF standard, (p72-74).

Physical activity usually reflects production (such as tonnes of output using a particular technology or process) or energy consumption (kWh). The amount of production by an issuer is then multiplied by standard emissions factors (as provided for example by IPCC Data or Ecoinvent Database), giving the likely GHG emissions by the company. Using economic activity (measured by amount of revenues from a particular product for example) is an alternative solution.

Setting a target

The participants use one of the following approaches to set targets:

• Paris Aligned Investment Initiative’s Net Zero Investment Framework (NZIF)
• Science Based Targets initiative for Financial Institutions (SBTi)
• Net-Zero Asset Owner Alliance Target Setting Protocol (TSP)

Targets can take a number of forms, ranging from increasing the percentage of holdings that are aligned with net zero to committing to a specific percentage reduction in carbon emissions over different time horizons.

Setting decarbonisation targets at the fund level would be the preferred option for many asset managers but is not feasible for reasons that include the wide variety of strategies and mandates that are applied by each asset manager and significantly different starting points for each asset class. It is more common to set targets based on assets managed under different strategies, for example fundamental equities or quantitative equities.

Assessment of individual issuers and their alignment with decarbonisation pathways is applicable to active fundamental strategies, while rules-based quant factor models could include a carbon-intensity or ITR target as part of the optimisation process. Passive strategies are best addressed using climate-aware benchmarks. In addition, different starting points will impact the steps taken and decisions made. Building a low-carbon portfolio from scratch requires a different process from introducing net-zero targets to existing portfolios.

Furthermore, investors need to disclose (as recommended by entities such as TCFD):

• whether the target is absolute or intensity based
• time frames over which the target applies
• base year from which progress is measured
• KPIs to assess progress against targets

Sector pathways

To understand how companies in economic sectors can and should decarbonise, investors make use of several sources of sectoral pathways:

• Science Based Targets (SBTi)
• Transition Pathway Initiative (TPI)
• OneEarth Climate Model (OECM)

Investors also found sector reports from the International Energy Agency useful. Where there is conflict between what the different models are suggesting, a judgement has to be made. Whereas the SBTi can be used for companies across the whole economy, the TPI focuses on assessing those sectors that contribute most significantly to greenhouse gas emissions, and currently provides assessments for close to 300 publicly listed companies across 16 high-carbon sectors as defined by TPI.

Evaluation of individual issuers

Many of the case studies focus on how to assess issuers’ alignment, a building block for building an aggregate portfolio picture and informing engagement. While there are many ways to understand the state of a company’s emissions and decarbonisation efforts, we see most asset managers use a categorisation, or traffic light system, to build an overall portfolio picture and to help prioritise issuer engagement and potential escalation. The findings from the company analysis help inform the exact nature and objectives of the engagement activities.

Some asset managers, for example Mirabaud, have developed company assessment processes and methods in one asset class that they are extending to others.

Climate Action 100+ provides assessment of the biggest corporate greenhouse gas emitters’ efforts to transition to net-zero businesses – based on TPI disclosure data and analysis. Some signatories also cited The Climate Bonds Initiative transition principles as a framework that helps investors evaluate whether companies are following a credible transition pathway.

Taking action

Investors understand they cannot passively rely on the portfolio to decarbonise. The key levers they use to align portfolios with net-zero targets are:

• Divestment
• Changing the size of portfolio holdings
• Investment in lower-carbon issuers
• Engagement.

These tools are complemented with investments aimed at supporting the transition to a low-carbon economy (see NZAOA target setting protocol).

Divestment is recognised as an option but few if any investors actively rely on it as a way of aligning portfolios, partly because it can result in unintended portfolio tilts, risk exposures and style characteristics. For companies that are early in the transition, engagement is seen and adopted as the way forward, particularly among those using fundamental active strategies. The case studies and discussions highlight recent advances in engagement on emissions reduction. Asset managers have developed detailed toolkits, sets of requirements and methods to categorise issuers based on GHG-reduction progress. These approaches recognise that smaller companies cannot face the same expectations level as larger companies with extensive resources.

Engagements are done on an individual and collaborative basis and increasingly focus on Scope 3 emissions in addition to Scope 1 and 2. The workshops and case studies have revealed that engagements include, where relevant:

• Calls on issuers to commit to decarbonisation and to disclose emissions and emissions reduction plans;
• Expectations that issuers comply with the decarbonisation paths they have committed to;
• Suggestions to issuers that they promote their low-carbon products and solutions to market segments and regions that are less advanced in decarbonisation efforts.

Asset managers have also raised the issue of how to treat the trade-off between investing in transitioning companies and transition-solution providers, noting that the taxonomies leave a lot of questions unanswered.

Assessment of progress and challenges – key issues

Holdings in high-emitting stocks

Practitioners recognised that setting targets may limit how much a portfolio can hold in high-emitting stocks that have ambitious decarbonisation plans. If portfolio managers invest in companies that are high emitters, this raises the portfolio GHG footprint or intensity. By setting portfolio-level targets, the portfolio may be limited in how much it holds in specific companies – even if they have ambitious decarbonisation plans in place. This issue may be somewhat alleviated by using forward-looking criteria and metrics. There is recognition of a variety of circumstances where, in order to provide future solutions, carbon emissions may need to rise first.

Factors beyond the fund manager’s direct control 

Comparing the latest point-in-time portfolio footprint and intensity metrics with those of target pathways or benchmarks is likely to result in inappropriate comparisons due to changes in portfolio holdings, AUM and asset prices. An apples-to-apples comparison requires adjustments, sometimes referred to as re-baselining. While no widely agreed solutions are available, this space is evolving. ROBECO’s case study provides one example. PCAF has provided guidance on the issue (p78, on inflation factors) and MSCI has also suggested a framework for attributing changes in a portfolio’s carbon footprint.

Related to this is recognition of some further anomalies that may arise when measuring the latest portfolio footprint. For example, if a company suffered a temporary loss of revenues, yet emissions remain unchanged, the carbon intensity reading would rise sharply. In addition, as the bulk of portfolio GHG emissions are concentrated in a small number of sectors, small changes in holdings in those sectors could have a significant impact on portfolio metrics.

NZAOA has issued guidance that calls on asset managers to disaggregate intensity reductions that arise from different sources: “Members should account (on a disaggregated basis) for: i) the portion of the intensity reduction originating from asset purchases and disposals, ii) the portion originating from organic emissions reductions generated by assets in the portfolio, and iii) the portion that originates from changes in financial metrics.”

Commonalities of approaches across asset classes

Although our workshops and case studies focused on the listed equity space, it was apparent that many asset managers relied on company-level assessment approaches that were used across asset classes. The identification of engagement topics was also useful to both equity and fixed income managers. The Mirabaud and Eurizon case studies provided examples of these approaches.

Disclosures

Reporting and disclosure conventions are rapidly evolving. In addition to regulatory requirements and those required by investor networks, such as the NZAM initiative, we noticed some emerging good practices. These include disclosures of:

• The extent of data coverage (particularly for GHG emissions);
• The percentage of reported versus estimated data;
• The scope of net-zero commitments and alignment;
• Information about benchmarks that are used to assess issuer decarbonisation;
• Information about benchmarks that are used for portfolio comparisons;
• In-scope year-end metrics for portfolios and benchmarks;
• Performance against a selected baseline;
• Issuers with SBTi-verified targets and those with any (unverified) target.