PRI Awards 2019 case study: Climate VaR integration

Overview of the firm’s approach to ESG incorporation  

Neuberger Berman has developed a top-down scenario analysis tool for modelling the impact of climate change across its listed public holdings in its U.S. mutual and UCITS funds. The function of this tool is to map the risks of climate change on its portfolios, and their impact, as well as to analyse the potential opportunities. Its board of directors oversees climate-related risks as a subset of all enterprise-wide risks, and reviews the firm’s approach at least once a year. This climate-related corporate strategy means that responsibility for climate-related risks and opportunities is distributed across the firm. 

The chief officers for investment, risk and operations oversee the strategy as part of the firm’s overall management, working alongside the ESG investing team and portfolio managers.  

The ESG investing team helps the portfolio teams identify where they believe integration of climate-related risks and opportunities may be material. After evaluating the results, the portfolio managers can then choose how best to apply all the tools of active management, whether that is to engage or ultimately to sell a security when it no longer offers an attractive risk-adjusted potential return. 

As part of its broader oversight of the firm’s ESG Policy, the ESG Committee is responsible for providing overall oversight of the integration of climate-related risks and opportunities by portfolio managers. 

Neuberger Berman believes its climate strategy is important not just because clients increasingly ask about the impact of climate change, but also because it will be a crucial driver of long-term investment returns. As such, it has put in place a uniform framework for its investment professionals to evaluate the climate risk and opportunities in securities. The focus has shifted from basic analysis of companies’ carbon footprints, to getting a full understanding of the broader effects of climate change on their businesses models. 

Why this approach stands out in the market  

Neuberger Berman believes its approach is unique amongst its US peers because of:

• board oversight of the corporate strategy;
• the sheer number of holdings that are evaluated;
• the comprehensive roll out of the tool to its investment teams.  

Neuberger Berman ran scenario analyses on more than $150bn of assets under management. The ESG Investing team then met with each investment team to explain the methodology, the results and the potential climate-related risks and opportunities of each portfolio. Once each portfolio had been examined, managers then began to look at individual companies within the portfolios to see what kind of a plan they had in place to respond to climate risks or capitalise on opportunities. 

Practical examples of how the approach was applied, and challenges overcome  

Neuberger Berman applied its approach to a mutual fund where the dividend requirement meant the portfolio naturally skewed towards high climate-risk sectors, such as utilities. This meant the fund had one of the highest climate value-at-risk (VaR) exposures at the firm.  

Amongst the list of utilities with the highest climate VaR, the team determined which of them had tangible plans to find low carbon generation alternatives, and which of them they believed would benefit from increased capital expenditures. 

For example, one utility in the portfolio had a high Climate VaR as a result of its fossil-fuel generation mix and its physical location. After evaluating the favourable solar resources available, a state regulator supportive of further storm-hardening spending, and a company commitment to owning significant renewable generation, the team believed the company in question would be well-positioned relative to its peers. 

This analysis helped the team stress test the company’s long-term business plan, its assets and its capital plan, while reiterating the importance of continuous monitoring. Additionally, some clients have asked Neuberger Berman to tilt a portfolio over time to ensure the aggregate holdings are on a two-degree Celsius path, using the tool as a way to quantify and verify its alignment.  

Measurements for success and lessons learned 

As of December 2018, Neuberger Berman found a Climate VaR of -2.3% across the firm’s listed public equity holdings in the U.S. mutual funds and international UCITS range. This compared to the S&P 500 Index of -1.2%, and was in line with the Russell 2000. 

The firm attributes the higher climate VaR to the fact that its portfolios are traditionally skewed towards value stocks in the US. Such stocks inherently have more climate-risk exposed sectors, like utilities, or industrials, than the S&P 500 Index, which has a higher technology weighting.

The thematic underpinnings of certain portfolios were reinforced through this analysis, which produced a positive climate VaR for one of the portfolios with exposure to electric vehicles. This indicated the portfolio could potentially gain in value from the impact of policies to mitigate climate change. 

The firm’s listed corporate fixed income holdings in the U.S. mutual funds and international UCITS range had a climate VaR of 0.3% compared to the Bloomberg Barclays Aggregate of -0.6% as of December 2018. 

Given the VaR is estimated over 15 years, we believe these firm-wide figures represent manageable climate-related risk over that time period. However, this value-at-risk is likely to increase going forward unless we shift our portfolios to those securities with less physical and transition risk over the long-term. Therefore, Neuberger Berman will continue to monitor the climate VaR of portfolios and review the findings at least once a year with each investment team. In this way it can better incorporate climate-related risk into the investment process. 

More broadly, the findings from the scenario analysis can be applied more broadly to the firm’s own proprietary ESG ratings which are maintained on more than 1,600 companies. The results can also help Neuberger Berman to prioritise its engagement with the holdings with the highest climate-related risk, and even identify businesses it believes are well-positioned if the negative effects of climate change begin to accelerate faster than expected.

Lastly, the firm’s board and risk team can use firm-level or security-level scenario analysis to assess enterprise risk. Neuberger Berman believes this multifaceted application of forward-looking climate VaR analysis helps it better manage its portfolios over the long-term.