Harnessing investment opportunities while saving Earth

Pictet’s new framework aims to help investors choose the companies that are fully committed to a net-zero emissions future.

The climate crisis is the world’s greatest challenge, but the transition to a more sustainable future also represents the biggest investment opportunity of our lifetime, says Pictet Wealth Management’s head of ESG Rosa Sangiorgio.

Yet, choosing the right investments – so that one not only makes the best use of the opportunities ahead, but also imparts a positive impact on the environment – can be tricky.

Recognising this, Pictet has come up with a framework to guide investors in choosing companies that are fully committed to a net-zero emissions future, which it calls “net-zero transition leaders”.

Its screening process purports to help investors determine which companies embody the necessary traits.

Rosa Sangiorgio - portrait square
“Our framework is simple to understand, complete with quantitative and qualitative considerations, and uses mainly publicly available data.”

Rosa Sangiorgio

Head of ESG, Pictet Wealth Management

To begin with, investors need to understand the transition that the global economy is undergoing.

“Climate change is a key topic for our future,” said Sangiorgio. “The current linear model, which generates negative externalities through the free use and degradation of the Earth’s natural resources and ecosystem services, is not viable anymore. There is a systemic transformation happening that impacts everything from energy and infrastructure to how we feed ourselves and travel. “It is the biggest investment opportunity of our lifetime.”

From an investment perspective, Pictet believes that climate-change considerations will become more visible in valuations through risk premiums, revenue growth, free cash flow and margins. “Companies with ambitious plans towards net-zero emissions will allocate significant resources to, and accelerate demand for, the climate solutions that will enable the transition,” Sangiorgio said.

Typical climate investment opportunities can be found in the areas of renewable energy generation, energy efficiency-focused businesses, green buildings, and technologies – such as battery storage and smart grids – which are critical accompaniments in the transition to a low-carbon economy.

But identifying the right targets can be a complicated endeavour. For example, while nearly one-third of the world’s largest 2,000 listed companies have now made net-zero commitments, there are many that have yet to set net-zero targets, and the majority still lack detailed, science-based plans for achieving them. There is also the risk of overreliance on offsets that skirt the need to make deep reductions in absolute emissions.

And so, Pictet, in its recently published white paper, “Demystifying Net Zero”, co-authored by Sangiorgio, detailed a screening process by which investors can identify true net-zero transition leaders – companies with robust commitments and plans to meaningfully reduce greenhouse gas (GHG) emissions.

“Investors can address transition and physical risks and capitalise on the investment opportunity by investing in companies that are fully committed to a net-zero emissions future (the aforementioned net-zero transition leaders),” Sangiorgio said.

Pictet defines transition risks as those associated with the process of mitigating climate change and transitioning to a low-carbon economy, while physical risks relate to those associated with higher severity and incidence of extreme weather events, or more gradual changes in climate.
“We take a forward-looking view on which corporates are performing best on climate, long- and short-term targets, governance, strategy and investment plans. This information can help indicate which companies are undertaking a credible transition, and conversely where the low-carbon transition poses a greater risk.

“Our framework is at the same time simple to understand, complete with quantitative and qualitative considerations, and uses mainly publicly available data,” Sangiorgio added.

Pictet’s framework advocates that investors look at 4 areas, in choosing their targets: suitability, climate relevance, intentionality and measurability.

Suitability

Pictet believes investors should begin evaluating their targets with an ESG-integrated financial analysis, which should include considerations about any physical and transition risks, and ensure that the target companies “do no significant harm”.

“The current linear model, which generates negative externalities through the free use and degradation of the Earth’s natural resources and ecosystem services, is not viable anymore.”

Climate relevance

Investors should ensure that target companies influence sufficient emissions for their absolute reductions to be impactful; they should also bear in mind how much indirect emissions these companies can reasonably influence.

As a rough guide, Pictet considers a company to be “relevant” from a climate-impact perspective when it emits more than 2 million tonnes of carbon dioxide (CO2) emissions per year.

Intentionality

Investors should look for companies that are intentional in their strategy. Pictet believes that companies that set ambitious targets today will gain a competitive advantage in the years to come, and that it is important that companies demonstrate their commitment to these targets by adopting the climate-governance processes and disclosure practices required.

Sound climate governance encompasses a comprehensive approach to managing climate change-related risks and reducing GHG emissions, Sangiorgio said. These include executive- and board-level oversight on climate, incentive-alignment mechanisms around climate, a process to identify and assess and manage climate risks and opportunities, and detailed disclosures in-line with the Task Force on Climate-Related Financial Disclosures (TCFD).

Track records are also important, and investors should look at the measures a company has already taken, which can be indicative of how committed it is to its future transition plans.

Measurability

Measurability, or an investor’s ability to track a company’s progress against targets, is critical because great plans – or intentionality – do not always translate into real progress, Sangiorgio stressed. Progress against these targets can be tracked against a company’s disclosures, including its sustainability reports

As for how investors can make the best use of Pictet’s framework, based on their individual objectives, Sangiorgio sees 3 “use cases” being implemented by investors: “Some investors use this framework to understand the ‘quality’ of their existing portfolio. Others use this framework to engage with the companies that they have in their portfolio and require them to move in the direction of net zero. And some use it to positively screen companies that are leaders in the space.”

She cautioned that data coverage and availability are rapidly evolving and that the landscape of available information and their trustworthiness is changing quickly. Investors should therefore be prudent in how they collect and analyse the information related to their investments.

“A high correlation between the same information gathered by different data providers is a good sign, so gathering more than one source of information is key. Data collected from the company and reviewed by auditors are usually more trustworthy than estimation; but, if the 2 are very different, then it is better to investigate. And calculation methods may change over time, so it is key to understand how the data has been gathered or calculated to avoid assuming patterns that are not there,” she explained.

michquah@sph.com.sg
@MichelleQuahBT

Source: The Business Times © SPH Media Limited. Permission required for reproduction.