How strategic asset allocation can work in a net-zero world

Sarah Peasey, Director of European ESG Investing at Neuberger Berman navigates how a net-zero world will need new strategies for investors.

Insurance Investor Editorposted on Monday, February 21, 2022

Sarah Peasey, Neuberger Berman

Opportunities in strategic asset allocation are varied but require knowledge of both industries and regulatory frameworks, says Sarah Peasey, of investment manager Neuberger Berman. She says the mobilisation of private sector finance is perhaps the most important factor in the pursuit of net-zero greenhouse gas emissions in today’s investing market.

ESG issues, particularly around carbon emissions reductions, are hugely important in today’s business world

In Clear Path Analysis’s recently released Insurance Asset Management - Europe 2022 report, several market experts from insurance groups including Aviva, New Re., LV+, ReAssure, explore how to navigate the post-pandemic financial markets and what investors need to know in the recovery phase, including environmental concerns.

ESG issues, particularly around carbon emissions reductions, are hugely important in today’s business world, with many funds redirecting their emphasis to be net zero. Last year, the United Nations Climate Change Conference of the Parties (COP26) massively publicised the cause, and saw the establishment of the Glasgow Finance Alliance for Net-Zero (GFANZ).

GFANZ brings together a network of 450 financial institutions that have pledged net-zero emissions from their investments by 2050. It also builds on the progress already made by the Net-Zero Asset Managers Initiative and Net-Zero Asset Owners Alliance, Peasey explains.

“Integrating climate considerations into an investment solution like this is not simply about investing in companies with the lowest emissions today"

“The path to decarbonisation is aligned with the Paris goals and executed in line with the Institutional Investors Group on Climate Change (IIGCC) Net-Zero Investment Framework,” she explains. The mandate is designed to have a portfolio carbon footprint - Scope 1 + 2 - that declines by around 7% a year on average, bringing it 20% lower by 2025, 50% lower by 2030 and to zero by 2050.

“Integrating climate considerations into an investment solution like this is not simply about investing in companies with the lowest emissions today. It is about robust quantification of the climate risk implied and embedded in companies for the future,” she adds. “Building a net-zero investment solution requires a multi-tool approach: setting ambitious and transparent goals, agreeing to minimum standards, measuring risk and opportunity, and engaging with companies with significant value at risk to assess and encourage their mitigation strategies.

"Net-zero investment solutions should have simple objectives from the outset"

Peasey says that measuring progress by using multiple climate indicators is one of the most effective ways for investors to hit targets.

“Net-zero investment solutions should have simple objectives from the outset, with milestones in between such as 2025 and 2030 emissions reduction targets to measure to success,” she says in the report. “We use a combination of traditional looking measures including carbon intensity and absolute emissions to measure annual declines in attributable portfolio emissions.” This is on the back of also relying on more forward-looking tools, she says, such as a Climate Value-at-Risk (CVaR) framework, deploying climate scenario analysis to pinpoint where risks reside at a granular, company level. This, Peasey explains, can result in more resilient portfolios.

“The CVaR framework seeks to quantify the impact that climate change and the transition to a net-zero economy might have on companies’ equity valuations and, through a cashflow methodology, their bond yields,” she says.

CVaR helps identify the risks and opportunities associated with certain temperature rise scenarios and translates them into an economic value. CVaR assesses a company’s risk in two ways: the business risks associated with the transition toward global net-zero emissions, such as policy and legal risks, technology risks and market and reputation risks; and the physical impact risks associated with climate change itself: extreme weather events, wildfires, floods, and rising sea levels are likely to disrupt some supply chains and threaten the viability of some capital assets.

Climate transition solutions will need to be individualised and every client’s net-zero journey will be different

However, tools like this cannot work properly unless they are combined with a climate-integrated strategic asset allocation.

“The transitional and physical impacts of climate change on different asset classes and business models will vary and be both positive and negative. We believe that using a CVaR framework can help to quantify these impacts and, as an input to strategic asset allocation processes, help to enhance portfolio expected risk-adjusted returns,” says Peasey.

She adds that climate transition solutions will need to be individualised and every client’s net-zero journey will be different.

It also means the changing legal and regulatory environment over time will require investment solutions that can be dynamic and adapt to change.

To learn more about this issue and others facing insurers, read our report Insurance Asset Management Europe here.

 

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