Blog - Aligning investors’ portfolios with Net Zero

By Dafydd Elis, Director

Today (10 March 2021) sees the publication of the Institutional Investors Group on Climate Change (IIGCC)’s Net Zero Investment Framework. This blog outlines the background for the Framework, how Planetrics helped investors to test the Framework, and what we learnt through the testing process.

Investors are acting on climate

Since the 2015 Paris Agreement on climate change, there has been a growing recognition that the financial sector has a central role in limiting the impacts of climate change. Many leading financial institutions are now grappling with how they can do this in practice.

The Institutional Investors Group on Climate Change is one of the pioneers in this field. IIGCC is made up of hundreds of asset managers and asset owners, who have joined forces to collaborate on climate action.

One of the key questions for investors when considering climate change is how they can align their investment portfolios with the goals of the Paris Agreement. Doing this has two benefits. It shifts capital in a direction that supports and accelerates the transition to a low-carbon economy; and it positions portfolios to perform strongly in a world that is decarbonising.

The Net Zero Investment Framework

In 2019, the IIGCC launched the Paris Aligned Investment Initiative (PAII), to develop a practical framework to enable investors to do this.

As a result of this work, the IIGCC has now published the Net Zero Investment Framework, which provides practical recommended actions, metrics, and methodologies for investors to implement Paris alignment. By applying the Framework to their portfolios, investors can reduce their exposure to carbon-intensive activities and increase investment in climate solutions.

Since this is a new activity for investors, IIGCC has adopted a staged approach for developing the Framework. So far, the Framework covers four major asset classes – sovereign bonds, listed equities, corporate fixed income, and real estate. Other asset classes will be added in the future.

Testing the Framework with Planetrics

While the Framework was being developed, Planetrics worked with a group of investors who tested the Framework in practice on their own portfolios. The purpose of this testing phase was to verify that the Framework succeeded in aligning portfolios with the Paris goals, to understand the improvement in the portfolios’ performance in scenarios that align with the Paris goals, and to understand the practical challenges to implementing the Framework.

The investors all took their current investment portfolios (‘Current Portfolios’) and applied the Framework to them, to create ‘Paris aligned’ portfolios (‘Aligned Portfolios’). They then used the Planetrics model to compare the performance of their Current Portfolios with their Aligned Portfolios in several different climate scenarios with strong climate action that achieve the goals of the Paris Agreement.

 

Method
Testing methodology: The Planetrics model took investors’ Current and Aligned Portfolios and tested their performance under multiple climate scenarios.

 

The Planetrics model simulated the impact of each climate scenario on every individual asset in the investors’ portfolios (as far as investors’ data permitted), spanning the four asset classes included in the current iteration of the Framework: equities, corporate bonds, sovereign bonds, and real estate.

What we found

Key finding 1: The Framework succeeds in channelling capital towards Paris-aligned activities and mitigating climate-related risks for investors. What’s more, the cost of alignment in terms of risk-adjusted returns can be small. This is despite some current limitations in existing data, methodologies, and tools.

 

Alignment Benefits
The benefits of Paris-alignment: All the investors’ Aligned Portfolios performed better than the Current Portfolios under the three Paris-aligned scenarios tested.

 

Key finding 2: For equities and corporate bonds, climate impacts can be highly company-specific, and investors benefit from taking a company-specific approach to alignment. This means that investors can improve their alignment and manage risks better by taking individual companies’ climate exposure and transition strategies into account, and by engaging with companies about their climate strategies.

Key finding 3: Testing the Framework yielded several useful lessons on data and methodology which will form the basis for further collaboration and inform the future use and development of the Framework. Unsurprisingly, existing data and tools don’t fully capture drivers of climate risk for individual companies, sovereign bonds, and real estate. Investors will continue to share knowledge and collect new data in these areas.

What it means for investors

As well as generating useful lessons, the testing of the Net Zero Investment Framework indicates that investors don’t need to wait to act on climate. Despite some limitations in data and methodologies investors can act now to align their portfolios with a low carbon trajectory.

Planetrics is working with asset managers and asset owners to test their portfolios against a range of climate scenarios; understand the size of climate risks and their drivers for specific assets, sectors, and asset classes; and align their portfolios with climate goals.

Learn more

To read more about the work, visit IIGCC’s Paris Aligned Investment Initiative website.

About the author

Dafydd is a Director at Planetrics, and supports clients across a range of activities related to climate risk, including stress testing, portfolio, portfolio management, and reporting. Email Dafydd at Dafydd.Elis@planetrics.com.

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