Portfolio Insight – Cambridge Associates
How can investors build a portfolio that successfully marries a net-zero approach with long-term outperformance? Speaking as an economist, it can be done, it is all about the underlying economic drivers. Two data points are interesting: between 2002 and 2012 the cost of non-fossil fuel energy generation has fallen dramatically. Solar is down 75%, while the cost of car- bon has gone up 10 times. Additionally, there is an enormous capital cycle that needs to occur if we are to reach our net-zero objectives, credible estimates range between 2% and 4% of global GDP. The next question, of course, then is: how can it be done? I did not say it would be easy. For clients that want to work towards net zero, we help them understand where their carbon exposures are coming from and if they are spending their carbon wisely. This does not necessarily mean investors should eliminate carbon from their portfolio, because that would merely dump the problem on somebody else without making a difference. Selling assets with a high-carbon foot- print does not mean the carbon in the air changes. If you are targeting net zero, you need to change the carbon levels in the air. For example, it makes sense to spend your carbon building electric trains. It does not make sense to have passive exposures in which you are not engaging with your companies. You need to under- stand where the carbon is, then engage and invest in climate solutions. A large part of the investment in climate solutions can be achieved through private market portfolios, because within that space, so much more can be achieved in terms of decarbonising existing processes and developing new technologies.
Does following a net-zero strategy mean investors have to sacrifice return? No. What you need to sacrifice is the idea that you are going to look like an index. An index is a snapshot of the past. It’s a collection of the things that worked over
28 | portfolio institutional | December-January 2023 | Issue 119
the previous years, but net zero is an enor- mous transformation into the future. You outperform by not looking like the index. That is the first conversation we have with anybody who wants to engage with net zero. You need to set up the governance mech- anisms in your organisation to accept, understand and underwrite this objective. You need to accept that year-on-year you will have large performance deviations. For example, you looked like a hero in 2021, but you underperformed in 2022. The level of success needs to be measured over time.
How easy is it to assess the non-financial outcomes of an investment?
When it comes to non-financial returns, you need to decide what material out- comes matter. Looking at the same meas- urement for all companies is completely useless. For example, if you are measur- ing carbon output for a steel manufacturer, that is an essential metric for that busi- ness. If you are measuring the carbon output of a biotech firm, it is not business critical.
What you need to measure in terms of non-financial outcomes for a biotech company is how they are creating new drugs, for whom and how they are going to be priced? Non-financial factors need to be tailored to each company and each sector because they are going to be economically material in a different way.
Greenwashing is a big issue. What steps can investors take to avoid it? I would say that there are three things. One, investment managers who simply outsource their ESG research and scoring to MSCI/Sustainalytics or others – dem- onstrate that they do not have an integrated process. Non-financial factors are economically material when they are understood in the context of the funda- mentals for each company. ESG analysis needs to be part of the investment under- writing not something that happens out- side of it. Would you hire a bond manager who tells you that they base their investments solely on the ratings by Moody’s/Fitch or S&P? No, you would probably conclude that if they are not doing the analysis them- selves, they are not serious investors. The second point is that investors need to understand that not everything is in the data. There is a growing demand for ESG data, but ESG integration is not a score- card you just tick. If you think that way, you will invest with managers who offer pretty reporting – but you will be missing the ones who are using information to make better decisions.
And the third point on greenwashing is, look at who at the asset management firm is telling you that an ESG approach to investing is important. If it’s the head of ESG, then essentially they are under- lining that their job is important, but that does not necessarily mean that the organisation as a whole believes it.
Selling assets with a high-carbon foot- print does not mean the carbon in the air changes.
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