Developing a Decarbonizing Roadmap in an Effort to Achieve Net Zero

Veena Ramani

Research Director
FCLTGlobal

Yasir Mallick

CA, CPA, CAIA, CFA

Senior Portfolio Manager
UBC Investment Management Trust Inc

Climate change continues to have a profound impact on the environment and global economy. With the unique challenges and opportunities presented in moving towards net zero, institutional investors are facing many unique challenges and opportunities in decarbonizing their portfolios.

Veena Ramani, Research Director, FCLTGlobal and Yasir Mallick, Senior Portfolio Manager, UBC Investment Management Trust Inc will provide their insights pertaining to decarbonization as institutional investors create a pathway to reducing their private market portfolios carbon footprint while aligning with their fiduciary objectives.

Institutional CONNECT: What are some of the challenges in decarbonizing investment portfolios when it comes to delivering results and aligning with fiduciary objectives?

Veena:  Climate change is now well understood as being a material investment risk and opportunity which is leading to some of the greatest shifts in asset allocation that we have seen in the last 50 years. Yet, given the unique nature of the impacts many investors struggle with how to manage climate risks, take advantage of opportunities and deliver strong returns to their clients. Many investors have started with a bottom up strategy – trying to get a sense of the current carbon footprint of the portfolio. But knowing that number doesn’t necessarily tell you what levers to pull to change the picture.

Two important challenges stand out to me in this context:

  • The time horizons in which investors are looking to make returns. Where investors are constrained to balance climate change and financial results in the short term, the options available to them for portfolio construction are limited to techniques like divestment or exclusions. This could however lead investors to miss out on meaningful investment upsides as companies transition as well as no net real world decarbonization outcomes.
  • Lack of consistent, comparable and decision useful disclosure and data from companies. This means that investors are still hampered in their ability to assess the extent to which their investments are being used drive meaningful change within companies, and building on this, their own portfolio climate impacts.

Yasir:  There are three main challenges we’ve seen that are worth noting. First, it is critically important to have agreement or consensus from governing bodies on the overall financial investment objective of the fund, such as a required return. From that starting point it can be better understood how other objectives whether it is decarbonization, divestment, or a focus on broader responsible investing objectives may impact the fund’s ability to achieve the financial objective in the short- and long-term. In addition, there needs to be an appropriate market-based benchmark that reflects the responsible investing wishes of our stakeholders.

Second, the speed at which different stakeholder groups expect the investment portfolio to transition to the decarbonization objective can vary considerably – this is borne from the general frustration that the broader global community has moved very slowly on addressing climate change and the world is now at a tipping point. This frustration borne from a lack of progress on the climate change movement is understandable, however it can lead to a desire to move very aggressively in the areas that have less of a real world impact on the crisis at hand but where activism can yield more immediate visible changes – such as the investment portfolio holdings.

Last, we should recognize the increasing challenge of decarbonizing portfolios once the low-hanging fruit has been picked. Many steps can be taken to make immediate reductions in the carbon profile of the portfolio with limited impact on the efficiency of investment implementation. Yet each additional reduction and move to decarbonize becomes increasingly difficult without actions from others (including government/policy-makers, other investors, investment managers, financial intermediaries, etc.). Reporting on progress in a measured way becomes challenging as stakeholders can see significant changes in a short period of time and then expect that momentum to continue. In this way your early success can become a disadvantage in future years where incremental reductions are less impactful.

Institutional CONNECT: What key indicators do investors need to consider when assessing the risks and opportunities within current and future portfolios when selecting assets that target for lower emissions?

Veena:  Many investors focus on greenhouse gas emissions as the critical indicator when selecting assets that would contribute to their own climate change goals. Yet, an exclusive focus on that single indicator could lead to “carbon bean counting”, and the investor is incentivized to “green” their portfolio at the cost of returns in the medium to long term, and potentially real world decarbonization outcomes.

Rather than considering emissions in exclusion, investors could consider the climate transition strategy of the asset in question, and importantly, the extent to which the assets climate transition strategy is linked to its long-term value creation plan. This would allow for capital allocation that supports not just climate change solutions, but also legacy industries that need to transition, and position themselves to take advantage of the value addition that results.

Yasir:  : In any portfolio, the sizing of any one investment idea, strategy, or theme should be proportional to its relative uncertainty. Although there appears to be global consensus developing that is influencing all capital toward a net zero or fossil fuel free global economy, the actual time frame for that transition is uncertain. In addition, what humanity is seeking to accomplish in the time frame required has never been done and so its impact on financial markets is unknown. Therefore, investors and asset owners need to evaluate active management strategies and capabilities and their ability to evolve. We believe that some early targeted investments in the climate transition theme can benefit us in two ways. First, they may offer incremental risk adjusted returns, but second, they can help us learn and develop greater insights in this space so as to be better investors over the coming 20 years as this theme takes shape. Selecting the right partners, who are experts in the theme, with a willingness to educate and share insights is an important consideration in our selection process. Investors that are too early in this theme and too concentrated may end up faring worse than those that don’t move at all. Therefore, each investor should explore early investments in a measured way with high quality partners that can provide the knowledge exchange necessary to improve their understanding of the market opportunity and risks associated with the decarbonization theme.
Institutional CONNECT: What steps need to be implemented when developing a framework to promote climate resilience and achieve decarbonization goals through stakeholder engagement?

Veena: FCLTGlobal’s Climate Transition Conversation Starter identifies a series of questions that companies can ask themselves, or that investors can ask companies on how climate change impacts every aspect of their long-term strategic plan. This framework could help investors identify which companies are best positioned for long-term resilient performance and real world decarbonization. These questions in the framework touch on every aspect of the company’s long-term strategic plan. These include considering how climate change affects:

  • The corporate purpose, or the company’s reason for being
  • The organization’s external operating environment
  • Implementation plans, long term goals and KPIs
  • Capital allocation plans
  • Risk management plans
  • Corporate governance systems, including accountability and implementation plans

Developing a strategy that incorporates these elements will go a long way towards building investor trust in corporate climate ambitions. To that end, in addition to developing a strategy, investors should encourage companies to identify the right metrics that will reflect progress on the strategy and develop a robust plan to communicate the strategy to investors and other stakeholders.

Institutional CONNECT: With transparency and disclosure being vital, is the current climate related data and reporting reliable enough when it comes to communicating decarbonization strategies and progress to investors and stakeholders?
Veena: The simple answer is that it is not. The more nuanced answer is that climate change disclosure is a relatively new, still unregulated and evolving space. While there has been significant growth in the number of companies that disclose, in the absence of regulations, companies have made individual and differentiated choices on what to disclose, how much to disclose and which indicators to use – which has resulted in disclosures that are not comparable – and are therefore not decision useful. Also, most climate change disclosures are not externally verified. The growth of regulations and proposed regulations from jurisdictions ranging from UK, to Singapore, Canada and even the US, will start to address these issues.

Yasir: We are still early in the data measurement period and believe that frameworks such as TCFD will help spur data and analytic improvements in both public and private markets. The challenge for us is navigating this evolution and making sure that our reported metrics in one period are comparable with the next and, if not, being able to explain changes in measurement frameworks as they occur.

As the calculation and methodologies for measuring portfolio-related emissions can be technical and are still evolving, a lot of informational value is lost when stakeholders simply look at a specific number without the context or understanding of period-to-period changes in measurement methodology. Very similar to risk information, the exact number is often less meaningful than the direction of travel and overall trend over time as a communication tool.

Institutional CONNECT: As investors move forward in creating a pathway to reducing carbon footprint in their private market portfolios, what are some possible deterrents to meeting their net zero goals?

Veena: As they look to decarbonize their private market portfolios, some investors may look to on funds that are exclusively oriented towards clean technology or green options – and building on that, exclude or divest from legacy or carbon intensive sectors. As noted earlier, while this may result in short term decarbonization outcomes, investors may lose the investment upside as the companies in question transition their business models and value creation approaches.

Private equity funds could also play an important role in driving the climate transition in their portfolio companies – especially given their expertise as change agents and driving performance outcomes. However, there are a few structural issues that need to be addressed first.

  • Short Fund time horizons. The investment horizon for PE funds is typically between four to seven years, which may not be sufficient time to help companies develop robust integrated climate and business transition plans and set them on a path to decarbonization.
  • Misaligned Fund incentives. The process of engaging in a business transition or transformation may result in short term impacts on fund returns as capital is reallocated to support transitioning efforts.
  • Limited Disclosure. Private companies disclose on their climate plans and performance at much lower rates than public companies. While there are a number of new efforts aimed at boosting transparency on issues like climate and diversity, these are still at the nascent stage.

Bumpy Decarbonization Pathway. As companies evolve on their transition journey, they may need to make investments that may result in a short-term increase in carbon emissions.

Yasir: It’s important to remember that investors that are working toward non-financial targets, such as net zero goals are operating with increasing portfolio constraints that the broad investment universe still is not. A portfolio that is lagging its benchmark or lagging peers creates short-term risk that can impact an investment team and impact the commitment to the non-financial objectives of our stakeholders. Further, the advancement toward non-financial objectives is continuously driven by peer risk whereby stakeholders look at other institutions and measure progress relative to others.

Therefore, when an institution plans to announce long term non-financial targets, it is important to ensure a clear framework exists, a long-term plan is outlined, and that this framework and plan is continuously reinforced to ensure consistency in the communication of the firm’s progress relative to its goals.

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Veena Ramani

Research Director

FCLTGlobal

Veena Ramani is an expert in corporate governance, climate change and ESG issues. Veena comes to FCLTGlobal after 15 years at Ceres, a leading sustainability nonprofit. During this time, Veena played a number of roles including launching a program on corporate governance, creating online training curriculum for board directors on ESG (in partnership with the Berkeley School of Law), jumpstarting efforts to engage financial regulators on the systemic risk of climate change and engaging with large global companies on their sustainability and climate change strategies and disclosures.
Veena has published and presented extensively on these topics. Key publications include Turning up the Heat: The need for urgent action from US financial regulators on climate change (2021); Addressing Climate Change as a Systemic Risk: A role for financial market regulators (2020); Running the Risk: How corporate boards can oversee ESG issues (2019) and Systems rule: How board governance drives sustainability performance (2017).
Prior to Ceres, Veena held roles at CDM Smith and Integrative Strategies Forum. Veena has also practiced law in India.
Veena is a board director of Norcross Wildlife Sanctuary and Foundation, which is an 8000 acre refuge created to preserve, protect and propagate native flora and fauna in Western Massachusetts. She holds a BA (Hons) LL.B degree from the National Law School of India University and an LL.M degree from the Washington University School of Law.

Yasir Mallick

CA, CPA, CAIA, CFA

Senior Portfolio Manager

UBC Investment Management Trust Inc

Yasir Mallick plays a lead role in sourcing, monitoring, and evaluating external managers across both public and private markets. In addition, to manager selection and portfolio construction Yasir leads various strategic projects including governance, corporate strategy, investment framework, and redesign of investment related processes and procedures.

Yasir joined UBC IMANT in 2020. In his prior role with KPMG, he was responsible for leading the target operating model design and implementations for Asset Management clients which included design and implementation of a new target operating model and new order management system for one of Canada’s largest pension funds. In addition to delivery within Management Consulting, Yasir was also part of the KPMG Sustainability Team carrying out ESG and Responsible Investing due diligence engagements for private market investments executed by one of Canada’s largest pension funds. Prior to KPMG, Yasir spent three years as a member of the Senior Investment Team and the Head of Private Markets at University Toronto Asset Management and six years at Ontario Power Generation (OPG) where he held various positions within the Finance and Treasury group including leading the Total Portfolio Management and Risk Management group overseeing OPG’s $30B investment portfolio.

Yasir holds both a Bachelor of Commerce (B. Comm) and a Masters of Finance (MFin) degree from the University of Toronto. Yasir is a member of the Chartered Professional Accountants of Ontario (CA, CPA) and holds the Chartered Financial Analyst (CFA) and Chartered Alternative Investment Analyst designations (CAIA).

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