Robeco started offering clients sustainable investments long before climate change became a global concern. Today, from bespoke funds to more thematic strategies targeting the long-term effects of global warming, we’re still at the forefront of climate solutions.
During the recent lockdowns, there was a mismatch between energy supply and demand (i.e., lower demand for power and high renewables supply), leading to an increased interest in energy storage systems.
Forestry, recognized in the Paris Agreement as a key part of the solution to climate change, is increasingly relevant for investors looking for sustainable long-term returns and environmental and social benefits.
Renewable energy sources and energy networks and distribution are also seen as attractive investment opportunities by many investors, along with energy efficiency. Wind power and solar energy score the highest.
“Lowering the carbon footprints of our portfolios by divesting simply means that carbon ends up in the portfolio of another investor, and the world stays the same. That's why it's important that we also engage with those companies, so that decarbonization really becomes part of their business strategy.”
“Decarbonization has to be part of the way that companies think about long-term value creation. That's the true essence of decarbonization – that there is a new business model based on the low-carbon economy.”
The circular economy begins where linear models end by looping discarded output back into the production cycle. Instead of extracting more resources to use as input for production, circular solutions focus on recycling, repairing, and reusing existing materials. In the circular economy, value is rescued and redeployed rather than destroyed.Our Circular Economy and Smart Materials strategies invest in companies at the intersection of sustainability and technology that are creating innovative solutions to help balance resource use and economic growth.
The damaging effects of linear supply chains within the global economy are hard to escape. Excess waste piled in landfills, littered along coastlines, and trapped in polluted air are all visible vestiges of a ‘take, make, use, and dispose’ paradigm fueled by business and devoured by consumers.
But excessive outputs are only one part of the problem, endless extraction of natural resources to use as input for production is also a serious environmental threat. Circular economy principles help by leveraging every part of the supply chain in order to reduce resource use and maximize input to its fullest potential.
Redesigning input focuses on reducing waste in the early stages of the supply chain by substituting scarce resources with renewable ones and polluting input with cleaner alternatives. The use of virgin plastics in product packaging is an illustrative example. Plastic feedstock is cheap to source and manufacture but devastatingly costly for the environment. Billions of metric tons have been created in the last few decades, most of which (91%) was quickly used before being discarded.Each year millions of tons are burned in waste plants or dumped in landfill and oceans, with devastating environmental consequences. Plastic incineration contributes significantly to greenhouse gas emissions, and plastic litter in oceans entangles aquatic wildlife, damages aquatic habitats and threatens biodiversity.
But circular solutions are available. Renewable inputs incorporate bio-based materials like plant fibers, algae oils, and complex proteins into packaging, that reduce the need for plastic feedstock.Renewable alternatives and more energy-efficient substitutes are being applied not just to plastic consumer packaging but to other products within other industrial sectors. For example, in the industrial sector, lightweight carbon fibers can replace heavy steel in vehicles and machinery to reduce fuel consumption. Moreover, in construction, bio-plastics are being used to improve the durability of building materials while still remaining eco-friendly. In farming, agri-biologicals are replacing chemical-based fertilizers to protect and nourish plants naturally instead of synthetically.
Extending a product’s useful life is another key aspect of the circular economy. Here, applying concepts of modular design can help. Modular-designed products can be easily disassembled so that worn-out parts can be replaced or refurbished. In addition, full-service repair and maintenance services that keep products fit and optimally functioning are also important for reducing physical waste.
Inevitably, products do wear out, which, in the linear model, landed them in the trash heap. However, circular economy solutions use ingenuity and technology to loop expired products back into the production cycle. Companies focused on recycling and end-of-life management systems recover embedded value from disposed products for re-use as inputs in the production cycles of new products or services.
Transforming conventional supply chains is a herculean hurdle and wouldn’t be possible without a major thrust from technology. But the scope, speed and scale of digital platforms for commerce are opening up new possibilities to apply circular economy principles to later stages of the supply chain. The success of the “sharing economy” that allows consumers and suppliers to collaborate and collectively consume existing assets (e.g. cars, drivers, rooms and offices) demonstrates the combined power of circular principles and technology.
But sharing principles are also happening upstream in the value chain, helping to increase collaboration and reduce inefficiencies in the design, production, use, and recycling phases. Manufacturing and production are currently dominated by inflexible, mechanical and physical processes. Robotics, automation and software are modular and highly adaptable so they can be reprogrammed to respond to changing business needs.
Moreover, augmented reality (AR), the Internet of Things (IoT) and cloud-based technologies connect sensors in factories with interfaces on remote devices that provide valuable information and a seamless connection between designers, manufacturers, suppliers and even customers. The result is improved product design, enhanced quality, reduced costs, accelerated production, and facilitated waste capture, recycling, and end-of-life management.
Our Circular Economy and Smart Materials strategies invest in the technologies that are removing inefficiency and waste in supply chains and preserving resources for future generations. Participating investors not only have access to sustainable, long-term growth themes, but they are also helping extend a lifeline to a planet in need of rescue.
From field to fork, smart farming uses technology to optimize resources, improve yields, reduce waste, conserve biodiversity and increase food security across the food value chain. Our Sustainable Water and Circular Economy Equities strategies invest in companies focused on applying technological advancements that target depleting water supplies as well as smart farming techniques for soil and crop management.
The UN estimates that by 2050 human populations will grow to 9.7 billion. That means more than 65 million additional mouths need feeding every year, adding pressure on food and agricultural sectors to produce more to keep pace. Moreover, land is getting even scarcer as populations and cities expand exponentially. The number of megacities – defined as having more than 10 million inhabitants – is increasing worldwide, particularly in developing markets.
Land is not the only critical resource in short supply. As populations boom, so does their water consumption. Global water demand already exceeds supply, with two billion people currently living in areas of acute water stress.
Moreover, water withdrawals are dominated by the agricultural sector, as the water used to produce food is exponentially more than what is used for personal consumption. To illustrate, just one apple requires more than 70 liters of water to produce.
Worldwide, dietary habits are shifting from staples such as roots, tubers and cereal grains towards animal proteins like meat and dairy that demand exponentially greater inputs of water and other resources. Though some of these shifts are healthy and desirable, they are also resource-intensive and costly and intensify pressure on water supplies. For example, producing one kilogram of beef requires 15,000 liters of water.
Furthermore, to transport water to fields and farms, efficient networks of pumps, pipes valves and irrigation systems are needed. Thanks to digitalization, these networks and systems are being equipped with sensors that rapidly detect leaks and breaks, monitor soil moisture levels, and customize water doses according to soil need. In addition, advances in water treatment and analytics are helping identify and extract chemicals, fertilizers, and contaminants from waste and run-off water so that it can be safely returned to the environment or recycled back into the system.
Finally, the importance of water extends beyond hydrating and nourishing crops. Improving soil’s water retention helps restore organic matter and reduce erosion. This leads to more nutritious crops and healthier livestock.
Ensuring safe water supplies isn’t the only approach to sustainable agriculture. From plants to plates, our Circular Economy strategy is investing in solutions that increase efficiencies across farming and food systems. Smart farming’s focus on reducing inputs and protecting soils and vegetation makes it an area ripe for application of circularity principles. GPS technology is already widely used to navigate tractors and harvesters, reducing costs and CO2 emissions associated with operating farming machinery.
Moreover, AI and machine learning can teach agricultural equipment to detect weeds in fields and to automatically apply crop protection chemicals with unprecedented precision and accuracy.
As a result, the volume of chemicals required can be reduced by up to 90%, significantly protecting biodiversity without compromising crop yields.
Population growth, scarce resources and climate change are straining the agricultural sector as well as the environment. Our Sustainable Water and Circular Economy investment strategies are helping address these challenges by providing solutions that are not only effective and efficient for crops and livestock, but also beneficial for all life on the planet.
As electrification spreads and demand for electricity increases, the energy generated will need to be consumed efficiently. Next-generation technologies are helping to reduce energy consumption in power-hungry applications and end-user devices in buildings, industrials, transportation and IT sectors.
Our Smart Energy and Smart Mobility strategies invest across the clean energy and transportation value chains, providing investors diversified exposure to the megatrends of decarbonization and sustainable mobility.
Populations and economies need energy. Unfortunately, primary energy supplies are still dominated by hydrocarbons, and global carbon emissions continue to rise. The urgency of climate change has propelled efforts to “green” the global economy, triggering disruptive innovation that is rapidly altering the energy landscape.
Governments worldwide have announced massive new initiatives aimed at decarbonizing entire economies. Prominent among them are strong commitments from the US and China, which are finally aligned with global ambitions to tackle climate change.
The electrification of the transport sector has already developed considerable momentum in recent years and will continue to be an important theme for energy-related investments. Electric vehicle (EV) sales have risen sharply in key markets like Europe and China and should remain strong. Again, internal estimates show global EV sales in 2021 nearly doubling from 2020 which was already an extraordinary year marked by 130% year-on-year growth in Europe and a significant rebound in China towards year end.The strategies’ investments in transportation are not limited to EV producers; they also cover a whole range of ancillary companies within the EV ecosystem that supply essential parts such as power semiconductors, battery storage, sensors and actuators, as well as EV charging infrastructure.
Transport is not the only high-emission sector being transformed by electrification; the built environment is also in transition. According to the International Energy Agency, buildings and building construction combined are responsible for over a third of final energy consumption globally and nearly 40% of direct and indirect carbon emissions.
Driven by stricter emission standards and the prospect of lower energy costs, commercial buildings are turning to clean electrification to power and regulate everything from heat pumps and cooling to energy-efficient lighting and building management systems.
The trend towards electrification is also driving other essential parts of the energy equation. Solar and wind power are clean but also weather dependent and intermittent. Cheap solutions must be created to temporarily store any surplus energy generated. Within passenger transport, lithium ion batteries within electric vehicles are providing cost-effective energy storage solutions; and further improvements are on the horizon.
Larger-scale industries are more energy intensive and difficult to electrify, but even here clean solutions are emerging. Green hydrogen is created by splitting water into hydrogen fuel and oxygen using carbon-free electricity from renewables. As it scales and becomes more cost-competitive, it will provide a critical link in decarbonizing high-carbon emitting industries like long-haul transportation (e.g. trucks, trains, ships and aircraft) and industrial sectors (e.g. semiconductors, fertilizers, and steel production).
Decarbonization of energy goes well beyond the production of solar panels and wind turbines. Reaching net zero in this century will require transformation across the entire energy value chain.
Our Smart Energy and Smart Mobility strategies give investors diversified exposure to these long-term investment trends that are transforming the energy sector and moving us closer to a carbon-neutral future.
How will Robeco’s recent announcements translate for quantitative equity strategies in the short term?
“We now plan to bring several of our ‘sustainability-focused’ strategies in line with the Paris Climate Accord in the coming months. Robeco has a broad range of quant equity strategies, that all integrate sustainability aspects to some degree. Within that subset, we have a ‘sustainability-focused’ range, intended for investors who have preferences that go beyond basic sustainability integration.”
“These quant equity strategies have a dual objective: performance and a strong sustainability profile. Their purpose has always been to lead the way in terms of sustainability integration. So, given the increasing emphasis put by the asset management industry on sustainability and climate risk, we consider it a natural step to bring these in line with the Paris agreement.”
When you say ‘now’, you mean ‘now’, right?
“Yes. We have actually already started. The first quant equity strategy to become ‘Paris-aligned’ is one of our Global Sustainable Conservative Equity strategies, for which we have already completed the client consultation process and received the greenlight from existing clients.”
“The most important change is a much stricter carbon footprint reduction objective. Our entire sustainable quant equity range already had a reduction objective of 20% relative to its reference index. For the Paris-aligned strategy, we implement a 50% reduction as a starting point. In addition, we target a 7% footprint reduction every year thereafter.”
This sounds like a very fast transition. How is that possible?
“We do not start from scratch. Our ‘sustainability-focused’ strategies already feature a carbon footprint reduction close to the 50% level we set as a starting point. Obviously, the 7% reduction will become an additional constraint in the future. But we think we can make this migration while keeping turnover at reasonable levels.”
Actually, how do you reduce the carbon footprint of these strategies in practice?
“So, to give you an example, while our sustainable quant equity portfolios already have a low exposure to the energy sector, restrictions will become even stricter once they are Paris-aligned. Companies involved with thermal coal will naturally be excluded, and so will most oil & gas companies, especially the oil majors. Restrictions on electric utilities will also be much tighter.”
“Apart from these stricter exclusions, the carbon intensity of companies will be a key component in portfolio construction. Stocks with relatively low carbon footprints will have a higher probability of being selected in the portfolio compared to stocks with high carbon footprints.”
Decarbonizing portfolios will necessarily have an impact on their risk/return profile. What consequences should investors expect?
“We have thoroughly researched this aspect. Our simulations show that we can build Paris-aligned portfolios that still enable strong factor exposures. In theory, limiting the opportunity set should bear some cost in terms of performance.”
“And this is what we actually find, although in a global investment universe with ample investment opportunities the impact is limited: Paris-aligned quant equity strategies would be able to capture about 90% to 95% of the risk-return potential compared to the standard quant equity strategies.”
“But these simulations are based on past prices and therefore assume that there is no alpha potential from getting a strategy Paris-aligned. If climate change-related risks, like stranded assets or transition risks, rise and materialize, then we will not be discussing the negative impact of getting Paris-aligned but rather its positive effect. So, it is also a matter of perspective.”
There’s been much talk about the need to decarbonize investments, in order to meet targets that mitigate climate change. What does this require of investors? Is a simple tweaking of existing portfolios, to improve their sustainability criteria, enough, or do asset managers need to make more fundamental changes?
Our view is that asset managers have a responsibility to identify and manage climate change risks through the investment decisions they make and the contact they have with investee companies and other institutions. Making superficial changes to existing investment processes is not enough.
Instead, a bold new approach is needed, based on a credible and well-founded understanding of sustainable investing, that is embedded in all aspects of the investment approach.
Robeco is able to harness its extensive know-how and proprietary processes to invest in line with the targets of the Paris Agreement. Specifically, we have pioneered a new investment solution for climate and decarbonization, by launching the world’s first global fixed income strategies that are fully aligned with the Paris Agreement: the Climate Global Bonds and Climate Global Credit strategies.
The Robeco Climate Global Fixed Income capability is a unique solution that reflects the decarbonization plan set out by the Intergovernmental Panel on Climate Change. The Climate Global Bonds and Climate Global Credits strategies invest in global fixed income assets in a way that strives to keep the rise in global temperatures well below 2°C above pre-industrial levels, and aims to limit it even further to 1.5°C.
These two strategies provide for a 7% year-on-year decline in the portfolios’ overall emission intensity. This is measured per capita for sovereigns and per unit of total capital for corporates. The Climate Global Credit strategy goes even further, by starting with a 50% lower emission intensity than the investment universe at inception, and excluding fossil fuel production. The two strategies are managed against new indices that are aligned with the terms of the Paris Agreement. What’s more, Climate Global Bonds is the world’s first global fixed income strategy to be fully aligned with Paris.
Importantly, the regulatory requirements for a Paris-aligned Benchmark exceed the requirements of the Paris commitment. It is therefore appropriate that the EU Technical Group on Sustainable Finance describes Paris-aligned Benchmarks as “tools for investors with the willingness to be at the forefront of the transition, favoring today the players of tomorrow’s economy”.1
The high standards Robeco pursues in following a demanding carbon-reduction trajectory for our investment portfolios reflect our commitment to combating climate change.1 The EU Technical Expert Group on Sustainable Finance, “Report on Benchmarks”, September 2019.
Robeco Climate Global Bonds and Robeco Climate Global Credits are active investment strategies that build on our established global fixed income capability. They combine our top-down perspective on the macroeconomic and credit cycles with bottom-up issuer selection, to navigate market cycles, exploit market inefficiencies, and contribute positively to sustainable activity. Climate change considerations are fully integrated in the investment process and portfolio construction, across multiple components.
The investment approach is contrarian, value focused and research driven – backed by a highly experienced team of nearly 30 macro and credit analysts, who are able to identify the best opportunities in global fixed income markets. The Robeco Sustainable Investing Center of Expertise shares its input with the investment teams and our data scientist team provides insight into greenhouse gas emissions and their varying intensities.
The top-down view is combined with bottom-up issuer selection that is grounded in rigorous fundamental research and contributes positively to sustainable economic activity. Robeco’s team of seasoned fixed income professionals filter down the available investment universe to a select list of issuers. This incorporates sector, country as well as environmental, social and governance (ESG) considerations.
We select issuers by factoring in the CO2 emission intensity of governments, sectors and companies. This ensures that the strategy follows a decarbonization trajectory that reduces the portfolio’s overall emission intensity by 7% on a year-on-year basis.
Victor Verberk - CIO Fixed Income and Sustainability
Robeco innovated in this area by working with Solactive to create Paris-aligned Benchmarks for fixed income investing – for corporate credits and aggregate bonds. These are the indices against which the performance of the Robeco Climate Global Fixed Income strategies is measured.
The benchmarks start with a lower CO2 emission intensity than the global market universe as a reference intensity, and will decarbonize at a rate of 7% per annum relative to the starting point. In the case of the Paris-aligned index for credits, the starting point will be 50% below the broader market, in line with the EU Benchmark Regulation for Paris-aligned Benchmarks.
For corporate bonds:
For sovereign bonds:
Despite these carbon-related constraints, we find that the index characteristics mimic those of the general market over time. Specifically, back-testing of the Solactive Paris-aligned Benchmark Indices for credits and bonds against the Solactive Global indices for credits and bonds gives favorable results: the behavior and yield characteristics of the Paris-aligned indices are very similar to those of their equivalent generic indices, with the important difference being that the Paris-aligned indices have a much lower carbon footprint.