Creating portfolios that are resilient to climate change is not just an issue of decarbonizing, says RobecoSAM’s Jacob Messina.
Investors need to take a more rounded view of the threat that global warming poses to companies, including assessing indirect ‘scope 3’ emissions that are currently under-reported, he told delegates at the fourth annual Sustainable Investment Forum that Robeco co-hosted with Allianz Global Investors in Brussels.
“Decarbonization is just a proxy – it’s a starting point,” says Messina, Head of Sustainable Investing Research at RobecoSAM. “For an asset manager selecting securities, the footprint of the portfolio does not indicate the actual risks of those holdings.”
“Understanding the company-specific risks and opportunities, including the transition risks, are essential to understanding what the company will look like in 10-20 years from now. And opportunities abound – it’s not all doom and gloom.”
RobecoSAM uses its proprietary Environmental Impact Monitoring Tool and a broad range of company data sets to assess the climate change resilience of companies, among other sustainability issues. Key factors researched are reporting levels of emissions and the company’s internal price for carbon.
It’s also not just about emissions of greenhouse gases (GHG) such as carbon dioxide which is blamed for global warming. “Looking across the whole supply chain, water-related risks will become increasingly important, and there are any number of other industry-specific questions such as fuel efficiency for airlines or auto companies,” Messina says.
“The Environmental Impact Monitoring Tool looks at four things when assessing stocks: GHG emissions, energy consumption, water use and waste generation. The aim in our sustainability focused strategies is for the resulting portfolio to have an environmental footprint that is at least 20% better than the benchmark.”
Levels of emissions are also not just those belching out of a factory chimney. They now fall into three categories, known as scope 1, 2 and 3. Scope 1 emissions are those made directly by the company, while scope 2 are those that accrue from the generation of the electricity that was used to create its products.
Scope 3 emissions are all indirect emissions that occur in the value chain; these can be produced upstream from suppliers or downstream by customers. Given their indirect nature, they are more difficult to calculate, and can also be counterintuitive. “People are often surprised how intense scope 3 emissions are in the Consumer Discretionary sector, where there is also a lot of waste,” Messina says.
“A fossil fuel producer may even have a lower impact for scope 3 emissions than a materials company, which is very labor and energy intensive, or a utilities company that generate the energy used by others. We think that scope 3 data quality is very close to the level at which we can integrate it into our portfolios systematically.”
This all means it is important to see the whole picture for the net contribution a company makes to global warming. “Carbon footprinting is a great place to start, but you have to go deeper and to understand specific companies and their plans for transitioning and mitigating their climate risks,” Messina says.
“The three areas to look are finding transition risks, transition opportunities, and the physical risks. The challenge here is that it's not a linear process – in our view, we will most likely reach a tipping point where there will be a rapid escalation of different policies and regulations which companies will quickly have to adapt to.”
“Those that don’t keep up will end up with potentially a large amount of stranded assets. We want to ensure that companies are aware of the regulations and have a strategy for future-proofing their businesses.”
“Physical risks are probably the most complicated and unclear area,” he says. “We need to understand where the assets are, what risk they're exposed to in terms of sea level rise and changing weather patterns, and what the local governments and companies are doing to defend against them.”
“What was surprising for me was that in the drought of 2018, we actually had several industries shut down in Europe. Historically low water levels on the Rhine between July and November 2018 meant production completely stopped in many places, and they had to declare force majeure for certain products.”
“Germany's economy shrank by 0.2% in the third quarter of 2018, and was flat in the fourth quarter, partly due to the supply chain disruptions from the Rhine being so low. It was really quite astounding that Europe was so badly affected by this.”