Balancing the carbon equation: how we are investing for a better climate

In 2019, there was a profound shift in awareness of – and engagement with – the climate emergency: it was the hottest year on record for the world’s oceans, the second-hottest year for global average temperatures, and wildfires raged from the US to the Amazon to Australia.

Protests were staged all over the world, led by Swedish teenage activist Greta Thunberg who encouraged young people to join in a ‘School Strike for Climate’ to protest against political inaction.

It is therefore unsurprising that as one of the most prominently debated terms of 2019, Oxford Dictionaries declared “climate emergency” the word of the year. In just 12 months, usage of the term “climate emergency” soared 10,796%¹.

But this is not something new – since 1998, extreme weather events have led to around 16,000 deaths and economic losses of $142bn on average every year. And by limiting the global temperature increase to 1.5˚C instead of 3˚C, 70% of climate-related impacts in the water, health and agriculture sectors can be avoided².

Today, climate change is an emergency – and 2020 must be the year for action. We must focus on outcomes, not intentions.

Source: Institutional Investors Group on Climate Change, Science Based Targets, and Energy and Climate Intelligence Unit, as at March 2020.

Bespoke ESG solutions

Within our Global Equities capability, one of the benefits of our investment process is the ability to tailor the investable universe and the portfolio constraints to the needs of the underlying clients. This includes meeting specific risk, reward and environmental, social and governance (ESG) requirements.

Environmental considerations are assessed primarily during the stock selection process – and the extent to which a company is exposed to environmental risks and the management of those risks is evaluated on an industry relative basis.

At a portfolio and corporate level, we also consider our exposure to climate change:

• At a portfolio level, we have worked with initiatives – such as CDP³, the Transition Pathway Initiative and the 2 Degrees Investing Initiative – to identify where risk is concentrated and pursue different approaches depending on the sector transition pathway to a low-carbon economy.
• As a company, we are members of many industry initiatives, including CA100+⁴, Institutional Investors Group on Climate Change (IIGCC), Institutional Investors Group on Climate Change (IIGCC), and the UK-China Green Finance Initiative.

Indeed, in our application of ESG considerations we use dynamic tools and a robust framework to identify material information. In addition, we are supported by our stewardship service, EOS at Federated Hermes ('EOS'). By using a combination of both quantitative and qualitative approaches, we seek to capture all relevant insights, including research and engagement updates from EOS. In turn, these insights inform our investment decisions.

Emission impossible?

There are also many different aspects of climate change that require our consideration:

• Carbon intensive assets: companies that can be highlighted using scope 1 and scope 2 carbon metrics – that is, companies within the utilities, energy and materials sectors. For companies in these sectors, standards for disclosure and management are generally higher. Within these sectors, we seek to target companies that have adopted the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD) and are already or in the process of adopting Science-Based Targets. In addition, engaging these companies is crucial: we encourage a faster adoption of lower carbon alternatives.
• Scope 3 emissions: It is here that companies are increasingly focussing their efforts as they recognise that scope 3 emissions make up the majority of their overall carbon footprint. This requires a more sophisticated total portfolio approach focussing on companies as well as suppliers, customers and end of use. The “demand-side” of the carbon equation is crucial to lowering carbon risk and for achieving the Paris goals.
• In line with the TCFD recommendations, it is our duty as investors to consider and more fully understand the carbon exposure of the companies in which we invest and, importantly, to communicate this with clients.

Of course, different asset managers will adopt different approaches to meeting clients’ needs on climate change. One of the key characteristics of the Global Equities product suite at the international business of Federated Hermes is that it is customisable: benchmarks, risk appetite, geographic regions, market sectors and weighting towards ESG exposure can be changed to meet investor needs. That means if an investor wanted to tackle their climate change concerns through an exclusion list, we would model different approaches to meet their goal.

To find out more about how we are investing for a better climate, read the full report.