Fast reading
- Encouraging carbon-intensive companies to implement decarbonisation strategies is crucial to bringing down global emissions and supporting the transition to net zero.
- Investors are in an important position to affect real change among high-emitting companies through purposeful and effective engagement.
- The greatest potential for improvement lies with small- and mid-cap (SMID) companies, in our view. The US, in particular, offers unique improvement opportunities on this front.
The scale of the challenge posed by climate change is now well documented. We know that 2023 was by far the warmest on record1 and the UK Met Office forecasts the global temperature for 2024 to be potentially warmer still2.
Meeting the goals of the 2015 Paris Agreement requires a complete transformation of the economy, radically reducing global greenhouse gas (GHG) emissions. It is an enormous and expensive task, putting the climate at the forefront of economic models – and therefore, investment outcomes – in the decades ahead. The targets set out by the Paris Agreement cannot be met unless investors play their part in enabling and incentivising change.
One can characterise low emissions portfolios as meaning that, at best, the investor will have a clean portfolio in a dirty planet.
Role of investors
More than 325 asset managers representing over US$57tn of assets have signed up to the Net Zero Asset Managers Initiative – and Federated Hermes Limited is among them3. Within public equities, investors can adopt varying approaches:
- Ditching ‘emitters’ and investing in companies that generate ‘green’ revenues.
- Shifting investments from higher- to lower-emitting companies within sectors.
- Engaging with portfolio companies to catalyse and accelerate implementation of decarbonisation strategies.
The first set of approaches, where portfolios are tilted towards sectors with relatively lower emissions, may be fully de-linked from real-world decarbonisation. There is a risk that with portfolio carbon footprint metrics gaining more attention, we reward actions that ultimately make little real difference. One can characterise low emissions portfolios as meaning that, at best, the investor will have a clean portfolio in a dirty planet.
In the third approach listed, portfolio emissions may be higher for longer, but real-world emissions should over time reduce.
Figure 1: Net zero targets among names held three-plus years
We need to get our hands dirty
Purposeful engagement is arguably the principal mechanism through which investors can have an influence with their investee companies. This still has caveats, namely:
- Not all companies and industries will be receptive to engagement. Many of the highest emitting sectors will still exist, and likely remain vitally important, in a net-zero economy. Others will not. Therefore, engagement should not be used as a fig leaf to enable ‘investing as usual’.
- Change typically requires capital expenditure and results will not be immediate. Patience and support are needed.
- What matters most are the emissions reductions rather than the establishment of policies and targets. We should avoid focusing disproportionately on form over substance.
Figure 2: Proportion of portfolio companies today meeting various expectations
Lower emissions tomorrow
Investors’ net-zero commitments need to be met, and it is clear that shifting to low-emissions portfolios will only pay lip-service to the ultimate goal of real-world emissions reductions. Working with the higher emitters is, in our view, a far more effective way to bring about the change we need.
Hence why the Federated Hermes SDG Engagement Equity Strategy has been structurally overweight energy-intensive industries since inception.
We also recognise, however, that engagement with certain sectors by itself is unlikely to result in meaningful change – and real progress is more likely to derive from regulatory amendments and shifts in customer demand.
We are looking for companies that have an ongoing role in a low-carbon economy, but which can benefit from engagement to embolden and accelerate their green transition as well as enhance their efforts to communicate their strategy – and the execution thereof – to the market.
We believe that, through our engagement, we can help expedite emissions reductions, and that this will enhance the resilience – and sustainable future success – of the investee companies.
Figure 3: SDG Engagement Equity – median three-year GHG intensity reduction
Focusing on SMIDs
In addition to focusing on higher emitting industries, the Strategy is also SMID-focused because this area of the market has the greatest potential for improvement. The US, in particular, offers unique improvement opportunities and it is no surprise that the Strategy’s principal emitter4 is a US cement company.
Eagle Materials case study
Eagle Materials is the second-largest domestic-only US cement producer – producing approximately 6% of total US clinker5 capacity6.
Cement is the key ingredient in concrete, which is the world’s most common building material. It is also the most used material in the world after water. Unfortunately, however, cement manufacturing is inherently carbon intensive.
According to the IEA, the sector will need to reduce annual CO2 intensity by 4% through to 2030 if it is to get on track with the Net-Zero-Emissions-by-2050 scenario. Measures to reduce emissions include the reduction of the clinker-to-cement ratio through the adoption of supplementary cement materials, the adoption of low-carbon fuels, and the capture of residual CO2 emissions.
We have engaged with Eagle’s management more than 20 times since 2018. The company has not, as yet, set science-based emissions reduction targets and those targets it has set are, we believe, far too conservative. However, Eagle is taking steps to reduce its clinker content, including scaling supply of low-carbon supplementary cementitious material. Likewise, it is allocating capital to improve the efficiency of its plants. This includes the US$430m announced in May 2024 for its Wyoming based plant which will bring about a 20% reduction in carbon intensity during production. Finally, the company is collaborating with Chart Industries (in which we are also invested) to pilot its Cryogenic Carbon Capture technology – a technology that has the potential to reduce emitted carbon emissions by 90-99%7.
Eagle Materials has taken a number of positive steps, but a marked improvement is still required – in terms of its own production and across the industry at large – if this essential commodity is to support rather than hinder national and global efforts to achieve net-zero emissions.
Please read our latest SDG Engagement Equity, H1 2024 report for further insights on effective engagement.
For more information on SDG Engagement Equity.
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1 NOAA’s National Centers for Environmental Information (NCEI)
2 2024: First chance of 1.5 °C year – Met Office
3 The Net Zero Asset Managers initiative is an international group of asset managers committed, to supporting the goal of net zero greenhouse gas emissions by 2050 or sooner, in line with global efforts to limit warming to 1.5 degrees Celsius; and to supporting investing aligned with net zero emissions by 2050 or sooner.
4 On a Scope 1 and 2 basis.
5 Clinker is the backbone of cement production. It is essentially a mix of limestone and minerals that have been heated in a kiln and have been transformed by this heat
6 Company reports
7 Eagle Materials press release
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