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IMPORTANT INFORMATION
Three technology value-chains are essential to unlocking the promise of a net-zero economy and explores the opportunities they offer
Investing in green tech – the keys to decarbonisation
Making liability matching part of our ESG mission
Practical steps to help clients tackle pressing ESG challenges and meet their cashflow need
How LGIM is positioning portfolios to help curb a climate catastrophe and generate sustainable returns for clients
The multi-asset battle against climate change
How to avert the worst climate outcomes
The longer climate action by governments, companies and investors is delayed, the more disruptive the costs
e now know that the world risks a grim future even if the global economy is decarbonised rapidly, according to a landmark report on
climate change. The assessment makes clear: inaction is simply not an option for policymakers, companies and investors.
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But the paper from the Intergovernmental Panel on Climate Change, whose investment implications we discuss in this Spotlight, not only emphasises risks such as devastating weather events. It also points towards huge opportunities for those willing to act today to have a positive impact for decades – and generations – to come.
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INVESTING TO FIGHT THE CLIMATE CRISIS
For professional clients only. Not to be distributed to retail clients. Capital at risk.
Past performance is not a guide to future performance. The value of an investment and any income taken from it is not guaranteed and can go down as well as up, you may not get back the amount you originally invested. This document is designed for the use of professional investors and their advisers. No responsibility can be accepted by Legal & General Investment Management Limited or contributors as a result of information contained in this publication. The information contained in this brochure is not intended to be, nor should be construed as investment advice nor deemed suitable to meet the needs of the investor. Nothing contained herein constitutes investment, legal, tax or other advice nor is it to be solely relied on in making an investment or other decision. The views expressed here are not necessarily those of Legal & General and Legal & General Investment Management Limited may or may not have acted upon them. This document may not be used for the purposes of an offer or solicitation to anyone in any jurisdiction in which such offer or solicitation is not authorised or to any person to whom it is unlawful to make such offer or solicitation. No party shall have any right of action against Legal & General in relation to the accuracy or completeness of the Information, or any other written or oral information made available in connection with this publication. Forward-looking statements are, by their nature, subject to significant risks and uncertainties and are based on internal forecasts and assumptions and should not be relied upon. There is no guarantee that any forecasts made will come to pass. Nothing contained herein constitutes investment, legal, tax or other advice nor is it to be solely relied on in making an investment or other decision. Contact us for further information about LGIM, please visit lgim.com or contact your usual LGIM representative As required under applicable laws Legal & General will record all telephone and electronic communications and conversations with you that result or may result in the undertaking of transactions in financial instruments on your behalf. Such records will be kept for a period of five years (or up to seven years upon request from the Financial Conduct Authority (or such successor from time to time) and will be provided to you upon request. © 2021 Legal & General Investment Management Limited. All rights reserved. No part of this publication may be reproduced or transmitted in any form or by any means, including photocopying and recording, without the written permission of the publishers. Legal & General Investment Management Limited. Registered in England and Wales No. 02091894.Registered Office: One Coleman Street, London, EC2R 5AA. Authorised and regulated by the Financial Conduct Authority, No. 119272 Legal & General Investment Management Ltd, One Coleman Street, London, EC2R 5AA Authorised and regulated by the Financial Conduct Authority.
Here we outline climate scenarios facing the world and how investors can help to avert the worst outcomes. Other topics include:
The climate scenarios facing the world
and how investors can help to avert the worst outcomes
As the global economy continues to recover from the pandemic, albeit haltingly, and in light of the COP26 summit in Glasgow, we are focusing on what the challenge posed by the climate crisis means for our clients. And how just as there is much to fear, there is also cause for hope and even excitement.
Taken together, the contributions from teams across LGIM indicate that markets are at an ESG inflection point. With the pricing of ESG factors still patchy, partly due to the availability and quality of data, there are clear advantages for investors with the capabilities to take forward-looking, strategic views of companies, sectors and markets. At the same time, accelerating long-term trends continue to present potent investment opportunities, from climate solutions to data as an asset and digitisation.
Inflection point
Indeed, is it any wonder that more and more end investors are demanding that analysis of criteria like climate risk become part-and-parcel of the investment process?
The experience of COVID-19 has intensified such demands, as the pandemic has reminded us all of the value of early, meaningful action to head off looming threats. COP26 is now over, but world leaders will have many more opportunities to demonstrate that they have learnt this lesson with regard to the era-defining challenge of climate change.
At LGIM, to highlight the urgent need for climate action, we have launched a global partnership with Lewis Pugh, the endurance swimmer and environmental campaigner, in addition to taking the steps about which you will read over the coming pages.
Lewis has recently swum across the mouth of the Ilulissat Icefjord in Greenland, the world's fastest-moving glacier, to underscore the damaging effects of climate change. Throughout this Spotlight, you will see photography of this extraordinary swim.
We are united with Lewis in our aim to tackle the climate crisis – as well as associated dangers, such as the threat to biodiversity. This mission is critical to our purpose: creating a better future through responsible investing.
Sonja Laud, Chief Investment Officer at LGIM
LEWIS PUGH endurance swimmer and environmental campaigner
LGIM's CONTRIBUTORS
Sonja Laud, Chief Investment Officer
Nick Stansbury, Head of Climate Solutions
Emiel van den Heiligenberg, Head of Asset Allocation
Anne-Marie Morris, Head of DB Solutions Strategy
Howie Li, Head of ETFs
NEXT
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Photography credit: Olle Nordell. All the photography featured in this document was taken on site in Greenland and Iceland by the Lewis Pugh Foundation. For more information, please visit lgim.com/lewis
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How asset allocators can generate sustainable returns while fighting climate change Investing in green tech as the key to decarbonisation How to address pressing environmental, social and governance (ESG) challenges while meeting long-term cashflow needs
WATCH Lewis Pugh on urgent need for climate action
Past performance is not a guide to future performance. The value of an investment and any income taken from it is not guaranteed and can go down as well as up, you may not get back the amount you originally invested.
Past performance is not reliable indicator of future performance. The value of investments and any income from them can fall as well as rise and investors may not get back the amount invested. Investing in fixed income securities comes with risks which will generally include credit risk, default risk, inflation risk and interest rate risk. Please refer to the respective offering documents for further details on the applicable risks. There is no guarantee that sustainability criteria will always be met for every investment and a negative impact on performance is possible where pursuing sustainable economic activity rather than a conventional investment policy. This is for marketing information and educational purposes only and should not be considered as investment research, investment advice or a recommendation of any particular security, strategy or investment product. Any views and opinions are those of the investment manager which are subject to change without notice and may have already been acted upon. No part of this material may be reproduced in any form without express written permission. TwentyFour Asset Management LLP is registered in England No. OC335015, and is authorised and regulated in the UK by the Financial Conduct Authority, FRN No. 481888. Registered Office: 8th Floor, The Monument Building, 11 Monument Street, London, EC3R 8AF. For further information visit the TwentyFour Asset Management website.
LEWIS PUGH
endurance swimmer and environmental campaigner
Climate scenarios
SPOTLIGHT
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At LGIM, we believe policymakers and companies cannot wait for changes in the climate to become so severe that they are forced to act. According to our research, if global emissions do not start falling until 2030, the cost of the transition will increase by five times.
must reach net zero around mid-century.
he UN’s climate panel recently published its most comprehensive assessment yet, with a clear warning: unprecedented and irreversible climate change is here – and it is only going to get worse. To minimise the impact, emissions
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The longer climate action by governments, companies and investors is delayed, the more disruptive the costs, according to Nick Stansbury, Head of Climate Solutions at LGIM
At LGIM, we use three central climate scenarios in our analysis:
Three pathways
1. The world takes no policy action, in a ‘business as usual’ pathway, consistent with global warming of around 3.5 degrees by 2100. This scenario would be associated with significant physical risks in the second half of the century, potentially resulting in widespread macroeconomic disruption and geopolitical stress.
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The science underpinning the UN report could not be clearer: governments, companies and investors must take action. We cannot wait until more and more extreme climate events force our hand.
Source.
(1) LGIM as at 27 May 2021. There is no guarantee that any forecasts, which are made for illustrative purposes only, will come to pass.
2. The world takes organised, logical policy steps to reduce global emissions at a rate fast enough for an outcome consistent with the Paris accord and well below two degrees (although not to net-zero emissions). This scenario has far smaller physical risk consequences, but is associated with moderately significant transitional risks as carbon costs rise from near zero today to around $400 a tonne by 2050, according to our research.
This is why we believe investors and their advisers must start taking concrete steps to ensure they are integrating climate analysis into their strategic frameworks. As fund managers, we can conduct this analysis and design products that channel financial resources towards mitigation and adaptation.
But the challenge goes beyond changes we can make at the fund level – climate change poses such a significant threat that we believe it needs to be considered as an issue of strategic importance by asset allocators worldwide.
Concrete steps
In our view, active engagement could also help ensure the worst outcomes are not realised. Hence our work with companies under LGIM’s Climate Impact Pledge, to encourage them to increase the quality of disclosure, set credible targets and adapt business models – with the threat of sanctions should they fall short of our expectations.
"Marine ice sheet instability in Antarctica and/or irreversible loss of the Greenland ice sheet could result in multi-metre rise in sea level over hundreds to thousands of years."
3. The world does little to address climate change until the end of the decade, thereafter attempting to reduce cumulative emissions by the amount necessary under the second scenario. This ‘disorderly’ scenario results in material macroeconomic disruption, creates a material risk of stranded assets, and pushes carbon prices to $1,000 a tonne. In addition to the consequences outlined above, each scenario would clearly hurt risk assets, with the first and third causing the most damage to markets like equities.
The physical risks from climate change – and potential policy risks from mitigation actions – will also have other profound repercussions for a broad array of assets that are unlikely to be priced in today.
IPCC, August 2021
multi-asset capability and particularly relevant to the current macro environment.
ithin the Asset Allocation team, we believe that climate change presents both urgent challenges, as outlined elsewhere in this experience, and appealing investment opportunities – some of which are unique to our
Emiel van den Heiligenberg, Head of Asset Allocation at LGIM, on how his team is positioning portfolios to help curb a climate catastrophe and generate sustainable returns for clients
As a result, we have adopted investment themes that, in our view, are likely to benefit from and hasten the global energy transition, deploying our portfolios in the fight to avert a climate catastrophe. We have also continued to future-proof those portfolios against broader ESG risks.
Markets have had an extraordinary run since the lows of March 2020. This means it is more important than ever for us to identify new investment themes and strategies to generate sustainable, long-term returns for our clients. Below are two examples.
Decarbonisation: We have built a basket of 25-30 stocks that, in our view, should benefit from the increased focus on decarbonisation and more explicit and realistic pricing of carbon emission costs, from clean energy generation to storage batteries. We aim to capitalise on this multi-trillion-dollar opportunity, which we see as a massive growth theme for the medium term, especially against a backdrop where economic output remains tepid.
Forestry: By this, we mean timberland companies that own forests and the associated lands as their main assets. Trees are a renewable resource that offer a sustainable solution to many products that the world demands. Moreover, responsible management of forests does not just protect the trees, but also the wildlife and ecosystems that depend on them.Forestry also exhibits low correlation and betas to equities and our other listed alternatives, which means its addition to our portfolios can improve overall diversification. We also see some positive, long term inflation-linked returns offered by the asset class in an investment landscape dominated by negative real yields.
More broadly, we continue to bake ESG considerations into portfolio construction, which includes establishing medium-term, decarbonisation glide paths. In addition, we stress test our portfolios using LGIM’s proprietary climate-scenario analysis, to reveal which assets are most at risk or offer the most potential upside.
Stress tests
We are also moving the equity exposures in most of our funds from standard market cap-weighted indices to ESG-integrated indices – a shift of assets in excess of £10 billion – in addition to launching multi-asset strategies with explicit ESG objectives.
In our view, strategic thinking about ESG factors should focus on two elements: Capitalising on opportunities provided by the paradigm shift in markets; and risk management by anticipating changes in how the market will price ESG risks in the future. We believe the actions listed above demonstrate this thinking in practice and show our commitment to responsible investing as a way of effecting positive change across a range of ESG topics, not least the challenge of climate change, and delivering sustainable returns to our clients.
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Anne-Marie Morris, LGIM’s Head of DB Solutions Strategy, on the practical steps to help clients tackle pressing ESG challenges and meet their cashflow needs
Given the clear financial materiality of ESG factors – and their impact on the creditworthiness of issuers – integrating these factors has been a core component of our credit research and portfolio management for many years.
challenges posed by climate change.
At LGIM, we believe both objectives are inextricably linked. Below we outline how LGIM’s Solutions team strives to meet them within liability-matching portfolios.
or long-term investors with liability payments to meet, the focus over the coming decade is likely to be investing in assets that deliver stable, long-term cashflows. But this period will also be pivotal to directing capital to address the
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Liability-matching strategies comprise assets that generate so-called contractual cashflows to increase the certainty of returns, reduce volatility and generate the funds needed to meet liability payments. At the core of such strategies are long-dated corporate bonds managed on a ‘Buy and Maintain’ basis.
Proactive stance
Growing numbers of investors are looking to take a more proactive stance on ESG themes within these portfolios, which make up an increasingly significant proportion of their overall assets, just as we are intensifying our efforts on issues like climate change. This means leveraging our proprietary toolkit to incorporate specific ESG objectives into Buy and Maintain credit mandates.
As shown below, examples include targeting net-zero carbon emissions by 2050 and improving portfolio alignment with the UN’s Sustainable Development Goals (‘SDGs’).
Integration of ESG risks into credit research process at sector and issuer level Combined with active engagement to drive change
Managing mandates to net zero / other climate objectives Leveraging our proprietary Destination@Risk climate toolkit
Managing mandates to reflect beliefs on sustainability and impact Leveraging our proprietary SDG assessment framework
ESG integrated within all portfolios
Net Zero and Paris-alignment
UN Sustainable Development Goals
1. A clear ESG objective 2. A mechanism for improving the ESG profile of the portfolio over time 3. Engagement with companies and policymakers to drive real change
Our climate-aligned portfolios are aimed at demonstrating these principles in action, illustrated by the example below.
To support investors in designing mandates that both incorporate their specific objectives and provide the flexibility to respond to the rapidly changing world, we look to adopt a consistent approach with three key principles:
Turning theory into reality
In order to construct and manage portfolios, we use our proprietary Destination@Risk climate toolkit. Our approach enables us to build portfolios that move towards a net zero target while achieving similar investment characteristics to a standard portfolio, with only a small decrease in diversification.
We have seen strong interest in this approach, as investors make clearer commitments to net zero, and now have over £1bn of assets under management implementing such strategies.
The framework evaluates to what extent companies are aligned to SDGs as a result of revenues from products or business practices that contribute to, or detract from, the goals. We classify each issuer into one of five categories: exclude, borderline negative, neutral, borderline positive and positive alignment. These feed into both portfolio construction and engagement activities, as we look to improve SDG alignment over time within the portfolio and across the wider investment universe.
Within the Solutions team, we also partner with our clients to help meet their needs and tackle pressing ESG challenges in other areas, not least Liability-Driven Investment and derivatives.
Climate risk is only one – albeit critically important – ESG factor of many. In addition to incorporating other ESG criteria in our investment process, we also use our proprietary SDG assessment framework to construct and manage portfolios that show improved alignment with the goals versus standard portfolios or benchmarks.
TARGETING SDGs
Net zero target: Target net zero by 2050 with a ‘pathway to net zero’ clearly established by 2030
Decarbonisation mechanism: Manage the portfolio to improve the temperature alignment at the outset and over time to target a temperature alignment for the portfolio of 1.5°C by 2030
Engagement with companies and policymakers: Incorporate LGIM’s Climate Impact Pledge
Three technology value-chains are essential to unlocking the promise of a net-zero economy. Howie Li, Head of ETFs at LGIM, explores the opportunities they offer
Supported both by net-zero targets becoming increasingly enshrined in law, and by scientific advances and scale effects making their adoption more economic, three technology value chains should in combination facilitate the transition to a decarbonised world and benefit from the waves of investment into climate and environmental solutions.
necessity of action at COP26, but also has a longstanding record of successful engagement on climate issues.
The importance of reshaping the existing economy is only part of the story, though; it is just as crucial to consider the new, greener economy we can create.
he need to transition to a lower-carbon economy has never been clearer. The evidence, from recent tragic extreme weather events to August’s landmark IPCC report, is compelling. We are proud that LGIM is not only a leading voice on the
About $130 trillion of investment is needed to achieve global net-zero emissions (including $20 trillion by 2025) – an essential investment in our future world, but also an investment opportunity in itself. For investors, the path to net zero is thus more than a social imperative; it is also an opportunity to align portfolios with climate objectives and invest in a long-term growth market focused on effecting positive change.
Clean energy: This market, related to the production of clean energy, spans equipment manufacturers, technology suppliers, and utilities and power producers, each of which will be vital in helping the world address the climate emergency. In our view, the market for clean energy is poised for sustained growth through a virtuous cycle of investment, technological advancement, and increased adoption.
Battery technology: Without better and more extensive battery storage, the potential of clean energy will be limited. Improved energy storage can help overcome the short-term intermittency – due to daylight hours or fluctuating weather – of renewable sources. Without an upgraded storage infrastructure, much of the electricity that could potentially be generated by renewables will be lost, and coal and gas-fired power stations will remain necessary to cover supply shortfalls. Battery technology is also integral to the process of replacing internal combustion engine vehicles with electric alternatives.
Hydrogen economy: The combination of clean energy and batteries can, however, only take the world some of the way to net zero. Many areas of the economy – such as heavy-goods vehicles, shipping, and some aspects of heavy industry and home heating – will be hard to decarbonise with just the aforementioned technologies. Hydrogen power and fuel cells are becoming a viable alternative in these spaces.
"Increasing warming amplifies the exposure of small islands, low-lying coastal areas and deltas to the risks associated with sea level rise for many human and ecological systems."
Together, these three themes can offer portfolios exposure to long-term secular growth markets, diversification potential relative to a market-cap benchmark, and a tangible ESG impact and alignment to the UN’s Sustainable Development Goals.
