Learn how we are redefining the decarbonisation opportunity
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What aspects of your investment approach played the biggest role in outperformance versus peers?
There are really two things that add to our performance and make us different from our competitors. One is agility, demonstrated by our ability to move quickly when we get new information that suggests our strategy is misaligned. The second is that we maintain a resolute focus on research, recognising that, as the world changes, we need to change our model sets and strategies to reflect it.
If we are going to successfully make this journey from where we are today to a low-carbon economy, we are going to need to avoid a lot of emissions
Scope 4, is hugely important. It could be more important than Scopes 1, 2, and 3 put together in the journey to the low-carbon economy
Why is now the right time to embrace a carbon solutions strategy?
The answer comes in two parts. The first part is just the sheer scale of the changes required to move from where we are today to a low-carbon economy. It is going to require every part of the world and most sectors of the economy in the markets to really rewire and re-engineer themselves. We think it is a multiyear, multidecade potentially, and multitrillion-dollar opportunity. The magnitude of this theme is huge.
The second part is that we think most investors are ignoring a large part of the solutions that we are going to need. They are really focusing on a small, but still very important subset – things like renewables, electric vehicles, and batteries – of what we are all going to need if we are going to get to where we all want to get to, which is a low-carbon economy with a similar or better standard of living than we have today.
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The transition to a low-carbon global economy will be a multi-decade, multi-trillion-dollar endeavour, yet most traditional strategies limit their ability to capitalise on it by emphasising renewables at the expense of less conspicuous contributors to the cause.
Client Portfolio Manager Raj Shant shares insights on the way the team at Jennison Associates, PGIM’s fundamental equity manager, is redefining decarbonisation, how a comprehensive approach can expand access to the opportunity and why now is the right time for investors to join the carbon-reduction revolution.
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Three
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Raj Shant explains how applying a broader scope to decarbonisation investing reveals a diverse
$2.5 trillion opportunity set with abundant alpha potential.
Do typical decarbonisation approaches make the most out of the opportunity given how they view traditional oil and gas producers?
However, emerging markets remain susceptible to technical factors. This year has produced the worst EM fund outflows on record, and the asset class remains vulnerable as the U.S. Federal Reserve and other central banks raise interest rates in an attempt to fight inflation.
Nevertheless, EM does tend to perform well once the path for Fed rate hiking becomes clearer. It may take some time for that to happen in this cycle, but we think EM is in a good position to outperform once that occurs.
For these reasons, at PIMCO we are constructive on emerging markets, but cautiously so for the near term.
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What sets your team’s holistic approach apart?
The key philosophical aspect is the idea of emissions avoided. If we are going to successfully make this journey from where we are today to a low-carbon economy, we are going to need to avoid a lot of emissions.
For example, imagine I am a company and I come into your company and give you lots of great advice on how to avoid wasting energy to reduce your energy demand and consumption. You may only be doing it to reduce your energy bills, and that is fine. But I am making a business out of helping you avoid future carbon emissions, and that should really count for any strategy that is playing to this kind of mega theme.
But it generally doesn't. Why? Because, firstly, most strategies tend to focus on minimizing their operational emissions Scope 1, 2 and 3, or reporting emissions falling from one quarter to the next or one year to the next. That's one part of the reason why Scope 4 often gets ignored.
Do typical decarbonisation approaches make the most out of the opportunity given how they view traditional oil and gas producers?
The short answer is no, and we think that is a function of the way that the investment community approaches carbon, climate and energy transition. Many strategies and indeed the regulatory environment really focus on reducing or having the lowest possible operational emissions. That is Scope 1, 2 and 3. How low can the emissions of the companies you hold be or, from one year to the next, focusing on how much you can reduce them by. That is the very tip of the iceberg.
If you think about the whole opportunity set much more broadly, which is what we want to do, you have to think about companies that enable other companies to avoid emissions. Emissions avoided, which in the industry jargon is called Scope 4, is hugely important. It could be more important than Scopes 1, 2, and 3 put together in the journey to the low-carbon economy and, within that consideration, we think transition fuels are being overlooked.
The other part is that it's hard. You're going to have to estimate what would your carbon emissions have looked like if my service didn't exist. Estimating counterfactuals is tough, but even though it is hard, we can all agree that it is going to be very important. Why shouldn’t we try, at least, to incorporate it into our analysis so that we can get a much broader range of investment opportunities and approach this mega theme of decarbonisation from many more perspectives than is normally the case?
This strategy is about finding companies that are underappreciated or overlooked in terms of their contributions to carbon reduction and carbon emissions avoidance. It's about generating alpha over the long term from companies benefiting from this mega theme of decarbonisation. That's in contrast, we would say, to most strategies in this thematic space that really focus much more on minimizing current operational emissions.
Comprehensive carbon strategy
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Enhanced emissions scope
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Underappreciated potential
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Understanding the opportunity
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We put a lot of effort into researching central banks and how the Federal Reserve has changed in the way it now sets policy. The Fed has switched from being proactive and trying to forecast inflation risks to reactive and waiting to see what happens before it actually moves rates.
We think the adjustments we've made there have been successful in dealing with big changes in the yield curve slope from where it was initially when the Fed wasn't moving and still talking about transitory inflation. We saw the long end selling off and the yield curve slope steepening, but then the Fed got very active and moved rates up aggressively. Eventually the yield curve didn't just flatten but inverted.
The sorts of strategies we've deployed were very successful over the last couple of years, making 40%, or so, returns on capital deployed. This should be really helpful to us in this environment where the Fed is still centre stage.
What do we mean by that? Even now, after years of great progress, coal, the dirtiest, most thermally inefficient fuel you can use, still accounts for 30% of all the energy humans create on the planet, 40% of all the electricity being generated on the planet, and 50% of all the carbon emissions. So, when you look at gas companies, we look at gas as a fuel that really helps displace coal and makes important contributions to reducing carbon emissions.
Will gas always be a decarbonisation fuel? Probably not. But we are going to go a long way in reducing the usage of coal first, and then we can think about alternative ways to reduce the usage of things like gas in the energy supply.
The short answer is no, and we think that is a function of the way that the investment community approaches carbon, climate and energy transition. Many strategies and indeed the regulatory environment really focus on reducing or having the lowest possible operational emissions. That is Scope 1, 2 and 3. How low can the emissions of the companies you hold be or, from one year to the next, focusing on how much you can reduce them by. That is the very tip of the iceberg.
If you think about the whole opportunity set much more broadly, which is what we want to do, you have to think about companies that enable other companies to avoid emissions. Emissions avoided, which in the industry jargon it is called Scope 4, is hugely important. It could be more important than Scopes 1, 2, and 3 put together in that journey to the low-carbon economy and, within that consideration, we think transition fuels are being overlooked.