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The journey to net zero – climate risks and opportunities
What does net-zero investing really look like? And how will our investment strategies evolve in this new world?
As focus shifts towards investing sustainably, at Lombard Odier we have the building blocks in place for our clients to prepare their portfolios for the transition to a net-zero emissions economy and the sizeable risks and opportunities it creates.
Climate and carbon emissions have created real financial exposure for companies. For investors, it is a very complex topic and even though there are tools out there to help such as ESG reporting and carbon footprint analysis, these are not necessarily the right ones to use. A more forward-looking perspective is needed, but it isn’t straightforward to find the right direction to create solutions.
One of the most significant issues the industry faces when investing with a net-zero mindset is that many companies and sectors are still far from aligned with the Paris Agreement. From an investment point of view, this can create all kinds of risk exposure. The immense changes coming mean that only companies that overhaul their business models and change profoundly will be fit for the transition. There will be winners and losers. As we see the continuing daily impact of climate change and weather catastrophes, it is clear climate is a common issue shared by everybody. But who should bear the responsibility? Who is responsible for failing to repair or mitigate those risks? And how can we deal with these problems?
Risks and challenges facing the transition to net zero
There are three issues when we think about companies and the shift to this new world - the transition exposure; the physical risk and the liability risk.
These dynamics vary differently depending on the scenarios we face. A rapid transition to net zero will reduce physical and liability risks, but increases transitional risk exposure, such as to carbon prices and market shifts. Vice versa, global inaction on climate change might limit the impact of regulatory and behavioral changes, but would lead to escalating levels of global warming and higher levels of physical and liability risk. Portfolios need to be prepared for any scenario.
Issues around climate change and how it is measured are complex. What are the emissions we should be focused on? Where are we going to find the right data? What about a company that is in a highly polluting sector today – should we simply exclude it, or include it because a leader in this sector might ultimately contribute more to decarbonisation than a company that is already in a low-carbon industry? What regulatory frameworks are available, in the EU and elsewhere?
Read more here: Debunking 7 misconceptions on scope 3 emissions | Lombard Odier
Perhaps most challengingly, major discrepancies still exist today between trends of emissions in the real economy on the one hand, and the ambition of government pledges and the Paris Agreement on the other. Government policies in effect today, and trends in emissions in the real economy, would take us to around 3°C of warming. Optimistically, net-zero targets announced thus far could reduce this to 2°C, but that still leaves a significant gap to the ultimate goal of limiting warming to 1.5°C.
Given this gap, if we want to allocate capital or invest in the global economy at scale, we have a significant issue we must deal with today, and could introduce significant country and sector biases, that require careful management.
Our net-zero investing approach
So how do we, at Lombard Odier, approach net zero investing?
Firstly, we do not focus on investing only in companies in low carbon sectors today, as we recognise that it is in higher carbon sectors where most of the transition will take place – and where true climate leaders are emerging. Focusing on low polluting sectors therefore doesn’t help the diversification of the investment universe, doesn’t aid the transition to net zero, and isn’t financially fit-for-purpose.
Secondly, we assess companies’ alignment to the transition by understanding their industry pathway to net zero and the trajectory of a company’s emissions. Temperature alignment frameworks help us analyse whether a company’s decarbonisation efforts are sufficient or falling short, and help us distinguish the leaders and the laggards.
Finally, we focus on climate related financial exposure, to understand not only the trajectory a company is on and the challenges it will face along the way – but the financial implications of that journey and transition. We call this the Climate Value Impact that portfolios will face.
Read more here: Sustainable investing in five easy questions | Lombard Odier
Climate Value Impact – the benefit to investors
We aspire to offer clients investment value propositions and the ability to neutralise climate-related financial exposure in portfolios. This is the core of our investment philosophy.
At a time of major disruption in the economy, regardless of how quick the transition occurs, our analysis of Climate Value Impact allows us to understand where carbon and climate risks are concentrated, and how we might address these.
Our approach to net-zero investing is focused on transition. We differentiate ourselves by focusing not only on a company’s performance today, but the pace of its transformation, and an assessment of that transformation’s financial implications.
We believe that net-zero investing will be the topic for the investment world in the year to come.
Today we already have a number building blocks, including our TargetNetZero and Climate Transition strategies, among others. And we will continue to build more, to help our clients prepare for the transition ahead.
Important information
This document is issued by Bank Lombard Odier & Co Ltd or an entity of the Group (hereinafter “Lombard Odier”). It is not intended for distribution, publication, or use in any jurisdiction where such distribution, publication, or use would be unlawful, nor is it aimed at any person or entity to whom it would be unlawful to address such a document. This document was not prepared by the Financial Research Department of Lombard Odier.
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