The race to net-zero: why it matters

The change we need

Our focus on sustainability is anchored in a profound investment conviction: that we are at the beginning of the next great economic revolution. And we see it as our fiduciary duty to help our clients navigate this profound transformation.

The economic framework in which we have operated for decades is becoming obsolete. It is what we call WILD—Wasteful, Idle, Lopsided and Dirty. And, as such, it is putting far too much stress on the environment. Every year, we extract around 92 billion tonnes of natural resources and use them to feed our ever-growing consumption model, generating a significant amount of harmful waste—including greenhouse gas emissions—at the other end.

To measure the damage our WILD economic model is doing to the environment, we use the planetary boundaries framework, which defines the extent to which we can use various natural resources without causing unacceptable environmental change. Crucially, we've already crossed some very dangerous thresholds. For instance, when soils are sufficiently degraded, there's a risk of them turning into unproductive deserts. And, due to issues like agrochemical pollution, soils in many regions are getting close to the point of no return. Then, of course, there's perhaps the most famous planetary boundary of all: the quantity of greenhouse gases we can put into the atmosphere before we see dangerous levels of climate change.

Of course, there are many obvious physical risks that come with crossing these planetary boundaries. However, as investors, we are particularly concerned with the economic dangers. Over 50% of global GDP relies directly or indirectly on nature, which makes our environment the most productive component of our economy.

Reasons for optimism

The good news is that these issues—including climate change—are still addressable, and efforts to find solutions are increasing. We strongly share that optimism. Indeed, we see evidence all around us both that the world has realised that we must transition to a new, sustainable economic model, and that the forces we need to drive this revolution are growing in strength.

We often talk about policymaking and regulation as one of those key forces. But we should not underestimate the power of other forces that, in some respects, are even more potent. The market is one such a force; one that, across virtually all sectors, is combining pioneering technologies and economies of scale to rapidly introduce new solutions into our economy that aren't just more sustainable, but also better, cheaper and more efficient. And this market force is central to our concerns as investors.

In our view, these forces are now unstoppable and the transition toward a more sustainable economic model is already underway. We call this model the CLIC™ economy: one that is Circular, Lean, Inclusive and Clean. From an environmental perspective, we believe there will be three components to this transition: the net-zero economy, the nature-positive economy, and the circular economy.

But despite the inevitability of the sustainability revolution and the potency of the forces driving it forward, not every company is moving in the right direction nor supporting it to the same extent. And distinguishing between companies along sustainability dimensions is what Environmental, Social and Governance (ESG) investing is all about.

There are three dimensions to ESG. The first of these is the 'HOW', which is all about a company's current business practices and is where the majority of our industry is currently focused. This kind of ESG data can tell us whether a company is at least tuned in to sustainability and is trying to adjust its business practices. That said, they aren't enough to tell us whether a company is truly prepared for this monumental transition and, in turn, whether investing in that company would deliver significant alpha or return opportunities and mitigate risks.

As such, we tend to focus more on the other two dimensions of ESG. The second dimension—the 'WHAT'—concerns transition trajectories, taking into account the fundamental nature of companies' business models and the products and services that they offer. Here, we want to understand the specific challenges faced by a company or industry, and the speed and shape of the transition. The third ESG dimension is the 'WHERE', which is about the physical risks a company or industry is likely to face as a result of climate change.

Investing in progress

Achieving net-zero emissions by 2050 is perhaps the most important component of the sustainability transition across all companies and industries. And while almost three decades seems like a long time to reach that target, the consensus of the scientific community is that we must first cut our emissions in half by 2030. That's less than nine years away, in a context where we have yet to figure out how to accelerate the green revolution, maintaining economic advancement while at the same time reducing our emissions and impact on the environment.

As investors, then, we must use our capital responsibly by making the net-zero trajectory a condition of investment. To accomplish this, we use the Oxford Martin Principles: a rigorous, scientific net-zero framework that helps us decide how we engage with companies across all industries and regions.

The first Principle looks at whether a company has set a net-zero goal—something that any business can achieve in the time it takes to update their website. The other two Principles, though, are much harder to satisfy. The second Principle requires companies to be able to explain how their business will remain profitable at net-zero and how they plan to get there, while the third Principle demands a quantitative mid-term target—ideally a 50% reduction in emissions by 2030.

All of this tells us the extent to which a company is future-proof in the face of the sustainability revolution. From an investment perspective, then, a company that satisfies the Oxford Martin Principles immediately becomes a significantly more attractive prospect than one that doesn't.

To optimise the sustainability of our portfolios, we feed all of this information into our decarbonisation process. First, we assess the climate value impact: the risks and opportunities we own as an investor as a result of a portfolio's carbon exposure. Then, we adjust the portfolio to ensure it's decarbonising in line with both a net-zero trajectory and the Paris Agreement's objectives to limit global warming. In practice, this means we tend to invest more in companies that are positioned to make greater contributions to limiting the increase in average global temperatures and less in companies that aren't on the right trajectory.

Crucially, this doesn't necessarily mean that we avoid high-emitting sectors; not least because companies in these sectors that are on the right trajectory have the potential to make particularly significant contributions to limiting global warming. In other words, when it comes to net-zero and sustainability more generally, there are no inherently 'good' or 'bad' sectors. For us, what matters is whether or not a company is moving in the right direction, because this will be one of the most critical drivers of returns in the coming decades. And it is our fiduciary duty to understand the risks involved in continuing to produce carbon emissions and the transition to net-zero, and to capture the opportunities that come with embracing that transition.