Aligning an investment fund to the Paris Agreement

We believe the most effective way to align an equity fund with the goals of the Paris Agreement is by taking a company-specific approach, where we consider the real-world climate impacts of investee companies, and the actions they are taking, rather than solely focusing on portfolio-level metrics. In particular, we look for companies taking positive climate action, either to reduce their own emissions or by providing solutions for others to do so.

Real world outcomes, not just metrics

Climate change is a real-world phenomenon, existing outside the parameters of an investment fund. As such, when investing we focus on the real-world impact of every investee company, and the positive action it is taking, rather than focusing solely on portfolio-wide metrics. While we believe these offer an important insight into the climate impact of investee companies, and they do form part of our investment process, prioritising metrics above all else can be counter-intuitive.

For example, a fund manager focusing solely on portfolio emissions data could simply hold a selection of traditionally low-emitting companies, such as software developers. While the fund would appear to align with the Paris Agreement on paper, it wouldn’t necessarily contribute towards the absolute emission reductions necessary to limit global temperature increases. The same level of carbon emissions would still exist, they would simply be outside of the fund.

A company-specific approach

Rather than a portfolio-wide approach, we believe it is preferable to focus on individual companies. We consider the amount of emissions they produce, their plans for reducing emissions, their progress against these targets, and where relevant, the amount of emissions they help others to avoid through their climate solutions. This way, we can more effectively determine how a company is contributing towards the goals of the Paris Agreement, how to best engage with the company, and how it might benefit from the decarbonisation trend that we expect to persist for decades.

Importantly, most companies looking to cut emissions will not experience a consistent, linear reduction year in and year out. Instead, there will be jumps as the company makes changes, such as switching to renewable energy or rolling out a new, more efficient process. With funds focusing solely on portfolio-wide emission reduction metrics, the company could be cut from the fund before its good work comes into effect, if the timing is wrong. Furthermore, a small number of companies may generate the majority of portfolio emissions, especially if they operate in an emissions-intensive industry such as manufacturing. A focus on portfolio-wide metrics above all else may tempt the fund manager to simply reduce their stake in these companies, improving the high-level metrics but making no real-world impact.

Active engagement

Active engagement should also form an integral part of the investment process for funds aiming to align with the Paris Agreement. By engaging with investee companies, we can encourage positive changes, such as improving emissions disclosures or setting science-based targets for emission reductions. We could also encourage companies to link executive pay to climate-related metrics. And if a company’s progress falls behind its targets, we can use engagement to understand why and encourage further action.

Measuring carbon intensity

While we believe real-world outcomes are the most important element of a Paris-aligned investment strategy, in practice we also consider portfolio metrics, such as carbon intensity. This is the amount of carbon emissions per million US dollars of sales. We use carbon intensity as a framework for assessing company eligibility and measuring our funds’ climate impact.

Within our range of funds that aim to align with the goals of the Paris Agreement, companies with a carbon intensity at least 50% lower than the benchmark are eligible for inclusion. These are considered to be ‘low-carbon companies’. Those with a carbon intensity above 50% of the benchmark should have set or committed to setting science-based targets for emission reductions, and are considered to be ‘reducing-carbon companies’. We also aim to maintain a Weighted Average Carbon Intensity (WACI) at least 50% lower than that of the benchmark. WACI is the carbon intensity of every holding, weighted to its proportion in the fund.

Companies doing no harm

In our Paris-aligned strategies, we look for companies demonstrating good sustainability or ESG credentials. As part of this, we also exclude certain companies from our investible universe, as we consider them to be in breach of the ‘Do no significant harm’ principle. These include companies which are flagged as violating the UN’s Global Compact, a global framework for businesses to adopt sustainable and socially responsible policies. We also exclude companies from a number of sectors,  including those involved in fossil fuel extraction and controversial weapons.

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