New framework aims to reduce emissions in investment-grade bond portfolios for pension funds and insurance firms.
JP Morgan Asset Management (JPM AM) has developed a framework to help long-term institutional investors decarbonise their fixed-income portfolios in light of the global transition to net-zero greenhouse gas emissions.
The approach emphasises inclusivity and engagement with issuers, and incorporates both qualitative and quantitative inputs into integrated assessments which track current and predicted emissions, as well as alignment of issuers’ climate and business strategies.
The firm’s ‘carbon transition framework’ ranks issuers based on current carbon transition ‘readiness’ and forward-looking carbon-reduction metrics. But JPM AM engages with issuers that don’t have fully formulated climate policies, rather than excluding them.
“To deeply decarbonise, you need to take into account those issuers in the bond universe that have the highest carbon footprint,” said Paolo Gazzola, Investment Specialist, International Fixed Income Insurance and Pensions at JPM AM.
JPM AM will use these issuer assessments to construct portfolios for pensions and insurance clients aimed at meeting three parallel objectives: 30% or greater reduction in carbon-intensity relative to the broader investment universe; 7% annual reduction in carbon intensity of the portfolio; and five-year cumulative carbon reduction targets per issuer.
The targets and framework are designed to be flexible enough to accommodate a gradual approach by fully-invested buy-and-hold investors, as well as recognising the need to avoid high turnover within portfolios and account for “the long-dated nature of many carbon-generating assets”.
Targets can be further refined depending on client requirements. “Insurance companies and pension funds might not be able to help where they started. Often, they can’t just suddenly turn over 30% of their portfolios,” said Emily Homer, Portfolio Manager, International Fixed Income Insurance and Pensions at JPM AM.
But Homer underlined the importance of the 7% year-on-year target for reducing carbon intensity, which will be monitored via third-party quantitative inputs such as the assessments verified by the Science-Based Targets Initiative as well as feedback from JPM AM’s stewardship and credit research teams.
Qualitative feedback from credit analysts is a critical element of forward-looking assessments, said Gazzola.
“A company might have relatively low carbon emissions and a very good forward-looking target. But management may not be as committed to that target, or may have a track record of over-promising and under-delivering,” he said.
The framework is initially focused on investment-grade corporate bonds. But JPM AM expects to expand to other sectors of the fixed-income universe, starting with sovereigns and high-yield bonds. In terms of selecting individual issues, JPM AM will use guidelines such as the International Capital Market Association’s Green Bond Principles.
The framework is also designed to accommodate existing factors influencing the fixed-income strategies of institutional investors, such as ratings, base currency, duration and concentration risk.
According to Homer, insurers are increasingly sensitive to the direct economic impacts of climate change, including ratings downgrades, such as those announced earlier this month by S&P, impacting several US oil firms.
“The potential impact on credit ratings is making this a priority among investment committee members, as it hugely impacts the amount of capital they have to hold,” she said.
Reducing portfolio emissions has become an increasing priority for institutional investors. In January, the UN-convened Net-Zero Asset Owner Alliance outlined its 2025 decarbonisation targets, with each of the group’s 33 members committing to publishing reduction targets of between 16% and 29% before COP26.
The growing pace of policy and technology change has increased the urgency of the need for institutional investors to actively manage transition risks to their corporate and sovereign bond portfolios, according to a paper released by JPM AM earlier this month.
“The introduction of emissions trading schemes or outright carbon taxes are likely to expose costs previously unaccounted for in an issuer’s balance sheet and cash flow expectations which could in turn have material impacts on credit fundamentals and ratings,” it noted.
The paper also flagged the growing risk of stranded assets as businesses transition away from established but carbon-intensive technologies and facilities, with vulnerable sectors including utilities, energy, automotive and industrials.