Asset owners plan to set emission reduction goals within next three years, as asset managers prioritise climate-related engagement.
Only 20% of global asset owners have set decarbonisation targets in line with the goals of the Paris Agreement, but many more intend to before 2025.
According to a State Street Global Advisors (SSGA) survey, all regions are likely to see an increase in the number of asset owners introducing targets to reduce their portfolio emissions to net zero in the aftermath of the COP26 climate change conference, despite ongoing data concerns.
Asset owners yet to set targets noted that “ESG data is considered a challenge and performance concerns linger”, SSGA said. A total of 53% cited the quality of ESG-related data from company disclosures as a barrier to robust target-setting, while 53% mentioned the possible negative impact on investment decision-making and performance.
However, two-thirds of global investors said they plan to introduce decarbonisation targets within the next three years: 71% of European asset owners; 70% of APAC asset owners; and 61% of US asset owners. Just 9% of respondents globally said that mitigating climate-related risks is “not a focus”, the SSGA report noted.
SSGA surveyed senior executives with asset allocation responsibilities across 300 institutions, spanning private and public pension funds, sovereign wealth funds, endowments, foundations and official institutions globally. SSGA is the investment management arm of State Street Corporation, managing US$3.59 trillion in assets.
Asset owners are considering how to decarbonise their portfolios across asset classes, but equities, fixed income and real estate are “top priorities for those who have already set targets”, the report added.
“Over half of investors are integrating ESG or green bonds into existing fixed income strategies. Over half aim to use green bond indexes as part of their portfolio strategy,” the report said.
Of the asset owners which have set decarbonisation targets, 44% referred to their responsibility to drive the economic transition to a low-carbon future. A further 41% said target-setting was driven by outperformance and 36% were mitigating investment risk.
Over 80% of asset owners with decarbonisation targets in place noted that increased allocations to climate-themed funds will be “highly important” to making progress over the next three years.
David Vickers, CIO of the Brunel Pension Partnership, said it is vital that all asset owners set decarbonisation targets that demonstrate how they plan to ensure alignment with the goals of the Paris Agreement. Brunel Pension Partnership is a local UK government pension scheme pool with £30 billion in assets under management.
“Committing publicly to a number gives you an ambition to move towards. If one doesn’t have a target, you can still measure where you are, but it’s difficult to know where you’re getting to and how to plan,” he said. “We have moved past the point of just having funds that are run with an ESG overlay, because that can mean, under some definitions, that you still end up with a lot of carbon-intensive industries as long as they are valued appropriately based on analysis of the ‘E’ risk.”
A number of the world’s largest investors which are members of the UN-convened Net Zero Asset Owner Alliance and the Net Zero Asset Managers initiative have committed to setting interim decarbonisation targets for their portfolios every five years, meaning that they are also increasing their engagement efforts.
Increased scrutiny of corporates and managers
Asset owners largely prefer to engage with companies rather than divest in order to cut portfolio emissions, the SSGA report noted. Around 63% of asset owners that have set decarbonisation targets said divestment will only be considered as a last resort in their engagement efforts with companies.
Beyond increasing engagement with investee companies on climate-related issues, a medium-term priority for asset owners surveyed by SSGA is the employment of more robust climate criteria when selecting their asset managers, ensuring chosen managers will prioritise climate themes when managing their equity and fixed income portfolios.
“Engagement is particularly important for index asset managers because they cannot divest their holdings due to investment mandates,” said Karen Wong, Global Head of ESG and Sustainable Investing at SSGA. “Therefore, engagement and proxy voting become critical tools for oversight of corporate management on climate-related disclosure and practices.”
The majority of global asset managers are now raising ESG-related issues in their engagement efforts with investee companies, according to a survey published by Russell Investments. Around 90% said they cover ESG in meetings with corporate senior management, compared to 80% in 2018. This year’s survey consisted of 369 asset managers globally, representing US$76.6 trillion in assets under management across a range of asset classes, including equity, fixed income, real assets and private markets.
“Asset managers are applying more rigorous ESG-related analysis and seeking to provide greater transparency,” said Yoshie Phillips, Director of Investment Research for Global Fixed Income at Russell Investments. “However, there is still much progress to be made, particularly with respect to climate change, which is increasingly defining ESG agendas and ranks as the number one concern among underlying clients.”
Around 60% of respondents said that environmental risks are a top concern for their clients, followed by social-related issues such as diversity and inclusion (20%). As a result, 80% of asset managers surveyed said that they incorporate qualitative or quantitative ESG factor assessments into their investment processes, with 46% saying that visibility of climate risks are key to understanding potential security risk.