Since the emergence of “Modern Portfolio Theory” and the “Capital Asset Pricing Model” in the late 1960s, institutional investors have taken a quantitatively driven approach to portfolio construction, looking to create portfolio diversification and obtain better risk-adjusted returns by balancing their asset-class exposures. This journey has seen several important advancements in thinking about how to optimally achieve desired results.
Funds that want to take the total portfolio approach first need to get the total portfolio view. To do that they not only need data – and lots of it – but a rock-solid understanding of exactly how they’re going to use it.
Start asking the right questions on net zero: Ninety One
Large asset owners are confronted with a sometimes bewildering path to net zero as they balance portfolio decarbonisation with benchmark risk and size up new opportunities in untested technologies, and it can sometimes be difficult to know how to proceed.
But as with almost everything investment related, the most important thing in the transition to net zero is to start asking the right questions about the way your organisation fits into it, according to Deirdre Cooper, head of sustainable equity at Ninety One.
“We’re never going to find the perfect ‘one number’ answer,” Cooper told the Frontier Advisors conference. “But asking the questions will tell us a lot of interesting things.”
In the case of net zero, the question that’s worth asking is about the natural advantages an asset owner has and the role it can play in actually furthering the transition by allocating capital to help push it forward.
That capital can flow to climate solutions, which Cooper characterises as companies with products or services aimed at addressing climate change, or companies that are heavy emitters in the here and now, but which are reducing their emissions (or will have to). Engagement sits over the top and takes place across the entire portfolio, with asset owners talking to management teams and boards and encouraging them to go on the same climate journey.
“And then you have to do the really hard job, which is optimising all of that in a way that delivers our first responsibility of delivering great returns,” Cooper said.
But while moving away from carbon intensive industries and towards asset-light businesses like software companies can “massively change” portfolio carbon intensity it has a negligible effect on real world emissions and does little to further the transition.
“We can say the same about divestment; you can have an argument that you want to divest from sectors because you’re worried about risk, that the transition is going to go super-fast and therefore I don’t want to own certain sectors,” Cooper said. “But I think it’s really hard to argue an impact element from divestment; if I sell a share of Exxon Mobil, they don’t care. They’re not looking to raise any primary capital and it’s not going to change real world emissions.”
And though carbon data remains a practical challenge, and one that Ninety One itself has dealt with – there’s still a very wide range of estimates on even scope one and two emissions, which are usually thought of as “much more consistent” – the biggest challenge some asset owners and managers face is in the setting of “very, very aggressive near-term portfolio intensity targets”.
“Because what they found was they could get to a portfolio that was even 80 per cent lower carbon than the benchmark surprisingly easy by tweaking the weights and celebrate a very big win early on,” Cooper said.
“But then it’s quite hard to keep delivering on that and deliver returns; it constrains you. What we’ve found is that people who have allocated to climate solutions and transition, over the five year performance those solutions have outperformed that outperformance is very lumpy. They’re very different performance footprints relative to the benchmark, and when they’re sized appropriately people who have gone down that path are very comfortable with that approach.
