The writer is a former head of responsible investment at HSBC Asset Management and previous editor of Lex
Of all the claptrap forced upon me as head of responsible investment at a global asset manager, the most egregious was net zero targets. Indeed, my industry’s response to the immense challenge of decarbonisation is one of the dumbest things I’ve seen in almost thirty years in finance.
Before I explain why, some background. From the 2015 Paris Agreement emerged the idea that investors must play their part in the energy transition. Damn right. From there came the concept of financed emissions — that providing funds to a belcher of carbon is basically akin to polluting itself, and hence capital should have net zero targets too.
Clearly there is a problem of knowing where to stop. Should accountants who audit dirty finance be net zero? What about the headhunters who recruited them? Even so, a framework where the owners and allocators of capital emulate real world objectives — and in doing so help to achieve them — appears logical and worthwhile.
Hence why almost 400 asset managers and owners — responsible for some $70tn — have rushed to join the Net Zero Asset Managers Initiative and its asset owner equivalent. Signatories promise to reduce financed emissions by some percentage by a particular date. Robeco, for example, has committed to a 30 per cent reduction by 2025, and aims to reach 50 per cent by 2050.
That the numbers are hokum, which I’ll show in a moment, is bad enough. So is the fact that pledges are made without many clients’ knowledge or permission. Big institutions know what’s up. But retail investors probably do not. Thought you were buying a European small cap fund? Sorry, you’re now saving the planet. Except you’re not. What rankles most is the claim that these initiatives help reduce emissions. No distinction is made between financing and trading. Sure, private equity assets can align with net zero goals, likewise direct loans or venture capital — you just stop giving money to polluting companies. But such primary sources of funding only make up a fraction of most manager and owner assets.
Mostly they own secondary market securities. Permanent capital such as equity cannot be withdrawn, it only changes hands. Real world impact: zero. And with traded asset classes, the Institutional Investors Group on Climate Change’s demand for total industry alignment is a fallacy. If I’ve sold my oil shares, the buyer of them is now misaligned.
So these initiatives are pure virtue signalling. A bigger worry for some investors is that making money seems increasingly an afterthought too. The Net Zero Investment Framework Implementation Guide is clear that financial objectives are to be “supplemented” with half a dozen climate change objectives. The word “return” only appears twice in 30 pages.
Back to the numbers. What does it mean when an asset manager commits to a 30 per cent reduction in financed emissions? Nothing. Signatories can choose what assets to include in their calculations. Money market funds? Too hard. Multi-asset? Let’s worry about it later. Government bonds? No data, so exclude. Robeco, in the example above, is only subjecting 40 per cent of its assets to net zero alignment.
Headline-grabbing pledges are a fraction of a fraction, therefore. But it gets worse. Take equities, which account for the bulk of the assets aligned with net zero. How is it decided that, say, the financed emissions of US stocks will fall 100 per cent by 2050? Everyone has their own approach. One well-known asset manager argued that given the US government is committed to this target, then by extension all American companies will reach it too.
Other managers simply take a firm’s public commitment at face value. A 25 per cent fall in emissions by 2025, says Coca-Cola? Good enough for us. To be fair, many are trying to calculate net zero pathways themselves. But there are so many assumptions behind these forecasts that comparisons between pledges are impossible.
Last year, for example, you might have modelled a European utility’s transition from coal to gas to renewables, estimating the likelihood that it would reach net zero by 2030. Now that governments want energy security, these forecasts may be wide of the mark. Similarly, net zero pathways are hostage to pricing, competition and regulators. A large carbon tax would change the picture completely.
What is more, financed emissions not only reflect the decarbonisation efforts of the underlying companies, but their change in value, as targets are a function of asset under management. If technology stocks rebound, say, their lighter emissions mean that a portfolio’s net zero alignment improves, even if a fund manager does nothing, and emissions stay the same.
You know an idea is flawed when it also makes sense the other way round. Why shouldn’t capital go to the companies that need help with transitioning the most — that is, the high polluters? Perhaps a net zero misalignment of portfolios should be under consideration in Sharm el-Sheikh.