Stockholm (NordSIP) – The early days of sustainable investing were characterised by the exclusion of stocks on ethical grounds. Investors then moved on to screening out so-called sin stocks by considering environmental, social and governance (ESG) factors. The more recent realisation that the global economy needs urgent and radical change to face up to the climate crisis has now shifted the emphasis away from negative screening towards the more proactive approach of transition investing and active ownership. Charlotte Månsson, Head of Sustainability & Transition Solutions for the Nordics & Netherlands at BlackRock provides investors with an introductory overview of the strategy.
The low-carbon transition and why it matters
Månsson begins with an explanation of the basic concept: “As a firm, we believe that climate risk is investment risk and that it will impact returns in investors’ portfolios as companies navigate both the physical and transition risks associated with climate change. As such the transition presents both extraordinary risks and opportunities.” While managing these evolving risks is crucial to protecting the value of long-term investment portfolios, Månsson believes that the historically significant low-carbon industrial revolution and the wealth of opportunities it presents will help encourage the vast capital flows needed to reach the goals of the Paris climate agreement.
The sheer scale of this historic investment opportunity was underlined by the International Energy Agency (IEA), which has estimated that $125 trillion will be needed to reach net-zero by 2050, of which $32 trillion must be generated before 2030. This will require a four-fold increase in investment from current rates but is also expected to generate roughly 30 million new jobs in power generation and grids, electric vehicles (EVs), bioenergy production, end-use renewables, and other innovative technologies.
The forces driving the transition
The transition is already underway; it just needs to be accelerated, Månsson believes. The drivers of the current changes are technology, societal preferences, and policy developments. “Technology costs are already going down,” she says. “There has been an 85% reduction in solar energy costs over the past decade. An example of societal preferences is the doubling of annual electric vehicles that we saw globally in 2021. Policy is also gaining momentum. 83% of global emissions are covered by net-zero targets and the U.S. recently passed the Inflation Reduction Act that provides nearly $370 billion of tax incentives, rebates and grants that aim to cut the country’s annual emissions by 40% by 2030 compared to a 2005 base level.” According to Månsson, these three long-term forces are creating a virtuous cycle that markets are currently underestimating. The fact that transition risks and opportunities are not properly priced into the market creates an excellent opportunity for forward-looking investors to grab with both hands.
Pushing for positive change in carbon-intensive sectors
How should an investor approach this journey into transition investing? The most carbon-intensive sectors such as electricity generation, oil and gas production, automotive manufacturing, and heavy industries represent the most attractive hunting grounds. As Månsson explains, it may seem counterintuitive at first but that is where the most significant positive impact on global greenhouse gas (GHG) emissions can be achieved. “All companies are having to navigate the way that economies are being rewired by taking a view on how the transition is going to shape their own operations or investments.” From the asset manager’s perspective, it is essential to meet with the management and board in these carbon-intensive industries and engage, as necessary, to assess whether governance practices and board composition are appropriate given the business and the broader context in which the company operates and to understand how companies’ plans to navigate the material climate-related risks and opportunities presented by the energy transition may impact investment outcomes.
Månsson points out that while more than half of the largest publicly traded companies have made net-zero pledges in the past couple of years, the markets are trying to distinguish between companies who have credible transition plans and those who do not. It is important to fully understand their plan of attack: are they truly diversifying or doubling down on their core business lines? Government policy and regulation also play a major role. “Company leaders are worried about policy clarity, particularly whether there are going to be sufficient investments in enabling infrastructure to support new technologies,” continues Månsson, adding that the ongoing development of multiple regulatory and reporting frameworks is another complicating factor that must be resolved as soon as possible.
The challenge of transforming the automotive industry
In practical terms, the transition can involve the transformation of entire sectors, offering up multiple investment opportunities along the whole value chain. “Take the automotive sector,” says Månsson. “Electrification is very much at the forefront with increasing consumer demand, but it’s not all plain sailing. The main challenges include speed of production, the cost of mining and refining many of the raw materials along with environmental issues related to the value chain, for instance with lithium. We are expecting regular bottlenecks as the transition unfolds, for example a shortage of batteries, but solving these problems also represents part of the investment opportunity. While we do expect some bumps in the road to electrification, it’s encouraging to see that companies are genuinely leaning into the transition effort.” Companies will need to explore new raw material supply chains, beef up the volume of battery manufacturing, increase research and development (R&D) spending and take big steps towards greater circularity in their production processes to reduce their overall carbon footprint and resource intensity. Policy and regulation will play a very important role in the shift to a low-carbon economy through regulation, incentives, and investment.
Making a start with transition investing
Once asset owners have fully taken on board the scale, drivers and mechanisms involved in the transition towards a global low-carbon economy, the next step is to figure out the practical aspects of implementing a transition strategy. Månsson explains that many of BlackRock’s clients are especially keen to explore the opportunities and understand the risks but face several key challenges: “We surveyed around 1,500 clients from EMEA, APAC and the Americas on this subject. The top two challenges they reported were the existence of multiple datasets with inconsistent disclosure levels and a lack of clarity regarding the speed and expected pathway of the transition. Our clients are really looking for help and guidance with execution, meaning where to start, with which assets and how to accurately measure subsequent progress with the right data and reporting frameworks. They typically start with listed equities but then also look for help in expanding the transition strategy across all the other asset classes in their investment portfolios.”
The low-carbon transition represents the potential of a new green industrial revolution. It will require enormous reallocations in public and private sector investment. Institutional investors can seize the opportunity to sharpen their risk/return profile, boost their sustainability credentials and future-proof their portfolios. In the next instalment of this three-part series of articles on the subject, we will walk through a practical checklist for investors taking their first steps on the transition investing journey.
