Beyond the shift from ambitious climate targets to implementation via metrics and ESG frameworks, sustainable asset managers increasingly need to find targeted strategies that can achieve measurable and specific outcomes to meet demand from asset owners. To discuss this evolution, NordSIP hosted a discussion with Ben Popatlal, strategist for multi-assets at Schroders, and Edson Fonseca, a sustainability specialist. Together, they explored how asset owners can strategically design their portfolios to align with both climate objectives and broader sustainability goals, offering a nuanced and practical framework to navigate this journey.
The discussion describes an investment management framework that considers two added levels of conceptualising asset management, beyond asset classes, delving into the types of strategies that best suit asset owners and the levers of change they are able to pull to pursue those ends.
The Three Climate Strategy Types
As part of Schroders offering Popatlal argues that investors can go beyond traditional asset breakdowns and find more granular approaches to investing in climate solutions.
“Increasingly, we’re thinking [about asset management] within asset classes, and breaking down different strategy types. Different strategy types within equities and within fixed income can do different things for [investors’] climate objectives. We break the portfolio down by three different climate strategy types,” Popatlal says.
“The low carbon strategy type is the strategy type that helps us to reduce the carbon risk inside the portfolio (…) [rather than] necessarily contributing to real world emissions reduction. It’s about carbon risk and it’s about managing that carbon risk in the portfolio,” Popatlal explains.
“The second strategy type is climate action. [It] shifts the focus back towards the real world,” Popatlal continues. He notes that the strategy is appropriate for investors that don’t mind having higher carbon emissions in that specific portion of the portfolio now because they have a better forward-looking trajectory of carbon emissions going forward. “So the companies or the underlying investments that we hold within the climate action strategy type are those that are driving real world emissions reductions to some extent,” Popatlal argues.
“The third strategy type is climate solutions. This strategy goes all the way to the other side [and focuses] to a much greater degree on companies and investments that have their actual products and services geared towards real world emissions reductions and finding climate solutions” Popatlal notes.
According to Popatlal, by pulling on different combinations of these tools, Schroders seeks to operate a feedback loop between the portfolio and the planet and make sure that they’re not just mathematically decarbonizing the portfolio but also contributing to real world emissions reductions.
An Easy Lens to Implement
Despite the innovation underlying the enhanced investment lens he proposes, Popatlal argues that this framework is not so revolutionary that asset owners would struggle to fit it into their existing asset allocation approaches.
“Asset owners already have to think about strategy types, (…) [such as] active fundamental equities or systematic equities. This is just another way of thinking about strategy types. It fits very well into existing asset owner frameworks. That’s one of the things that makes this so convenient to use,” he says. Popatlal even argues that some of asset owners’ existing investment strategy approaches can be fairly well mapped to his three strategies.
“We found that low carbon is usually [well-matched to] those systematic, quantitative or broadly diversified single asset class components (…) , because you’ve been able to quantitatively optimize for lower carbon whilst minimizing tracking error. That type of thing for risk reduction tends to suit the low carbon type of strategy, whereas maybe the fundamental security selection tends to be [a match to the] climate action [strategy] type. (…) Thematic or alternative strategies are maybe [closer to] the climate solutions-oriented type of strategy,” Popatlal adds noes.
Levers for Change: Influence and Impact
Popatlal describes another framework that classifies investments based on “levers of change”, including active ownership, use of proceeds, and impact investing. “Active ownership” focuses on engagement efforts around public stock investments. Meanwhile, “use of proceeds” is concerned with leveraging investors influence at initial public offerings (IPOs) of stocks and identifying relevant projects and goals ahead of fixed income transactions. However, the podcast discussion focuses on the last of the three levers for change: Impact investing.
“We’re conservative about how we think about impact. We make sure that if you are going to claim impact for a portion of your portfolio, it does need to demonstrate intentionality with the impact that you’re trying to achieve. [Impact investments need to show] additionality, as well, whereby if you hadn’t made the investment, then the impact wouldn’t [have occurred]. [The third pillar of impact investment is] a robust measurement framework […] for understanding the impact that you’ve had with your investments. Impact is that higher bar. Usually when we break the portfolio down into those three levers for change, impact is only a small portion of the portfolio,” Popatlal explains.
“The most potent form of impact that we have in our cross asset or multi asset portfolio is renewable energy infrastructure. Considering the intentionality of those investments, we know exactly what wind farms and solar farms, [for example,] are trying to achieve. They’re trying to replace the need or reducing the need for fossil fuel-generated electricity,” Popatlal adds.
“Additionality is very clear as well [in renewable energy infrastructure], because we’re providing new capital for developing these new assets. It is not actually just renewable energy generation. There’re also other energy transition assets within that bucket, [including] electric vehicle charging infrastructure, battery storage, heat pumps, and hydrogen-related assets,” Popatlal continues.
Speaking of the third impact pillar, measurability, Popatlal notes that climate impact metrics can help justify impact claims. “One of the key metrics for measuring impact in this space is avoided emissions and or the amount of renewable electrons generated or clean electrons generated. Because the assets are private assets, because we’re dealing directly with the project managers (…) [who] have access to all of the data,” he says.
Impact in Listed Equities?
Beyond renewable energy infrastructure, the discussion shifts to listed equities and fixed income and how it is possible to achieve impact in these asset classes, including considerations of market capitalisation and the stage of companies’ path along the energy transition.
“It is possible to have impact in in the listed markets. In reality [the three levers for change] overlap. They are like a Venn diagram whereby within listed equities, your main tool is it probably [active ownership and] ‘engagement, but you can [also] have a small amount of ‘use of proceeds’ because you might be investing in the primary markets […] through IPO’s,” Popatlal argues.
“Impact is more potent where you’re investing in at the smaller cap end of the spectrum. (…) We have impact funds which do tend to invest down the market cap spectrum, (…) [to] increase the influence that they have over that company either through engagement or through guiding the development of the products and services that that company has to offer,” he adds.
“However, small caps are not the only place where listed impact can occur. “Even at the higher end of the market cap spectrum, there are companies undertaking bad activities or less good activities, the improvements that they can make can be quite impactful. […] These big companies have such an influence in the real world that anything that they do […] can be quite important,” Popatlal continues.
Use of Proceeds in Fixed Income
Asides from listed equities, Popatlal argues that investors can take advantage of companies need to borrow funds to tailor their use of proceeds requirements and nudge businesses in the right direction.
“[Through] “use of proceeds” we can understand to what extent the proceeds that the [bond] borrower is raising from capital markets are being used for positive (…) green projects. […] In fixed income there are market leaders, especially in the corporate space, and there are market laggards, and each issuer might have general obligation bonds and it might have green or sustainability linked bonds,” Popatlal explains.
“[Our approach to use of proceeds] can differ. For market leaders in the sustainability space perhaps, if they are operating in an industry that is already climate-friendly or climate-oriented and their products and services are climate-related, then perhaps we don’t need a green bond. Perhaps we can invest in their general obligation bond and they will use the proceeds for good things because their company is already a market leader in sustainability. That might be different for a market laggard who is trying to improve but maybe has a higher cost of capital and so issues a green bond to say to investors ‘Look, we are trying to do more green projects, but we’re a market laggard at the moment and we have a high cost capital, so can you invest in our green bond?’,” he adds.
According to Popatlal, companies can talk to investors at the early stages of their bond issuance inquiries to include restrictions on what the borrower can do with the funds to become more appealing to sustainable investors.
The Speed-Limiter: Balancing Decarbonization and Risk
A central theme of the discussion was the importance of recognizing and managing trade-offs in sustainable investing. Popatlal argues that it is important to recognise that the relationship between carbon emissions and risk is complex and marked by discontinuities and non-linearities.
“You can reduce your carbon emissions [only] to a certain extent without taking on additional risk until you get to a breaking point whereby that additional unit of carbon reduction suddenly leads to a massive increase in tracking error, or a big marginal contribution to risk,” Popatlal explains.
“There is a trade off between how far you can push your climate ambitions in the portfolio and the investment integrity of the portfolio that you’re trying to manage. But that trade off is not linear. [The trade-off is] cheap for say 50-60% reductions in carbon emissions and suddenly it becomes very expensive because you’re trying to push the carbon reduction faster than the universe will allow you to go,” Popatlal adds.
“It doesn’t mean we suddenly give up at that level. We just need to be very aware of what that trade off is at all times going forward. (…) You don’t want to be reducing your carbon emissions by an additional 5%, but not being aware of the additional amount of tracking error that results from that additional reduction in carbon emissions.
Ambitious Nordic Investors
Fonseca, who works closely with Nordic investors, highlights their long-standing commitment to sustainability. Many Nordic asset owners, he explains, have frameworks centred around exclusions, integration, and active ownership.
“One commonality that you will often see in the Nordics is that a lot of investors’ own sustainability frameworks will normally work around three core components, which would be things such as exclusions, inclusion and integration, and active ownership,” Fonseca says.
“Net-Zero ambitions have really been more of a rule than an exception, [with asset owners] investing in different types of climate strategies as well, [not just] low carbon strategies and tracking Paris line benchmarks but also in climate solutions investments and infrastructure that’s related to renewables,” Fonseca adds.
However, the challenge remains in balancing these ambitions with practical considerations. Fonseca emphasizes the importance of deliberate, evidence-based decision-making, guided by metrics that capture both backward-looking data (such as carbon intensity) and forward-looking projections (like implied temperature rise).
Collaboration, Customization and Scalability
For asset owners embarking on their sustainability journey, Popatlal and Fonseca offered a reassuring message: you don’t have to do it alone.
“We would love to work with any asset owners that want to work on this. Some asset owners will want us to put the entire portfolio together and pull the levers for them and look at their portfolio from the top down across the asset classes all in one place. [For other] asset owners, we provide the components for them to then put together in their own house and pull the levers themselves,” Popatlal explains.
“It’s about striking a balance that you have conviction in,” Fonseca adds. “We can help at different stages or different levels of granularity. [We can] combine the art of customization for clients with the science of scalability and the tools that we have to deliver on the client’s objectives,” Popatlal concludes.
