What Does Net Zero Mean for Portfolios?

We discuss how we are navigating net zero in our portfolios to achieve real-world decarbonization.

Key Points

• Newton’s approach to net zero seeks to support the achievement of real-world decarbonization through the investments we make.
• We believe that there are significant opportunities to invest in companies or lend to entities that are going to enable the energy transition and provide solutions to climate-change challenges.
• Regulation and policy have a major impact on the rollout of renewable energy, and the geopolitical backdrop has accelerated this.
• As active investors, we think it is important to be engaged with companies to understand their net-zero ambitions.

In June 2022, Newton announced its approach to net zero. We have aligned ourselves with the Science Based Targets initiative approach, which involves a commitment to aim for an interim target of 50% of the financed emissions from the investments we make on behalf of our clients being covered by credible transition plans by 2030, and 100% being covered by 2040.

We do not think it is credible to decarbonize portfolios simply by cutting out certain sectors; that is not necessarily going to translate into decarbonizing the real world, which is ultimately what we want to achieve. In practice, the path of real-world decarbonization looks different depending on the portfolio. For our Sustainable Real Return strategy, for example, we look for companies that are either providing solutions to climate-change challenges or are aligning themselves to a net-zero pathway. In our global infrastructure strategy, net-zero targets may be perfectly achievable for some companies, but for investments in utilities it can be more difficult as they have the transition in front of them, although that may be where a lot of the value creation will lie.

Enabling the Energy Transition

We believe that there are significant opportunities to invest in companies or lend to entities that are going to enable this transition. On the Real Return team, we have undertaken a mapping exercise to look at the emissions that are currently being produced across all sectors. We have examined the solutions that can address each layer of those emissions, as well as the marginal cost and the viability of each step of CO2 mitigation. This gives us a structure to know exactly what to look for, which ideas to pursue, and where we should focus our fundamental analysis. Our multidimensional research platform underpins this process, and brings together colleagues from across the business, including the responsible investment and data teams, as well as our fundamental analysts and portfolio managers.

Our mapping exercise has highlighted that the backbone infrastructure that our economy runs on is going to require a very energy-focused and material-intensive overhaul. The framework helps us to look right across the value chain, for example identifying copper and lithium as key commodities, finding mining businesses to invest in, and investigating the supply-chain companies feeding into the mining operations, such as specialist underground mining equipment. We also explore where these materials such as copper and lithium are being used and applied, for example in solar-panel batteries and wind turbines, and can think about what the supply chains and component parts for those products look like. In addition, we can look at who is ultimately using these products, including the developers looking for the sites and doing the construction, along with the companies operating the facilities.

These examples highlight that there are a huge number of varying opportunities covering different areas and asset classes. Having the platform in place to draw from the different skill sets that we have available at Newton is incredibly helpful for finding those ideas.

Rolling Out Renewables

Over the last 12 months we have seen some major macro and geopolitical events take place, from Russia’s invasion of Ukraine to the cost-of-living crisis, to supply-chain issues. Before the Covid-19 pandemic hit, there was already a progressive renewable energy agenda being pushed out in Europe. During the pandemic, many policymakers were trying to pull the agenda forward to get the economy going again, but recently, with the energy crisis taking hold, energy independence has become a lot more important.

The main limiting factor on building renewables is not supply of solar panels, or labor shortages, but regulation. In areas where the regulator is accelerating the permitting process, the rollout of renewables is going to be faster.

When the conflict started breaking out between Russia and Ukraine, the European Union wasted no time in fully accelerating the permitting process. Understanding the direction of travel for regulation is therefore likely to be critical in order to determine whether there will be a faster push towards renewables. It has been suggested that the best cure for high energy prices is high energy prices, and we are now starting to see that the current crisis is accelerating the growth of renewables.

We have seen some of the most progressive policy in the UK, where, despite windfall taxes, the government is capping prices at a level at which companies still maintain plenty of profit, which provides a clear incentive for them to keep developing renewables.

Engagement

We think it is important to be actively engaged with companies that have credible transition plans in place, and to understand their net-zero ambitions. This enables us to assess how realistic these goals are and to track the signposts along the way.

When we are engaging, we are on the same side of the table as these businesses. If the company is taking the right action that is going to improve its path towards net zero, that may also create a good deal of shareholder value. We want these companies to do the right thing for the right reasons, and ultimately we believe this should result in good outcomes not only for the company itself, but for the world and for our clients too.

Authors

James A Lydotes

Head of equity income and deputy chief investment officer, equity

Philip Shucksmith

Portfolio manager, Real Return team