Engagement-led investing: The time for climate action is now

What actions listed companies take to lower their emissions matters to us as investors. In aggregate they are responsible for roughly half of all direct CO2 emissions[1] – and exert significant influence over indirect emissions that are difficult to measure but are likely far greater than these companies’ direct contribution.

To be on track to reach net zero by 2050, we would expect to see these emissions declining at around 6-7% a year. But they aren’t. Instead, the COVID-19 crisis aside, we have seen emissions from listed companies remain essentially flat over the past decade.

The evidence, we think, is pretty clear – this failure to decarbonise at an appropriate pace is likely to lead not just to significant systemic risks to the global economy, but also a significant misallocation of capital by individual companies. Cumulatively, our research suggests this could amount to as much as $250 billion a year by 2030 alone.

As the broader economic backdrop has worsened, the ‘tug of war’ between meeting net-zero commitments and maximising long-term shareholder value has become more fraught. Some investors, and many companies, seem to view these two commitments as mutually exclusive, but we don’t believe the evidence supports this. We just think a new approach is needed.

That is why we’ve developed a new engagement-led approach to climate action investing, aimed at redefining the net-zero paradigm for companies. This approach seeks to invest in a focused portfolio of companies that are underperforming their net-zero potential and to identify specific actions for these companies to take to both improve their contribution to net zero and also target attractive shareholder returns as the transition accelerates.

Active engagement with these companies is crucial if we are to persuade them to lean in more closely to the energy transition. Furthermore, engagement-led investing is specifically designed to complement other investment approaches tending to tilt away from companies currently underperforming their net-zero potential.

We believe there are a number of levers companies can pull to target improved shareholder returns by aligning more closely to net zero:

• For some companies, aligning more closely to net zero may allow them to grow faster than their peers as they take market share from less-well-aligned businesses
• For others, it may allow them target greater profitability, for example by taking an opportunity to sell their products at a higher price that captures an emerging green premium for lower-carbon products and services
• Companies could also target a structural cost-of-capital advantage by becoming lower carbon than their peers as they reduce the volatility of their earnings over time

Taken together, we firmly believe these actions have the potential to add up over time to unveil a material opportunity to both create shareholder value and also deliver a significant reduction in real-world emissions.

It’s time to cut the rope in this tug of war.

Assumptions, opinions and estimates are provided for illustrative purposes only. There is no guarantee that any forecasts made will come to pass.

[1] Source: CO₂ emissions – Our World in Data and LGIM Destination@Risk analysis, as at August 2023.