In the quest for net zero, approaches based solely on emissions could increase portfolio concentration risk, slow the transition and limit investment growth. We highlight an alternative approach.
At Lombard Odier Investment Managers, our way of deploying capital in the transition to net zero differs from typical low-carbon strategies. Instead of excluding all high-emitting companies, we apply forward-looking analysis across all industries to identify attractive businesses that are rapidly decarbonising and becoming fit for an emissions-free economy.
In doing so, we aim to help investors achieve portfolio objectives while seeking to decarbonise, diversify and drive the transition forward.
Why exclusions limit opportunities
We do not employ emissions-based exclusions that may lead to investing only in businesses with carbon footprints that are already aligned with net zero. In our view, such approaches typically:
- Limit diversification. Exclusions restrict the investment universe to sectors with inherently low levels of emissions, like media and IT, creating potential concentration risks in portfolios.
- Slow the transition. Investing only in low-carbon-now companies withholds capital from transitioning firms in economically important but hard-to-abate sectors, like steel and agriculture. This slows emissions-reduction where it is most needed.
- Miss opportunities. By excluding companies with high carbon footprints but credible decarbonisation plans, these strategies risk omitting quality firms that are aligning to net zero and whose progress might be underappreciated by the market.
For these reasons, we invest not only in low-carbon companies but also target transitioning firms in hard-to-abate sectors. Because these firms are effectively cooling the economy by transitioning in next zero, we call them ‘ice cubes'.
Seeking ice cubes enables us to build diversified portfolios that better reflect decarbonisation across the economy. It also provides exposure to potential growth opportunities, as firms that are reducing emissions are better positioned to take advantage of increased demand for low-carbon products and services. Also, investing in ice cubes helps drive the transition forward by supporting the material emission reductions they are delivering.
Adding ice cubes to lower portfolio temperatures
To build our decarbonisation strategies, we designed a proprietary implied temperature rise (ITR) methodology to measure the alignment of a company or a portfolio to the goals of the Paris Agreement. ITR answers the question: if the global economy were behaving like a particular company or my investment portfolio, what would be the likely resulting degree of global warming?
Our ITR methodology has been independently reviewed by the TCFD's Portfolio Alignment Team and the University of Oxford. To illustrate how it informs our analysis and helps to identify ice cubes, we provide three case studies [1] from equity, fixed income and convertible bond markets below.
The case studies provided in this document are for illustrative purposes only and do not purport to be recommendation of an investment in, or a comprehensive statement of all of the factors or considerations which may be relevant to an investment in, the referenced securities. The case studies have been selected to illustrate the investment process undertaken by the Manager in respect of a certain type of investment, but may not be representative of the Fund's past or future portfolio of investments as a whole and it should be understood that the case studies of themselves will not be sufficient to give a clear and balanced view of the investment process undertaken by the Manager or of the composition of the investment portfolio of the Fund now or in the future.
Investing in transition
Using ITR, our TargetNetZero investment strategies aim to invest in equity, fixed-income and convertible bond opportunities that offer return potential, diversification, and aim to decarbonise in alignment with the Paris Agreement.
We believe this forward-looking approach helps identify companies whose adaptation to the climate transition might be mispriced by the market, while also supporting emission reductions by companies in hard-to-abate sectors where progress is essential.
Ultimately, our TargetNetZero solutions aim to deliver performance, provide diversification and help drive the transition.
A diversified, low-tracking-error strategy with a portfolio temperature firmly aligned to the Paris Agreement
High-conviction, core exposure across industry sectors in bonds whose issuers are decarbonising towards net zero
[1] Important information on case studies. The case studies provided in this document are for illustrative purposes only and do not purport to be recommendation of an investment in, or a comprehensive statement of all of the factors or considerations which may be relevant to an investment in, the referenced securities. The case studies have been selected to illustrate the investment process undertaken by the Manager in respect of a certain type of investment, but may not be representative of the Fund's past or future portfolio of investments as a whole and it should be understood that the case studies of themselves will not be sufficient to give a clear and balanced view of the investment process undertaken by the Manager or of the composition of the investment portfolio of the Fund now or in the future. 2 HolistiQ analysis, as of September 2023 3 annual-report-2022eng.pdf (hydro.com) 4 Scope 1 emissions comprise all those directly under the control of a company. Scope 2 emissions come from the generation of power, heat, steam and cooling a company buys. Scope 3 emissions include emissions linked to a company's wider value chain. These emissions can be roughly divided into those linked to the company's upstream supply chain and those linked to the downstream lifecycle of its products and services. 5 The future of oil and gas is now: How companies can decarbonize | McKinsey 6 Source: HolistiQ analysis as of September 2023. HolistiQ is a trading name of the Lombard Odier Investment Managers group ("LOIM") and is not a legal partnership or other separate legal entity. Any dealings in respect of holistiQ shall be carried out solely through LOIM regulated entities and their authorised officers. Systemiq Limited is not a regulated entity and nothing in this website is intended to imply that Systemiq Limited will carry out regulated activity in any jurisdiction. 7 Source: Eni for 2022. A Just transition 8 Source: Eni for 2022. A Just transition 9 Source: Eni for 2022. A Just transition 10 Source: Eni for 2022. A Just transition 11 Source: HolistiQ analysis as of September 2023. 12 Scope 1 emissions comprise all those directly under the control of a company. Scope 2 emissions come from the generation of power, heat, steam and cooling a company buys. Scope 3 emissions include emissions linked to a company's wider value chain. These emissions can be roughly divided into those linked to the company's upstream supply chain and those linked to the downstream lifecycle of its products and services.
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