Implementing Net Zero in emerging market public equities

Purpose – why is this important to us?

Arisaig Partners’ Investment Philosophy is founded on the belief that Purposeful Growth – taking a multi-stakeholder view of the world – generates superior long-term investment returns in the emerging markets. Climate change and its most disruptive outcomes poses an existential threat to humanity itself, and therefore to all businesses.

Action – what are we doing about it?

We have no doubt that action on climate change is imperative. The decision to commit 100% of our assets under management to net zero – though not taken lightly – was relatively straightforward. We joined as one of 30 inaugural members of the Net Zero Asset Managers (NZAM)[1] initiative in December 2020. One year on, we have set the decarbonisation targets for the coming decades that will allow us to fulfil this commitment.

Working out how to implement net zero, given our on emerging markets[2], has required considerable thought and research. In this piece, we share a few of the challenges faced and the solutions adopted during our target setting endeavour.

 

Targets supporting Arisaig’s Net Zero Commitment

Source: Arisaig Partners

Process – how are we implementing this idea?

Challenge 1: Choosing the right target setting methodology.

There is no commonly agreed definition of ‘net zero’, let alone a consensus on how companies should get there. Asset managers must also decide how to measure their emissions exposure and monitor alignment. NZAM endorses three target setting methodologies[3],

Each have their pros and cons. For example, the ‘financed emissions’ metric adopted in the Paris Aligned Investment Initiative’s (PAII) Net Zero Investment Framework measures emissions in absolute terms, reflecting an investor’s share of portfolio companies’ emissions. While using an absolute metric such as this gives a transparent view as to whether a portfolio is trending to net zero (as opposed to intensity metrics based on company revenue), it is not ideal for comparison or benchmarking. The ‘Portfolio Temperature Rating’ metric from the Science Based Targets Initiative involves translating portfolio companies’ emission reductions targets into long-term temperature outcomes associated with the ambition of the target. Compared to most methods which are based on historic emissions, the temperature rating method gives a forward-looking view by focusing on future targets. However, it relies on portfolio companies setting their own Science Based Targets, which can pose significant financial and technical challenges for emerging market businesses.

Our solution: We decided that PAII’s Net Zero Investment Framework was the most pragmatic for our portfolios, which has led us to set targets with reference to financed emissions. The majority of other NZAMs have also chosen this framework[4]. However, we believe having a broader view of our progress is valuable and therefore will also monitor our portfolios’ temperate ratings and weighted average carbon intensities.

 

Challenge 2: Choosing the right emissions reduction pathways[5].

There is a lack of guidance on emissions reduction pathways for the geographies and sectors we invest in. The UN Framework Convention[6] calls for ‘common but differentiated responsibilities’ for countries to act on climate change, recognising that emerging markets bear less of the historical responsibility and have fewer resources to fund the climate transition. A slower starting pace for emerging markets is justified but needs to be made up for by accelerated progress in future. More precise guidance on the appropriate trajectories is not widely agreed upon[7].

From a sectoral perspective, most research on reduction pathways to date has (rightly) concerned sectors with the highest carbon intensities. Arisaig’s focus on companies offering ‘sustainable domestic demand growth’ means we have no exposure to such high intensity sectors.

Our solution: As we wait for clearer regional and sectoral guidance, we have initially adopted the International Energy Agency’s ‘Net Zero’ 2050 pathway[8] for emerging markets. In line with this, across our portfolios we have set an annual emissions reduction target of 1.6% between 2020 and 2025, increasing to 6.1% p.a. reduction between 2025 and 2030. This translates into a total emissions reduction of 34% compared to 2019 by 2030.

 

Challenge 3: Closing the data gaps.

Most of our portfolio companies currently do not report greenhouse gas (GHG) emissions. While estimates from third party data providers are available, their accuracy remains questionable, making reliable measurement of net zero alignment challenging. With emerging market regulation on climate lagging the likes of the EU, it could take some time to close these data gaps

Our solution: We have set goals to steer our portfolio companies through direct engagement and proxy voting towards better management and reporting on climate change. These goals are based on the Transition Pathway Initiative[9] (TPI) Management Quality framework, which lays out a useful roadmap via five clearly defined ‘levels’ of climate change integration. Our short-term target is for 100% of our AUM to reach at least ‘Level 2’ of the TPI framework by 2023, which requires a company to have: (1) set GHG emission reduction targets; and (2) published information on operational (Scope 1 and Scope 2) GHG emissions. We should therefore have reliable GHG data for all our portfolio companies by 2023.

 

Looking beyond COP26

We know our targets and goals aren’t perfect but, as the saying goes, perfection should not stand in the way of doing something good. We will strive instead for continuous improvement, reviewing our targets regularly to keep ourselves on the forefront of the climate change transition.

 

[1] https://www.netzeroassetmanagers.org/

[2] We believe we are one of the few, or even the only one of the 42 NZAMs that have published their targets to be exclusively invested in emerging markets

[3] Paris Aligned Investment Initiative Net Zero Investment Framework, Science Based Targets Initiative for Financial Institutions, Net Zero Asset Owner Alliance Target Setting Protocol

[4] 24 out of the 42 asset managers that have published their targets under NZAM initiative to date have chosen the PAII Net Zero Investment Framework

[5] Pathways is the term used to describe the emissions, technologies and investment trajectories that will be needed to deliver net zero

[6] Article 3 of the United Nations Framework Convention on Climate Change (1992)

[7] Organisations like CERP have put forward useful research, but still some subjectivity involved

[8] International Energy Agency (2021) Net Zero by 2050

[9] https://www.transitionpathwayinitiative.org/

Disclaimer:

This material is being furnished for general informational and/or promotional purposes to professional investors only. The views expressed are those of Arisaig Partners and should not be considered as advice or a recommendation to buy, sell or hold a particular investment. They reflect opinion and should not be taken as statements of fact, nor should any reliance be placed on them when making investment decisions. This material does not constitute independent research and is not subject to the protections afforded to independent research.

The statements and views expressed herein are subject to change and may not express current views. Arisaig Partners makes no representation or warranty, express or implied, regarding the accuracy of the assumptions, future financial performance or events. Emerging markets are generally more sensitive to economic and political conditions than developed markets and may be more volatile and less liquid than other investments.

All information is sourced from Arisaig Partners and is current unless otherwise stated. Issued by Arisaig Partners (Asia) Pte. Ltd. Not for public use or distribution. Arisaig Partners (Asia) Pte. Ltd is licensed and regulated by the Monetary Authority of Singapore.

 

Sign up to request our research