Climate change and its most disruptive outcomes pose an existential threat to humanity itself and, therefore, all businesses. We believe the trend towards a low carbon economy is firmly entrenched and decarbonisation will drive growth in emerging markets in the coming decades. Given our multi-decade investment outlook, it is imperative that we adequately manage both risks and opportunities relating to climate change to preserve our clients’ capital.
In 2020, we became one of the 30 founding members of Net Zero Asset Managers’ Initiative, committing to manage 100% of assets in line with net zero by 2050. However, we had been looking at climate risks long before that. Our focus on investing in the highest quality businesses that capture domestic demand in emerging markets has meant that we have never invested in fossil fuel companies. From an operational standpoint, Arisaig has offset its GHG emissions since 2010 but the step change was really taken in 2015 when we engaged Trucost (now part of S&P) to help us track and report our portfolio carbon emissions. Our focus at this juncture was on analysing the role of our dairy businesses in our portfolio as we weren’t convinced that their profitability was sustainable if they were in any way forced to internalise the environmental externalities of their operations (we have since divested).
Our climate commitments may come as a surprise to some as our strategies don’t have ‘climate’ or ‘low carbon’ in their names. Even so, compared to even low carbon emerging market benchmark indices, our portfolios have significantly lower carbon intensity. For example, we estimate that our firm-level weighted average carbon intensity is about half that of the MSCI Emerging Markets Climate Paris Aligned index, and about a third of that of the MSCI India ESG Climate Transition Benchmark (India is the market to which we have greatest exposure across our strategies)[1].
Reassuringly, the weighted average carbon intensity of the MSCI EM Climate Paris Aligned index is significantly lower than the MSCI EM index. This is evident when comparing the top 10 constituents, where we see that fossil fuel and mining companies (i.e., Reliance Industries, Vale) have been removed from the former[2]. What is perhaps more surprising is the lack of climate solutions companies in the Paris Aligned index, i.e., companies that are not just on the path to net zero but are actively developing products and services that help to mitigate climate change. Whilst we are very much off the index in terms of our investments (>97% active share) this is not dissimilar to our own experience in emerging markets, as we have only found a handful of listed businesses of the requisite quality that offer solutions to address climate change.
Relatively low carbon intensity portfolios mean we should have lower exposure to climate transition risk compared to the benchmarks. This is further borne out in the findings of our shadow carbon pricing exercise last year, which estimated that the imposition of a USD 75/tCO2e carbon tax on scope 1 and 2 emissions would hit indicative portfolio returns by roughly only 3% (more detail in an earlier blog). However, mitigating climate risks is only one side of the coin; as stewards of long-term capital, we should also capture relevant climate opportunities, which we believe are significant and growing. Recent investments in this area include Chinese companies in the batteries space, an Indian energy exchange platform, and an Argentinian agri-tech business that produces crops that are resilient to a changing climate.
All this, however, does not mean it will be necessarily easier for our portfolio companies to transition to net zero, particularly given we only invest in emerging markets. Initially, it may be more difficult to see year-on-year improvements in the ‘real world’ emissions of our holdings because they are relatively low emitters, which means there is less regulation targeting them and less collective action taken by civil groups, including investors. For example, Climate Action 100+, one of the most supported investor-led initiatives to engage companies on climate change, is focused on 166 of the world’s highest emitting companies, only 25% of which are in Asia, South America or Africa, and none of which overlap with our holdings[3]. While it makes complete sense for the wider industry to tackle the largest emitters first, it means we aren’t able to rely on the might of initiatives like this to help move the needle for our portfolios.
The path to net zero is certainly daunting. Nonetheless, we believe the best way to approach this is the same way we have been engaging companies for the last 27 years. We see ourselves as ‘constructive owners’ – over time, we hope to become trusted partners of our investee companies, helping them to become better versions of themselves. Our specialist focus – exclusively emerging markets, generally domestic demand-driven businesses – allows us to maintain detailed knowledge of global best practices, which (we hope) makes us a valuable partner. It is fair to say that some of our earlier engagements back in 2015 fell on deaf ears as our low carbon intensity businesses didn’t see the importance of this issue: “we aren’t a fossil fuel company”.
There are some signs our persistence is working, alongside other factors which mean emerging market businesses are ever more aware of the potential challenges that climate change will bring to their operations. When we first set our net zero targets in 2020, our top priority was for all holdings to reach Level 2 as measured by the Transition Pathway Initiative (TPI) Management Capacity framework. This includes reporting scope 1 and 2 GHG emissions. In 2020, only 14% of our holdings were at Level 2 or above. Every year since then, we have engaged with nearly all our companies at TPI Level 0 or 1. We followed up meetings and video conferences with our ‘engagement packs’, which include a suggested step-by-step process for TPI progression, examples of strong reporting from peer companies, as well as contacts at carbon consultancies that could provide support. By the end of 2022, the proportion of our holdings at TPI Level 2 or above tripled to 42%. While we can’t put a number on what part of these improvements are attributable to our efforts (and don’t see the value in trying to do so), we’d like to think we had a role. We are cautiously optimistic about getting close to our ambitious target of 100% by the end of 2023 or soon thereafter.
We won’t be relaxing anytime soon, though, and in fact will need to double down on our climate engagements over the next few years. There is a long way to go with regards to our other net zero goals. For example, our financed emissions last year actually went above our 2019 baseline, and only a handful of our holdings are currently net zero aligned (more details in this blog).
In our day-to-day work looking at emerging markets, we are often reminded of why we’re doing this. In Mumbai, where our India office is based, recently 14 people died of heat exhaustion at an awards ceremony, and agricultural labourers outside the city are confronting increasingly lethal daily conditions; in Argentina (which we visited last month), farmers have just experienced the worst drought since records began in the 1920s, causing crop harvests to drop by half and crippling the local economy. When we made our commitment to net zero, hard graft is part of what we signed up for. It is becoming increasingly clear that this endeavour is not only worthwhile, but necessary.
Notes:
[1] Firm-level weighted average carbon intensity achieved by calculating the carbon intensity (Direct and First-tier Indirect emissions, including scope 1, 2 and other first-tier upstream scope 3 / USDm in revenue) for each portfolio company and calculating the weighted average by pooled portfolio weight. Carbon intensity data is based on latest figures available from S&P Trucost Limited as of 1 April 2023. Carbon intensity for Arisaig portfolios is based on firm-wide holdings as of 31 December 2022. MSCI EM carbon intensity based on iShares MSCI Emerging Markets ETF constituents as of 31 January 2023. MSCI EM Climate Paris Aligned carbon intensity based on SPDR MSCI Emerging Markets Climate Paris Aligned ETF constituents as of 28 February 2023. MSCI India ESG Climate Transition Benchmark based on iShares MSCI India Climate Transition ETF constituents as of 28 February 2023. MSCI World Climate Paris Aligned based on SPDR MSCI World Climate Paris Aligned UCITS ETF constituents as of 28 February 2023.
[2] MSCI EM carbon intensity based on iShares MSCI Emerging Markets ETF constituents as of 31 January 2023. MSCI EM Climate Paris Aligned carbon intensity based on SPDR MSCI Emerging Markets Climate Paris Aligned ETF constituents as of 31 Janaury 2023.
[3] Climateaction100.org, accessed 25 April 2023; Arisaig analysis
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.
