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Fixing ESG challenges with climate solution investing

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Our industry has built an incomprehensible jumble of information and ratings to define and measure climate change risks and opportunities, Stewart Investors wrote in a July 2020 article.

But these are “near meaningless and often misleading”, it claims.

The UK active asset manager, which belongs to First State Investments, argues that current methods are unable to provide certainty that a company will belong to the future low-carbon world.

The firm applies a climate solution approach to identify holdings and believes that it presents a straightforward and assured way of low-carbon investing.

ESG measurement cluster

Pablo Berrutti, senior investment specialist at Stewart Investors’ Sustainable Funds Group, explains that measures such as carbon footprints are backward-looking and limited when seeking to measure emissions from companies’ products and services and supply chains.

“[Carbon footprinting] provides a very limited view of the company’s positioning in relation to the transition to a low-carbon economy,” he says.

Methods such as carbon footprints and capital expenditure plans, including tools like the Paris Agreement Capital Transition Assessment (Pacta), help rather those investors who want to engage with highly polluting companies, the article writes. But the methods can’t identify sustainable companies with a potential to solve the climate crisis.

While forward-looking measures exist, such as companies setting 2° targets, these signal transition plans but don’t guarantee that they will truly align with the Paris Agreement.

Berrutti explains to Expert Investor: “We love to see companies commit to ambitious targets, but we want to see the action that supports that as well.

“What we’re really trying to do is to find something to complement and better tell the stories of future solutions, rather than focusing on more or less backward-looking frameworks.”

To identify ‘truly’ transitioning companies, Stewart Investors looks at how well firms are positioned in line with long-term sustainability trends.

It also applies a solutions-based framework to its investments, to confirm that its selection of companies is on the right pathway to deliver the climate targets.

Project Drawdown

The long-term asset manager has mapped its World Sustainability portfolio to climate solutions that non-profit organisation Project Drawdown has identified.

Project Drawdown was initially co-founded in 2014 by Paul Hawken and Amanda Ravenhill to uncover the most substantive and existing solutions to reach the tipping point when greenhouse gas emissions start dropping.

Using analytical models, a research team estimates how many metric gigatons of carbon dioxide a given solution avoids or sequests over time if it is scaled. In its Drawdown book in 2017, it identified 80 solutions with the potential of meeting the Paris climate goal, and updated these in 2020.

Stewart Investors separates the companies’ contributions into direct, enabling/supporting, indirect and no drawdown solutions.

For its Worldwide Sustainability fund, it found that 33 out of 53 companies make contributions to drawdown solutions, with 26% making direct contributions, 30% enabling/supporting and 6% indirect (see graph below).

Berrutti says: “Our focus is very much on whether the companies themselves are making a ‘meaningful contribution’ [and] will have meaningful involvement with the delivery of those solutions.

“If that solution continually reaches its ultimate scale that Drawdown predicts, then that is a fantastic opportunity for those companies that are involved in that solution to be able to grow over the long run as they deliver that.”

He emphasises the importance of a credible third-party source, such as Project Drawdown, that can verify sustainable investments, and also ensure that these are made at the target and not just at the goal level.

Investment approach

The Drawdown solutions focus on existing technologies, and the fund does not invest in start-ups.

Berrutti says that the asset manager invests in large cap companies, which either have sustainability as part of the core business model, or target sustainability in their research and development, revenue growth or capital expenditure.

The top holding of the euro-denominated fund is consumer goods company Unilever. It was launched in February 2019 and its benchmark is the MSCI ACWI. At the end of July, it had €248m of assets under management and returned in the last year 6.3% and outperformed its benchmark (0.9%). The equity fund invests both in developed and emerging markets, but the latter makes up a smaller portion of its allocations.

“What the Drawdown approach allows us to do is to look at what are the potential next legs of growth and opportunity that exist for these companies,” he says, adding that they are taking a 10-year view in their valuations of companies and focus on financial quality.

German industrial cooking appliance manufacturer Rational, for example, is one of the asset manager’s holdings.

“They’re making more efficient appliances that make better use of water, that create healthier food because they use steaming power rather than frying as the main mode of cooking, so the food is healthier and tastier as a result,” Berrutti explains.

Over the next months, Stewart Investor plans to map its remaining strategies along the Drawdown solutions and has announced it will disclose all portfolio holdings and the rationale for selection on its website.

Elena Johansson

Senior Reporter

Part of the Bonhill Group.