Partner Insight: How do you identify decarbonisation leaders?

Maximising opportunities in decarbonisation leaders

clock • 9 min read
Partner Insight: How do you identify decarbonisation leaders?

Which companies are decarbonisation leaders? Our proprietary metric identifies those aligned with the goals of the Paris Agreement to maximise the investment opportunities and reduce climate risk.

Need to know:

  • To build our decarbonisation strategies we have designed a proprietary implied temperature rise (ITR) metric 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 my investment portfolio, what would be the likely resulting degree of global warming?
  • Using ITR, we compare two food-industry companies to show how much projected decarbonisation trajectories can differ within the same sector, helping us to determine which business merits a place in our TargetNetZero strategies in equities, fixed income and convertible bonds
  • Rather than simply excluding high emitters, our forward-looking approach enables us to prioritise emissions reductions by investing in decarbonising companies across the economy, expanding the opportunity set and improving diversification
  • Assessing climate exposure

Climate change is profoundly altering the investment universe as we transition towards net-zero greenhouse gas emissions. But assessing the climate exposure of a company is complex and many issues arise from the lack of data disclosure by companies and the large spectrum of industry standards.

At LOIM, we have developed a forward-looking tool, ITR, to measure how well aligned a company (or portfolio) is with the goals of the Paris Agreement to limit global warming to well below 2°C.  ITR compares historical and projected emissions of a company or a portfolio to the carbon budget allocated for its sector and region to remain below 2°C of global warming. It considers whether the projected emissions of a company are increasing, flat or decreasing and, if so, whether they are falling quickly enough. We translate this into a temperature-alignment score that tells us what level of global warming would result if every actor in the economy were to be managing its emissions with the same level of ambition as the company or portfolio in question.

With this metric, our goal is simple: to design TargetNetZero strategies in different asset classes that maximise opportunities and reduce climate risk in a decarbonising global economy. Rather than excluding companies point blank because they are high emitters, our approach instead seeks to identify fast-transitioning companies in vital economic sectors with credible plans to decarbonise. It's all about mitigating transition risk, recognising that only economy-wide decarbonisation can achieve a net-zero future, and deploying capital to those most aptly positioned to make the transition happen.

What's in an ITR tool?

Our ITR analysis begins by defining exactly how quickly each industry can and must decarbonise as part of the economic transition to net zero. These decarbonisation benchmarks vary by industry as well as by region. In some industries, such as power, all of the technologies needed to decarbonise are already viable. In others, such as chemicals, new technologies still need to be commercialised. This influences the shape and speed of required decarbonisation for each industry. In other words, a steeper and faster decarbonisation is expected from the power sector compared to the chemicals sector.

Then, we move to company-level and project for each company an estimation of their future emissions. This projection is based on the recent trend in its carbon emissions, its decarbonisation targets, the credibility of these commitments, strategies and financing plans. These factors enable us to evaluate whether the company's emissions are expected to fall in line with sector-specific decarbonisation benchmarks.

The figure below compares a company's projected emissions to different industry decarbonisation benchmarks. If the company were in the industrial sector, its decarbonisation trajectory would outperform that of its industry: the company would be considered a decarbonisation leader in its sector, complying with the goal of the Paris Agreement. If the company were a power company, however, it would be underperforming and would be considered a decarbonisation laggard, not complying with the goal of the Paris Agreement.

Figure 1. Company X emissions trajectory: an illustrative comparison

Source: LOIM. For illustrative purposes only.

ITR, expressed in degrees centigrade of global warming, gauges:

  • A company's current and expected emissions
  • How a company's absolute emissions are expected to progress, relative to sectoral and regional carbon budgets
  • The level of global warming that would result if every company were to manage its emissions with a similar level of determination

Ultimately, ITR assesses the ambition and credibility of a company in its alignment with Paris Agreement decarbonisation objectives. It is also a first step in deciding how the company will be considered in one of our TargetNetZero equity, fixed-income and convertible-bond strategies.

Understanding the temperature score of all the companies in our portfolios helps to avoid exposure to crippling stranded assets and identify the most valuable investment opportunities. This forward-looking analysis also helps us to identify transitioning companies across the full breadth of the economy, improving diversification by not restricting our portfolios to inherently low-carbon sectors. Such companies, especially in hard-to-abate industries like steel and construction, are vital to the transition and their progress could be underestimated by the market, providing a source of opportunity for our strategies.

Putting ITR into action: a comparison

Two companies in the same sector can have very different decarbonisation strategies and therefore projected emissions. That helps determine if one merits a place in a climate-aligned portfolio, while the other does not.

Let's take a look at an example in the food products industry. Company A has an ITR of 5.4°C. This means it would not be classified as a climate-aligned company. We would call this company a ‘burning log' as it will heat up a portfolio by having no credible plans for decarbonisation.

Company B has a much lower ITR of 1.6°C. It is projected to meet the Paris Agreement goals. This means it would be classified as a climate-aligned company in our portfolios. We would call it an ‘ice cube' because it is cooling the portfolio by plotting a credible path to meet the net-zero emissions target.

Source: LOIM. For illustrative purposes only.

Generally speaking, we orient our investments towards ice cubes in order to differentiate, within a sector, which names are best undershooting their industry's carbon budget benchmark and offering the most decarbonisation potential. Our TargetNetZero portfolios include issuers already targeting net-zero CO2 emissions by 2050, as well as those without such targets but which may be brought into line through regulatory action, investor engagement and market changes.

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Why is a forward-looking approach necessary?

While a carbon footprint is a useful measure of a company's emissions today, it is static and fails to quantify how a company is decarbonising or how successfully it will transition to a net-zero tomorrow. For this, a more sophisticated and forward-looking tool like ITR is needed.

Using a company's ITR as a gauge means moving beyond simply excluding heavy carbon emitters. This exclusionary approach often entails eliminating entire carbon-intensive sectors, or exactly where real reductions in emissions are most needed to reach net zero and where the most compelling investment opportunities arise.

By looking to the future, ITR enables us to build portfolios that focus on real decarbonisation across all sectors by investing in companies with credible decarbonisation plans, regardless of their carbon footprint today. Ultimately, our TargetNetZero approach uses ITR to help investors decarbonise, diversify, and drive the transition forward.

Find out more about investing for Net Zero

At Lombard Odier Investment Manager our TargetNetZero solutions aim to deliver performance, provide diversification and help drive the transition.

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A diversified, low-tracking-error strategy with a portfolio temperature firmly aligned to the Paris Agreement


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High-conviction, core exposure across industry sectors in bonds whose issuers are decarbonising towards net zero


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Net-zero alignment through an active portfolio with the growth and defensive features of convertible bonds


 

important information

For professional investors only

This document is issued by Lombard Odier Asset Management (Europe) Limited, authorised and regulated by the Financial Conduct Authority (the "FCA"), and entered on the FCA register with registration number 515393. This document is approved at the date of publication.

Lombard Odier Investment Managers ("LOIM") is a trade name.

This document is provided for information purposes only and does not constitute an offer or a recommendation to purchase or sell any security or service. It is not intended for distribution, publication, or use in any jurisdiction where such distribution, publication, or use would be unlawful. This material does not contain personalized recommendations or advice and is not intended to substitute any professional advice on investment in financial products. Before entering into any transaction, an investor should consider carefully the suitability of a transaction to his/her particular circumstances and, where necessary, obtain independent professional advice in respect of risks, as well as any legal, regulatory, credit, tax, and accounting consequences. This document is the property of LOIM and is addressed to its recipient exclusively for their personal use. It may not be reproduced (in whole or in part), transmitted, modified, or used for any other purpose without the prior written permission of LOIM. This material contains the opinions of LOIM, as at the date of issue.

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Neither this document nor any copy thereof may be sent, taken into, or distributed in the United States of America, any of its territories or possessions or areas subject to its jurisdiction, or to or for the benefit of a United States Person. For this purpose, the term "United States Person" shall mean any citizen, national or resident of the United States of America, partnership organized or existing in any state, territory or possession of the United States of America, a corporation organized under the laws of the United States or of any state, territory or possession thereof, or any estate or trust that is subject to United States Federal income tax regardless of the source of its income.

Source of the figures: Unless otherwise stated, figures are prepared by LOIM.

Although certain information has been obtained from public sources believed to be reliable, without independent verification, we cannot guarantee its accuracy or the completeness of all information available from public sources.

Views and opinions expressed are for informational purposes only and do not constitute a recommendation by LOIM to buy, sell or hold any security. Views and opinions are current as of the date of this presentation and may be subject to change. They should not be construed as investment advice.

No part of this material may be (i) copied, photocopied or duplicated in any form, by any means, or (ii) distributed to any person that is not an employee, officer, director, or authorised agent of the recipient, without Lombard Odier Asset Management (Europe) Limited prior consent. ©2023 Lombard Odier IM. All rights reserved.

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