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It’s never too early to think long term—How investors can align with net zero by 2050

19 Oktober, 2023

 

 

On July 6, 2023, the average global temperature reached an all-time high of 17.23⁰C. Sadly, climate change is all too real, and this heat record will probably not hold for long. In fact, if we carry on business as usual with the current level of greenhouse gas (GHG) emissions, the planet is projected to warm 2.8⁰C on average by the end of the century. This would cause dramatic sea level rise, increasingly extreme heat, severe fresh water stresses, and more intense and frequent climate events.

 

Moreover, the impacts of climate change will most likely be felt sooner than later. The World Economic Forum Global Risk Report 2023 states that 6 of the top 10 risks for the global economy over the next 10 years are climate and environment related.

 

Source: World Economic Forum, Global Risks Perception Survey 2022–2023.

The timeframes to make fundamental changes and avoid the worst climate damage and nature collapse are compressed—the international scientific consensus is that we need to reach net zero GHG emissions by 2050 globally. While 2050 may seem a distant point in time, it’s actually an ambitious target that requires concerted and constant efforts, starting now. Many countries, cities, companies, and other institutions have joined forces to reduce global GHG emissions, but we believe investors also have a crucial role to play in achieving that goal. As such, we expand on three key elements that can help long-term investors align their investments with reaching net zero by 2050:

  • Having a plan to reduce all emissions
  • Identifying climate leaders
  • Creating value for companies and shareholders through engagement


Having a plan to reduce all emissions


Simply put, net zero means that GHGs produced through human activity are balanced by removal of GHGs from the atmosphere. The term net zero is important because this is the state at which climate change stabilizes. To get there by 2050, the Intergovernmental Panel on Climate Change (IPCC) estimates that we’ll need to reduce GHG emissions by 50% by 2030 globally, and realize further reductions coupled with increased ability to absorb pollution.

Companies are stepping up to this challenge for a variety of reasons such as demonstrating leadership, leveraging opportunities, reducing risk, anticipating or complying with increasing regulation around GHG emissions reductions, and aligning with customer and investor expectations. In any case, companies need to address emissions at all levels: direct emissions (scope 1), indirect emissions (scope 2), and those in their value chain (scope 3).

GHG emissions can be categorized into scope 1, 2, and 3

Definitions using the example of an automotive company

  • Scope 1
    Produced by the company directly. For example, running machinery to build cars in its factories produces scope 1 emissions.
  • Scope 2
    Generated by the company indirectly. For example, using electricity to heat or cool its buildings produces scope 2 emissions.
  • Scope 3
    Generated across a company’s upstream and downstream value chain. For example, customers driving the automobiles produced by the company produce scope 3 emissions for the company.


As of September 2023, about 50% of the more than 1,500 companies listed on the MSCI World Index had net zero targets by 2050 or earlier, and the index’s weighted average of tons of GHG per million dollars of revenue declined by almost 15% since the metric peaked in 2018 at 310 tons. However, we believe that to have a fighting chance of reaching net zero by 2050 this decline must accelerate, and this acceleration will come from initiatives and plans that focus on all emissions, including scope 3.

Companies have started reducing GHG emissions

Emissions intensity (scope 1, 2, and 3 upstream)

Source: S&P/Trucost, Manulife Investment Management, as of December 2020. Emissions intensity is measured on a weighted average basis in terms of tons of greenhouse gas (GHG) emissions per unit of sales (US$1,000,000). The universe is the MSCI World Index.

Scope 3 emissions are the most difficult to calculate but usually represent the bulk of a company’s total GHG emissions (more than 90% in some instances). In our opinion, to implement an effective climate strategy or to align capital with net zero by 2050 all emissions must be considered, including scope 3 emissions.

For example, there’s a U.S. retailer that we particularly like from a net zero transition standpoint. The company is addressing scope 1 and 2 emissions effectively, but with 98% of its total emissions stemming from scope 3 emissions, the retailer is having an amplified environmental impact by putting measures in place to reduce GHG emissions across its suppliers, transport network, and providers of materials it uses. Essentially, it’s helping to decarbonize the value chain and the wider economy in which it operates.

Initiatives from the U.S. retailer to reduce scope 3 emissions

  • Suppliers
    One key initiative the company implemented with its suppliers is to eliminate all fossil fuel-powered boilers used in the manufacturing process and replace them with more efficient electric motors.

  • Transportation
    To control emissions related to transport logistics, the company is turning to electric vehicles and reducing its use of air freight by prioritizing cross-border trucking and ocean freight (air freight emits 47 times more GHG than ocean freight per ton per mile).

  • Materials
    The company is increasingly using sustainable materials in its products by scaling recycled polyester and replacing conventional cotton with more sustainable alternatives.

 

To align capital with net zero by 2050, it’s important for long-term investors to make sure their portfolio companies have a clear and effective plan to reduce scope 3 emissions. After all, one company’s scope 3 emissions are another’s scope 1 and scope 2 emissions, and for companies with thousands of suppliers and millions of customers, the knock-on effect can be powerful.
 

Identifying climate leaders


For us, climate leaders are companies that are prepared for a world that transitions to a net zero carbon economy. We categorize them into three main groups:

  1. Cleantech companies
  2. Companies in transition
  3. Companies with low emissions


1 Cleantech companies
 

While it’s undeniable that clean technologies such as renewable power and electric vehicles are front and center in the low-carbon transition, the main challenge for climate-oriented investors with this group is to identify companies that will be well positioned in a low-carbon future, and that can be bought at compelling valuations in the near term.

With initiatives such as the U.S. Bipartisan Infrastructure Deal and the European Green Deal intended, in part, to accelerate the transition to clean technologies, market excitement around clean tech has grown to new heights in recent years; however, it’s important to keep in mind that many cleantech companies are still in the early stages (i.e., start-up or growth) of the business lifecycle. This means that many of them are cash flow negative, don’t benefit from economies of scale, and are far from reaching maturity. Moreover, there are only 47 companies listed on the MSCI World Index deriving at least 50% of their revenues from clean technologies. Therefore, there are significant amounts of money chasing relatively few securities, helping stretch valuations over time.

To expand the investable universe in the cleantech space, investors can also find opportunities with companies that have small but growing revenues from cleantech—for example, 20% today but the long-term outlook is that they could reach more than 50% revenues from cleantech and be a dominant part of the low-carbon economy of the future.

Cleantech companies show characteristics of early-stage companies

Key fundamental statistics, median

 

# of companies

P/E ratio

Free cash flow yield

Revenue

Cleantech companies (>50% revenues from cleantech)

47

20.9

1.7%

$4.5B

Companies with revenues from cleantech between 20% and 50%

71

17.2

3.0%

$22.3B

Source: Manulife Investment Management, Bloomberg, MSCI, as of October 10, 2023. The universe is the MSCI World Index. Price to earnings (P/E) is a valuation measure comparing the ratio of a stock’s price with its earnings per share.

Reaching net zero requires new cleantech companies to grow and succeed. But it also heavily depends on today’s mature and established companies to innovate their existing systems and processes to expand into cleantech solutions, and investors can support both.
 

2 Companies in transition
 

While investors can choose different paths to effectively support the low-carbon transition, according to the IPCC and as enshrined in the Paris Agreement, there’s no place for fossil fuels in a 1.5⁰C warming scenario. This is why Article 9 funds with a climate objective under Europe’s Sustainable Finance Disclosure Regulation—and many investors who want to be aligned with net zero by 2050—are screening out hard-to-abate sectors such as fossil fuels.

However, there are companies and industries that may have higher GHG emissions today but also have credible and aggressive low-carbon transition plans that will enable decarbonization throughout their value chain. These companies are poised to have an outsized impact on decarbonizing segments of our economy if they can successfully transition.

As such, we believe it’s critical for companies in transition to have set a science-based target (SBT), as it tells us how committed a company is to its emission reduction journey and allows us to track its progress over time.

An SBT is a corporate sustainability, climate, or GHG emissions reduction goal that meets three criteria:

  • It has a clearly defined emissions reduction pathway;
  • It has a defined baseline amount and year, as well as target goal date (i.e., reduce absolute GHG by 50% by 2030);
  • It's set in line with the latest climate science necessary to meet the goals of the Paris Agreement: limiting global warming to well below 2°C above preindustrial levels and pursuing efforts to limit warming to 1.5°C.

 

Companies in transition need to reduce their carbon emissions significantly if they want to contribute to a low-carbon future and be competitive in the long run. For investors, the key is to monitor the transition and reward companies that are proactively part of the solution.


3 Companies with low emissions
 

Companies in inherently low-carbon sectors such as financial services, technology, and pharmaceuticals are often central to climate investment strategies, but there are criteria that can differentiate climate leaders from laggards, regardless of the sector of activity. These include:

  • Beyond net zero
    While low-emissions companies may have a head start because of the nature of their business (some are already net zero), that doesn’t mean they can pause reducing GHG emissions. To reach net zero globally, some companies should aim to be carbon negative if their starting point is lower and explore opportunities to absorb and incentivize excess emissions reductions directly or throughout their value chain.

  • Beyond GHG emissions
    Reducing GHG emissions is widely considered to be the main tool to fight climate change, but there are other synergistic issues, such as water management and protecting nature, which we believe companies should include in their climate plans.

  • Peer leadership
    This includes taking an industry leadership role, being an example to peers, being involved in collaborative research and standard setting, and showing that profitability and top environmental performance go hand in hand in today’s world.Whether it’s by innovating in cleantech, tackling emissions throughout their value chain, or driving initiatives to address climate issues beyond emissions, climate leaders are, in short, companies that are at the forefront of the low-carbon transition. In any case, it’s important for climate-oriented investors to make sure they deliver and remain climate leaders over time, and we think the best way to do that is through engagement.
     

Creating value for companies and shareholders through engagement


Climate-oriented investors usually have dual investment objectives: mitigating climate change while generating strong returns. We believe sound engagement practices (e.g., communications with company management, boards of directors, and proxy voting) can help them achieve both over the long term.

Companies around the world and from different sectors are making net zero pledges and setting increasingly aggressive emission targets. But navigating the net zero transition is complex, and setting targets is only the first step. Companies also need to meet those targets, and we believe active ownership can help companies deliver at the right pace for their specific emission reduction journey so that financial resilience isn’t compromised.

Investors can influence how companies address GHG emissions

Source: Manulife Investment Management. For illustrative purposes only.

When we engage with companies from a sustainability standpoint, it’s often on SBTs, GHG measurement and reporting, board oversight of climate risk management, and on measures that can help both improve the companies’ environmental practices and create value for shareholders. For example, we engaged a global professional services company with concerns that its cleantech revenue was underreported using its current approach. The outcome was that the company committed to setting an SBT and getting a third-party audit of their cleantech revenues so that market participants could better assess the company’s quality.

To align capital with net zero by 2050, it’s important for investors to select companies that have a clear vision on how to be successful in meeting their targets and in a green economy that will most likely have very different risks and rules. But we believe investors also have a role to play in guiding and keeping them on track with their emission trajectory.

 

Staying aligned


The impacts of climate change are forcing our society to adapt and reduce GHG emissions. While the net zero transition is already well under way, it also needs to accelerate significantly if companies and governments are to reach their net zero goals by 2050. As such, governments, companies, and citizens continue to adopt new environmentally friendly regulations and behaviors—yet, in our opinion, reaching net zero can’t be done without investors’ contribution.

For us, contributing to a sustainable future for investors doesn’t mean having to compromise on performance; rather, it’s investing in climate leaders with the ambition to be a part of the low-carbon transition that we think will deliver on their promises. There will certainly be bumps along the net zero by 2050 road, but if we’re all rowing in the same direction, staying aligned with this ambitious target becomes a possibility.

 

 

 

 

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