Asset owners should adopt a comprehensive approach to net-zero investment programs that incorporates climate targets alongside traditional risk and return objectives, according to a new report from the CFA Institute. The industry group highlighted the “short-termism problem,” stressing that the long-term goal of reaching net zero by 2050 must be achieved by meeting interim targets over the short, medium and long term.
In the report published Tuesday, the organization argued that having a narrow focus, such as evaluating portfolio returns relative to a market index over short time horizons, often presents barriers to net-zero investing.
Instead, the report suggested that asset owners need to take a more holistic “scorecard” approach that combines financial performance metrics with climate-specific measures, such as emissions reductions. This would mean that their climate objectives could coexist with their financial objectives, rather than compromise them.
“There isn’t really one metric that captures it all, and furthermore, it can be really complex or confusing, let’s say, to try and integrate all this climate analysis alongside the financial analysis into a single benchmark or index,” said Chris Fidler, head of global industry standards with the CFA Institute, in an interview with Investment Executive.
“It’s probably best to have a suite of metrics and to look at risk, look at return, look at real-world impact.”
This scorecard, he said, can allow for “clear and productive” conversations to take place between asset owners and asset managers. Asset owners include pension funds, insurance companies and sovereign wealth funds.
“If an asset owner wants to be very aggressive with achieving real-world impact, well, that might require some tradeoffs in terms of … the length of the contract, the amount of risk they’re willing to take, in terms of deviation from, say, a broad market index, concentration risk and other things,” Fidler said.
The report also argued that asset owners should look beyond short-term time horizons.
As Fidler explained, large asset owners typically hire asset managers on a three- to five-year contract, which is not long enough to assess their effectiveness in achieving climate objectives. While annual returns are important, he said they should grant managers enough time to effectively manage a net-zero investment strategy.
“Driving real-world impact really is probably going to take something more like eight to 10 years to get a good assessment of how effective that strategy has been,” Fidler said.
The report further highlighted the use of incentives to motivate asset managers to decarbonize portfolios, invest in climate solutions and engage with corporations on climate matters.
It suggested that because asset management fees are generally not high enough to compensate managers for the time and effort needed for successful corporate engagement, asset owners could consider paying managers an engagement fee in addition to a portfolio management fee, in appropriate cases.
The report pointed to the example of the Government Pension Investment Fund of Japan, “which pays four of its external passive managers to implement engagement activities to ‘encourage investee companies to increase their corporate value and the sustainable growth of the entire market from the long-term perspective.’”
Overall, Fidler said benchmarks, time horizons and incentives “are all very interrelated” and that asset owners and the finance industry in general must treat them as such.
“You have to think about them like a system. You can’t just change one part individually. You need to think strategically and holistically about how all these things fit together,” he said.
On achieving net zero, Fidler said “a lot more still needs to be done.”
“We really need the policymakers to take the lead to set the right rules, boundaries, what’s permissible, what’s not permissible and to shape the economic incentives.”