Stephen Langen: Good intentions? Put them to the test!

Stephen Langen: Good intentions? Put them to the test!

Climate Change Energy Transition
Stephan Langen (foto archief ASN Impact Investors)

This column was originally written in Dutch. This is an English translation.

By Stephan Langen, Head of Portfolio Management at ASN Impact Investors

December is the month in which we take stock and look ahead to the new year. And that of course also includes our good intentions.

We reflect on our sins and express the intention to do things differently and better in 2024. But unfortunately, before January is over, many good intentions have been watered down or even abandoned.

Good CO2 resolutions

I see something similar in the management of sustainable investment portfolios: that tension between good intentions and what is actually achieved. Take the targets for CO2 emissions. Years ago we started footprinting our portfolios. Based on the share that an investor owns in the capital of a company, the emissions of that company are allocated to the investor on a pro rata basis.

Sustainable investors want to look ahead

Generally accepted standards have been developed internationally for this purpose, which are now widely applied. But footprinting is not suitable for managing a portfolio. It is looking back, because it looks at historical emissions. And as we all know, past performance is no guarantee of future performance. As a sustainable investor you prefer to look ahead.

Now, large numbers of companies have also published good intentions regarding their CO2 emissions. The so-called science-based targets are truly state of the art. These are objectives that are in line with those of the Paris Climate Agreement, which aims at a maximum of 1.5 degrees of global warming. The objectives of companies, their good intentions, enable us as investors to look ahead.

Science-based metrics

A company whose emissions are still too high compared to the 1.5 degree scenario could still end up with or even below that scenario with its targets over a certain period. A metric that provides more insight into this is the implied temperature rise (ITR). ITR is a science-based metric, because it is based on climate scenarios, such as the 1.5 degree scenario, and uses the objectives of companies to make a statement about where the company is heading compared to the climate scenarios.

That of course sounds very nice, the objectives that companies formulate. But just like with our own personal good intentions, the bottom line here is that actual performance must at least be in line with those objectives. That's where footprinting comes into play again. It is important to continue to monitor over time whether the actual performance, in this case the carbon footprint, confirms that the objectives are actually being achieved.

Commitment: know what you own!

For example, if actual emissions in year 2 are higher than the target for year 2, expectations must be adjusted. But of course we prefer to prevent that. We want the companies in our portfolio to keep their promises and preferably go the extra mile so that their emissions actually go down.

We use engagement for that. A good conversation in which good intentions are compared to concrete results. When it comes to carbon emissions, that dialogue is based on data from or about companies themselves. It does require investors to conduct research into the robustness of the carbon data of the companies they have in their portfolio: know what you own!

Periodic testing against robust criteria

It also requires that investors periodically test this robustness. To do this, they must enter into dialogue with the companies that are lagging behind the portfolio objective. Experience shows that this is impossible with a portfolio that follows a broad market index. It is simply too time-consuming and therefore too expensive to keep a thousand companies sticking to their good intentions. On the other hand, with a concentrated portfolio, built up on the basis of robust sustainable criteria, this is very possible.

So companies' good intentions regarding carbon emissions are fine. But just like those of ordinary people, they are only of value if they actually lead to something. It is therefore necessary to investigate robustness and actively monitor progress and make adjustments where necessary. So that even after January the world continues to improve month after month.

Happy Festive Season!

Stephan Langen is Head of Portfolio Management at ASN Impact Investors. The information in this column is not intended as professional investment advice or as a recommendation to make certain investments.