With COP28 approaching, governments, investors, corporates and scientists are focused on driving the transition towards a net-zero world that is aligned with the goals of the Paris Agreement. A key question for investors on this journey is how they can meaningfully measure the alignment of a portfolio with their net-zero goals.

We have seen private-sector initiatives – such as the Glasgow Financial Alliance for Net Zero (GFANZ) – aiming to measure the financial sector’s progress in terms of portfolios’ alignment with net-zero pathways. Indeed, the Taskforce on Climate related Financial Disclosures (TCFD) now recommends a portfolio’s alignment to be disclosed.

We analyzed portfolio-alignment metrics across 20,000 companies to discover which metrics work best in the real world and, based on our results, we believe that the Maturity Scale Alignment (MSA) approach is the most useful for investors.

Background

To align with the goals of the Paris Agreement and prevent global temperatures rising by more than 2°C, we must focus on year-on-year decarbonization of around 7-8% and target net-zero emissions by 2050. To measure a company’s and portfolio’s alignment with this goal, GFANZ has identified four portfolio-alignment metrics:

• Binary Target Metric (BTM) – measures alignment based on the percentage of portfolio companies with 2050 net-zero emission-reduction targets
• Maturity Scale Alignment (MSA) – sorts companies into alignment categories that go beyond BTM targets
• Benchmark Divergence (BMD) – compares a company’s or portfolio’s emissions pathway with a net-zero-aligned benchmark to predict how far emissions are over- or undershooting
• Implied Temperature Rise (ITR) – translates a portfolio’s emissions trajectory into an end-of-century temperature increase

Investors can choose which metric they want to use to comply with TCFD-aligned regulations. Many clients with net-zero ambitions prefer Maturity Scale Alignment, which is also recommended by the IIGCC Net-Zero Investment Framework (NZIF).

Interpreting portfolio-alignment metrics

By analyzing maturity alignment across a more focused universe of 6,000 companies, we found that only 2% could be considered fully aligned and just 7% were on track to align with a net-zero pathway. Around 40% had made a commitment but were not yet taking sufficient action. Critically, we found that data gaps meant that 39% of the companies had insufficient data to make a definitive conclusion on alignment.

Active investors can add value here by incorporating bottom-up analysis to improve data quality and set meaningful engagement milestones for companies. This is difficult with BMD and ITR because there is often a lack of transparency on company-specific data.

Source: abrdn as at September 2023

What inputs are needed to categorize companies using MSA?

• Ambition – company aims to be net zero by 2050
• Targets – company has set interim targets (by 2035 at the latest) to meet its net-zero ambition
• Emissions Performance – historical emissions performance shows a positive trend
• Disclosure – the company provides full disclosure of emissions
• Decarbonization Strategy – the strategy to support targets is articulated
• Capex – there is a clear capex strategy to support decarbonization targets

Assessing the ITR and BMD approaches exposed significant limitations because these metrics rely on uncertain assumptions and modelling. Warming is driven by cumulative global emissions and not the rate at which individual sectors decarbonize, so an assumption must be made about how interdependent different sector decarbonization are.

This complexity is highlighted by counterintuitive results at the company level, including some oil and gas companies receiving a low temperature score, and utilities with credible transition plans receiving high temperature scores. We also found that data providers of ITR and BMD often had diverging results for the same company.

Our approach

While we have the ability to report on all four metrics, our preferred approach is the Maturity Scale Alignment method. It’s a transparent and intuitive process that can show real-world impacts and is most suitable for integration into the investment process. The MSA approach provides company-specific data that can inform engagement milestones. This is integrated into abrdn’s Net-Zero Stewardship Strategy and helps assess how companies are positioned for the climate transition.

The binary target approach is too simplistic and reflects target-setting and not action and, while ITR and BMD may appear to be theoretically robust, there is a lack of transparency and a reliance on uncertain assumptions that make them less suitable for investors.

It’s worth noting there is no guarantee that aligned companies will achieve net zero, but we have developed a credibility framework that considers company action and enabling factors like policy and technology maturity to assess the likelihood of targets being implemented.

What’s next?

As a minimum, asset managers will need to source relevant data and develop reporting capabilities to meet regulatory portfolio-alignment requirements. The metrics should also be used by investors to add value to the investment process. As investors think about the metric of their choice, it is important to consider what they are trying to achieve and assess the implications of their choice when it comes to real-world impact.

At abrdn, we believe that employing a strategy focused on Maturity Scale Alignment will be the best approach for driving real-world decarbonization and delivering value to investors in the long term.

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