Globally, it is estimated that investments of US$5 trillion a year are needed by 2030 if the world is to reach net-zero by 2050 and keep a chance to meet The Paris Agreement's 1.5 °C target.

Failure to meet these objectives could have dire consequences for Asia, potentially jeopardising 27%¹ of its GDP. Given what is at stake, Asia not only has a pivotal role to play in decarbonising the global economy but offers a huge opportunity to drive transformative change throughout this energy transition megatrend.

Portfolio composition: from divestment to transition

Initially motivated by the urge to offload high-carbon companies and mitigate their portfolios' carbon emissions – something referred to as ‘paper decarbonisation’ – many investors now appreciate the value of investing in real-world decarbonisation as a way to contribute to positive climate outcomes.

Steering clear from firms that may face unmanageable carbon-related regulatory, financial and, in some cases, physical risks, while investing in green solution providers, seems like an intuitive strategy for profiting from the energy transition. However, this approach overlooks a few vital considerations. First, since only a certain percentage of companies can be classified as either carbon-intensive or green, so simply using that dichotomy would drastically reduce the investable universe.

Meanwhile, as more businesses are now under pressure to execute their own energy transition, there is a growing recognition by major investors like GIC and Australian Super in the value of working with higher-carbon companies which are shifting towards greener operations to both lower portfolio carbon intensity and reduce real-world emissions. Where the investment community has been focusing on divestment over engagement, this oversight has left many 'brown' companies undervalued and potentially ripe for creating transition alpha.

Finally, understanding the transition strategy of a firm is also crucial for investors to assess valuation. As a firm executes its transition energy plans and gets eventually recognised by the market, investors who understand these plans can focus on maximising transition alpha over time instead of being forced to immediately divest from such a company at a discounted price.

Creating transition alpha: the power of engagement

In this context, fund managers must assess each company on its own, as even a company currently perceived as high-risk could potentially evolve into an enabling platform of the energy transition, thus offering significant value in the medium term. They must adopt a nuanced approach, evaluating a company's decarbonisation plans for their credibility, effectiveness in creating value, and commitment to execution. This also includes looking at the regulatory environment of the markets in which these companies operate, as well as their access to decarbonisation technologies.

While actively owning and engaging constructively with these companies through their transition can yield transition alpha for investors, it comes at the cost of a temporary increase in a portfolio’s carbon footprint.

Green deals: More than Meets the Eyes

Given the global imperative to decarbonise power grids, pouring investments into solar module manufacturers and solar farm operators once seemed like an obvious play, though the returns have often been underwhelming. The reason? In addition to inflated valuation created by this “gold rush”, some managers did not appreciate how relying on intermittent power sources like solar can heighten grid instability and impact performance. Investors should instead go beyond seemingly obvious investments to look at the entire energy transition value chain, from transmission lines and smart grids to the minerals used in manufacturing the modules, wind turbines and batteries driving the energy transition.

Meanwhile, opportunities are arising from public-private partnership, as institutions such as the Asian Infrastructure Investment Bank uses infrastructure securitisation to enable institutional investors to co-invest in risk-weighted tranches tailored to satisfy their return, duration and emission requirements.

Prepping Fund Managers and Investors to succeed

In addition to employing local professionals with a deep understanding of their respective markets and comprehensive industry knowledge, fund managers should be able to work across multiple jurisdictions and assess technology risk. Investors are also on the look-out for fund managers with domain expertise, a longer-term time horizon, the patience necessary for constructive engagement, the ability to offer high-quality ESG research coverage as well as the credibility to help shape regulations and industry standards.

In any event, asset owners must develop a robust framework to integrate climate risk and sustainability across their decision-making processes. Such a framework should include the adoption of clear success metrics, staff education, data and model integration strategies, and the systematic implementation of engagement protocols with investee companies.

Transitioning to a sustainable economy necessitates organisation-wide dedication that transcends mere "transition-washing." Both long-term financial returns and the prospects for a better world depend on it!