Supporting our clients’ net zero goals

Wellington is committed to working in partnership with clients who ask us to implement decarbonization objectives into new and existing mandates we manage on their behalf. 

Why we are committed to supporting our clients’ net zero goals

Aiming to achieve competitive long-term outcomes
Our core commitment is to aim to deliver superior investment results and exceptional service for our clients. Through our research partnership with Woodwell Climate Research Center, we have come to appreciate that the physical consequences of climate change will be felt sooner and be more disruptive than markets expect. As policymakers and markets increasingly recognize and respond to this, the transition to a low-carbon economy is likely to transform certain business models. As a result, we believe actively considering transition-risk management at the company and portfolio levels can help us deliver better financial outcomes for our clients.

Companies will face many climate-transition-related challenges
To remain competitive, companies need to address transition risks that may affect asset valuations and risk profiles. While the transition will be uneven across geographies and over time, new regulations and shifting consumer preferences away from high-emitting companies may lead to rising expenses and falling margins from carbon taxes, litigation fees, capital costs, and loss of business. We believe a credible decarbonization strategy will help attract stakeholders seeking to reallocate capital toward companies embracing the low-carbon transition.

Client-directed glidepath implementation

For those asset-owner clients who have requested implementation of a decarbonization glidepath in the portfolios we manage on their behalf, we developed two standard approaches: a bottom-up glidepath based on holdings’ transition alignment and a top-down glidepath based on the portfolio’s overall emissions footprint. The tool(s) selected by each portfolio management team and the resulting measurement is driven by client objectives and each team’s investment philosophy, style, time horizon, concentration, and name-based turnover rate. We recognize that there is no one-size-fits-all metric, and we continue to evaluate additional metrics that may be added to our glidepath implementation toolkit.

Bottom-up glidepath: Increasing exposure to aligned issuers
Client objective: Increase the proportion of the portfolio invested in net-zero-aligned companies.

For certain clients’ investment mandates, the investment team pursues implementation with a glidepath that outlines an increasing percentage of portfolio exposure invested in companies that have set science-based emissions-reduction targets. 

This approach is philosophically aligned with the Science Based Targets initiative’s (SBTi’s) Guidance for Financial Institutions’ Portfolio Coverage. We currently use SBTi-validated targets as our standard metric to measure portfolio exposure. Our approach to evaluating targets, including the use of our proprietary transition alignment assessment, may evolve in response to improvements in data availability and evolution in client expectations. 

The glidepath shown in Figure 1 starts with a 2019 portfolio baseline (or later inception date), as measured by market-value exposure to companies with SBTi-validated targets. From there, an interim 2030 target is set, consistent with a linear increase to 100% portfolio exposure to companies with targets or the equivalent by 2040, and a 2040 target of 100% exposure to companies with science-based targets. (The target date for this glidepath is 2040 because portfolio decarbonization relies on underlying holdings executing against their final decarbonization targets to achieve net zero by 2050.)

To facilitate progress toward the interim target, some portfolio management teams focus on engagement with companies that are the highest contributors to the portfolio’s footprint, encouraging them to disclose their climate transition-risk-management approach and set science-based emissions-reduction targets. Because a subset of holdings often represents most of a portfolio’s weighted average carbon intensity (WACI), we believe this approach can help align portfolio decarbonization with a goal of net zero by 2050. Depending upon the receptivity of existing portfolio holdings, some teams may also tilt the portfolio toward companies with science-based targets to achieve the target.

Top-down glidepath: Reducing a portfolio’s emissions footprint
Client objective: Reduce portfolio emissions, consistent with a fair share of the requisite 50% global reduction in GHG by 2030, and net zero by 2050 or sooner.

The glidepath shown in Figure 2 starts with a baseline from 2019 (or later if a strategy’s inception date is more recent), representing a portfolio’s investable universe. From there, a 50% portfolio emissions-reduction target by 2030 is set, as well as a net-zero target by 2050 or sooner. We have selected WACI as the portfolio metric our investment teams will monitor and target for the interim 2030 target, as we find it to be more consistent with our research focus to compare companies’ efficiency of operations, including energy and materials use. That said, we may adopt a financed emissions-intensity metric (tons/US$ millions invested using enterprise value including cash) as methodological and data challenges are addressed and will report on both metrics in the meantime.

Where a glidepath is adopted as complementary to the primary investment objective, investment teams can use a combination of constructive dialogue and portfolio construction, depending on the pace of progress among net- zero aligning companies. Progress is not expected to be perfectly linear year over year. That said, we are committed to reporting on our progress along such glidepaths and proactively communicating any challenges we encounter.

Tools to support progress against client-directed glidepaths

There are several tools that portfolio management teams can use — individually or in combination — to meet clients’ decarbonization objectives over time. Individual portfolio managers make their own determination with respect to how much emphasis to place on each of these tools based on their investment philosophy and process.

Constructive dialogue
We believe constructive dialogue with companies can be a powerful tool to achieve better investment outcomes. Portfolio management teams use internal research and tools to assess the potential financial materiality to issuers and prioritize dialogue accordingly. To the extent that the investment team deems transition risk to be potentially financially material to the issuer, we aim to highlight this risk and encourage risk mitigation. These discussions can help companies appreciate the potentially wide-ranging effects of the low-carbon transition on security valuations. Company meetings can also help certain investors better understand a business’s emission footprint and transition-risk-management approach.

We can ask companies about their climate risk mitigation strategies to better understand their readiness for the low-carbon transition. The scope of these discussions varies by company and may include such topics as:

• Enhanced disclosures including footprinting
• Implications of transition-related policies on operations and business model
• Consideration of adoption of emissions reduction targets for transition-risk management
• Assessment of capital expenditures required to meet such targets

As more company management teams appreciate the contribution of a robust transition-risk-management strategy to long-term success, the investable universe of climate-ready companies is likely to expand. These dialogues take one of several forms, involve interacting with different company representatives, and typically continue over multiyear periods. 

Sell discipline
Notably, we do not mandate blanket exclusions of sectors, industries, or regions. Any portfolio-level exclusions are implemented at our clients’ request.

Over time, however, a portfolio management team’s fundamental view of a company’s long-term competitiveness may shift based on insights gleaned from conversations with the board and management team. This change in assessment may result in a reduced or eliminated position (Figure 3). The decision to sell could be temporary; a company that remains in the opportunity set may become eligible for reinvestment by demonstrating meaningful progress on risk management.

Investing in climate transition leaders, improvers, and/or solutions providers
Individual investment teams can also adjust portfolio holdings. Consistent with its philosophy and process, a portfolio management team may increase exposure to climate-transition leaders that the team believes may outperform peers over time. These may include carbon-efficient companies with existing cost advantages, those that generate revenue from products or services that reduce their customers’ emissions, or those whose active decarbonization progress improvement may be underappreciated by the market.

Unfortunately, investing in climate solutions is difficult to measure at scale with respect to quantifying avoided emissions for a wide array of products. Companies offering climate-mitigation solutions, such as utilities and industrials, tend to have high Scopes 1 and 2 emissions but low Scope 3 emissions, as emissions from the use of their products are relatively small. Investment strategies focused on these sectors tend to have higher emissions profiles relative to diversified strategies, given the current challenges in measuring Scope 3 emissions. Due in part to this data gap and rising demand from consumers seeking to lower their own carbon footprint, we believe these companies have underappreciated tailwinds to revenue growth. Standards for measuring downstream Scope 3 emissions are being developed, which should help investors and clients accurately assess and price in the demand for climate solutions.

Measurement through proprietary dashboards

Our Climate Research Team has developed proprietary dashboards that facilitate company- and portfolio-level monitoring. 

Future emissions reductions matter more than current emissions
While our dataset includes both recorded and estimated emissions, we weigh a company’s future emissions-reduction commitments more heavily than its current or historical emissions. As a qualitative overlay to these quantitative metrics, we aim to assess the credibility of each decarbonization plan and consider its implications for broader corporate strategy and capital allocation approach.

Current and historical data

Forward-looking data

Investment strategies in scope for decarbonization glidepaths

Currently, only strategies investing in equities, investment-grade bonds, or high-yield bonds can adopt client-directed glidepaths because these are the only asset classes for which emissions data is available and accepted decarbonization approaches are implementable. We also consider inclusion of multi-asset mandates — within which corporate exposure is a meaningful subset — on a case-by-case basis. We will expand the universe of eligible strategies over time as better data and methodologies emerge.

Please let your relationship management team know if you would like to explore potential net-zero glidepath implementation in greater detail.