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Building a Climate-Aware Portfolio

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SEP 20, 2022

Companies that adapt for the low-carbon future are ahead of the game.

In the investing world, climate change has quickly catapulted from a fringe concern to a top consideration. Many countries, including the U.S., have committed to net-zero carbon emissions by 2050, and regulators are pushing companies to lower their carbon footprints. The Inflation Reduction Act, which passed in August, could encourage more than $300 billion in climate and clean energy investment. This massive transition is creating opportunities for investors to invest in renewable energy and technology enabling more energy-efficient construction and transportation. “Investors that weren’t thinking about the physical or transitional risks that come with climate change five years ago are now leading with it in our discussions,” says Jim Landau, head of environmental, social and governance, real estate and agricultural finance at MetLife Investment Management (MIM).

The International Energy Agency (IEA) estimates that annual investment in clean energy could more than double to $5 trillion to meet existing net-zero carbon goals, which entail cutting greenhouse gas emissions to as close to zero as possible by reducing and removing remaining emissions. The agency estimates investment in global energy could increase 8% to $2.4 trillion in 2022, with most of the growth coming from renewable power and energy efficiency. Another sign of investor interest is the market for green bonds, which has grown to about $2 trillion in five years. In real estate, there’s been a push to track and reduce the greenhouse gas emissions generated by buildings. New regulations from the Securities and Exchange Commission, expected later this year, will determine the extent to which public companies are required to disclose Scope 1, 2 and 3 emissions in their annual filings. There’s also been a rush toward LEED certification in the U.S. or BREEAM certification in Europe for new buildings and toward better energy efficiency in older ones.

Prepping for the future

As companies prepare for this greener future, MIM sees value in companies and projects that are pivoting in an attempt to benefit from the transition to a low-carbon economy. There’s still a way to go before that kind of economy becomes a reality. Renewable energy from solar, hydroelectric, geothermal and biomass became the second-largest source of electricity in 2020, but still accounts for just 21% of energy consumption, according to the U.S. Energy Information Administration. In Europe, renewable energy makes up almost 40% of energy generated, according to the International Energy Agency.

There’s growing awareness that climate change will have financial repercussions, but not all companies have a plan. Management may not stay abreast of regulatory changes that can create added risks. Companies may not have the capital to invest in needed infrastructure or the foresight to pivot. The most promising are the ones that are “charging forward faster than anybody else,” says Brian Funk, head of credit research at MIM.

Thinking ahead is particularly crucial for long-term investments, says Aurélie Hariton-Fardad, senior portfolio manager and ESG team lead for corporate and infrastructure private debt. MIM follows a buy-and-hold strategy for its private credit investments. Given the long timeframe, “it’s all about thinking how a company or a project will fare over time,” she says.

New risks and opportunities

Climate change is shifting the way portfolio managers look at investments. In real estate, Landau says there’s been a dramatic increase in climate-related regulation and legislation. “If you wait for regulations to be passed before taking action, it may impact the value of some assets. You need to factor in decarbonization risk today,” he says. Cities such as New York and Boston have already passed legislation limiting how much greenhouse gas emissions buildings can produce before facing a fine.

Given the regulatory risk, MIM believes real estate investors need to focus on the environmental impact of a property, scrutinizing efficiency ratings and power sources and looking for low-carbon building materials and energy-efficient construction techniques in new developments.

One challenge in creating a more climate-aware portfolio is the lack of reliable data. There’s plenty of intention, but it’s not easy to verify whether a company is taking the steps to actually switch to renewable energy or improve water usage. Increasing interest in ESG is fueling the growth of an entirely new industry of data providers, but the data can be inconsistent and patchy. To fill in the gaps, MIM relies on traditional qualitative analysis—talking to management, understanding their vision and assessing whether their actions and investments are commensurate with their goals.

In the private credit markets, Hariton-Fardad sees opportunities in infrastructure, renewable energy and utilities. She’s also keen on green investments that help companies in other sectors transition to lower their carbon footprint. With markets starting to factor environmental considerations into valuations, she sees credit deals where the coupon rate increases or decreases depending on whether certain sustainability-related factors have been met.

Funk sees opportunities in sectors such as energy, cement, steel and shipping, all of which have big carbon footprints that are difficult to abate without significant investment. He’s particularly keen on emerging market economies where transitioning to affordable renewable energy can help yield additional benefits, such as cleaner air or surplus capital, which can be directed to improvements in health care and education. Eliminating a diesel-generated power plant to deploy new, more efficient renewable energy can not only take carbon out of the atmosphere, but also lower the cost of power and provide energy to a greater portion of the population.

It’s still early days, but Funk and his colleagues are optimistic that as data becomes more standardized, climate-aware investing can expand to incorporate even more precise investment modeling estimates and new investment strategies. Change is underway and climate-aware investing will not be a short-term trend.

“Whether you’re a true believer in sustainability or not, this is going to dictate how capital gets allocated and businesses get valued for the rest of our investment careers,” Funk says.

Disclaimer
This article has been sponsored by and prepared in conjunction with MetLife Investment Management (“MIM”) solely for informational purposes and does not constitute a recommendation regarding any investments or the provision of any investment advice, or constitute or form part of any advertisement of, offer for sale or subscription of, solicitation or invitation of any offer or recommendation to purchase or subscribe for any investments or investment advisory services. The views expressed herein do not necessarily reflect, nor are they necessarily consistent with, the views held by, or the forecasts utilized by, the entities within the MetLife enterprise that provide insurance products, annuities and employee benefit programs. Subsequent developments may materially affect the information contained in this article. Affiliates of MIM may perform services for, solicit business from, hold long or short positions in, or otherwise be interested in the investments (including derivatives) of any company mentioned herein. This article may contain forward-looking statements, as well as predictions, projections and forecasts of the economy or economic trends of the markets, which are not necessarily indicative of the future. Any or all forward-looking statements may turn out to be wrong. All investments involve risks including the potential for loss of principal.
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