Nimisha Sodha, Responsible Investment Lead, Just Group, explains the art of setting Net Zero targets and back book optimisation.
Once an insurer has pledged to become Net Zero by 2050, it then needs to come up with interim targets – how is that done?
Scope 3 really is the lion's share of an insurer's emissions, of which the investment portfolio is a large part. With that in mind, Just Group has set an ambition to reduce scope 3 emissions by 50% by 2030 and achieve Net Zero by 2050 relative to a 2019 baseline. We're also a signatory to the Net Zero Asset Owner Alliance, which recommends setting, at a minimum, specific engagement-related targets and to consider setting targets for at least two of sub-portfolio, sector or climate solutions based targets. These are the targets we are working towards defining and publishing externally as per our commitment to this initiative.
So what do we do? In line with the guidance, we consider portfolio level metrics and individual asset level metrics, in particular on emissions for the purposes of setting either of sub-portfolio/sector specific targets. As for climate solutions, our existing sustainability bond framework outlines the key criteria for green investments for which we already have a target to invest a total of £750m in green and social investments by 2025. As such, in this case we consider the best ways in which we can further enhance our targets to ensure alignment with the Net Zero Asset Owner Alliance. Guidance and standards in the market are a key tool for setting interim targets for an investment portfolio.
Having said this, before setting these targets it's particularly important for us to understand what the overall portfolio footprint actually looks like. In order to do this, we collect data on current and historic emissions using either reported or estimated data with a view to ensuring calculations are aligned with the Partnership for Carbon Accounting Financials standard. We already know that the data is not perfect and there are clearly issues in both reported and estimated data but this does give us a good starting point for improvements going forward. Once we have this data then it's important we consider this in the context of our broader approach for portfolio management, analysing the future profile of the portfolio based on the current in-force portfolio as well as the potential impact of new investment activity. Due consideration is given to the future profile of an investment based on the issuers' existing commitments, for example commitments to relevant external initiatives such as the Science Based Targets Initiative to understand the potential future direction of the issuers emissions as well as identifying opportunities to engage and influence, where possible, rather than simply divesting alone. In doing this analysis we can therefore aim to understand what the future portfolio might look like in 2025, 2030, etc. with/without actions being undertaken.
In doing this, we mustn't lose sight of traditional financial metrics that need to be considered as part of portfolio management and really bringing all of this together to understand other financial impacts of implementation is the reality of setting and implementing targets as an insurer.
We socialise the outcomes internally and get people's views before making decisions and actually implementing them.
How have the outcomes been received internally?
In general, the discussion have been well received internally with a desire to do more, sooner, but taking a pragmatic approach in doing so. Partly that's been driven by the recognition that there could be future unintended consequences of not acting now by being forced to act over a much shorter period of time. And at the same time, there's likely to be a spread impact. So, you want to get ahead.
Another driver is that we tend to manage our back book actively . So adding an emissions intensity aspect to this is easily incorporated.
What does this optimisation look like in practice for the portfolio?
Inevitably, our liquid bond portfolio is an important tool for optimising the back book as opposed to the illiquids. Our liquid assets do represent a fair share of the portfolio's financed emissions and so it isn't a surprise that this part of the portfolio is a key driver of optimisation.
We generally have a preference for illiquid assets on a like-for-like basis. Even if we have to sell now, but we can't necessarily reinvest straightaway, we might hold some cash waiting for an illiquid asset to materialise.
One of the big concerns is the potential for concentration risk in certain sectors that we might be exposed to post-optimisation. The 'dirtier' names tend to be the Energy, Mining, Basic Materials and the Utilities companies. In an area where the data is exposed to significant estimation or errors, it's important to be rational in our approach. Continued enhancements include giving due consideration to the sector decarbonization pathways, rather than simply divesting whole sectors which aren't necessarily supportive of achieving a real world transition.
And when does new business come into the picture? And how do you approach it?
As long as we're investing below the level of emissions of the previous year-end, we're going to be decreasing the average emissions of our portfolio. We are doing that, and it's not really too difficult. So, we're trying to bring in an element of forward-looking analysis into the allocation of new business.
Another element that applies to both new business and the back-book optimisation is our stewardship activities. We expect that this will form a small, yet key, part of our emissions reduction strategy over the coming years. Each of these levers together form the basis of a well-informed transition management strategy.
Taking a step back, we've talked about it from a very holistic portfolio level standpoint; when do you start looking at and differentiating between asset classes?
We actually break the emissions down by individual asset. Even within our real estate debt portfolio, for each commercial mortgage, we are getting either actual or estimated emissions data. We go as far as ensuring this data is available pre-investment ensuring we do not consider an investment without having estimated or actual emissions to understand any potential portfolio implications from adding a new investments. We have a real opportunity here, as an asset owner, to encourage asset managers to continue to provide the data we need in this space supportive of achieving our longer term ambitions.
But do you have the same strategy for all asset classes? If I take government bonds as an extreme example, do you apply the same methodology?
We aim to align our calculations with the Partnership for Carbon Accounting Financials to ensure we are taking a broadly consistent approach. Therefore on an individual asset class basis, the calculations do vary. For instance for government bonds, the emissions intensity is calculated using the exposure to a sovereign bond as a proportion of PPP-adjusted GDP. Having said this, there are parts of our portfolio where the data has not been available and therefore an estimate is applied using sector averages. This is where it gets really, really tricky. There's a real data integrity point in particular where lower quality estimates have been applied.
Going beyond the numbers, there are countries where a significant proportion of the energy usage is from renewables. We would consider this alongside their commitments and the data to do a wholistic assessment of their future profile. This is looked at very carefully and is a genuine input into an investment decision as per credit, ALM and all the other aspects that we take into account, including other environmental, social or governance considerations.
The other thing we do is optimise across asset classes by considering the relative value, in emissions terms, of holding one asset versus another. Meaning we might consider swapping out one for the other, depending on the emissions profile and other aspects of the deal, such that at an overall portfolio level we've got the same exposure (or lower) compared to what we has before but in a different buckets.
You mentioned earlier that you look at the financial impact of existing investments and entering new ones, have you seen a gap? Is there a financial impact either positive or negative of your optimisation?
Making investment decisions based on emissions could have potential financial impacts, which may not necessarily be positive. Consideration needs to be given to the sectoral impact; in terms of concentration risk, credit quality and from a capital point of view, any costs from trading as well any further liquidity requirements.
So, in a nutshell there could be potential costs associated with this, that we need to be aware of and pragmatic in decision making to avoid significant cost.
What's the place of asset managers in all this? Do you tell them what to do and that's the end of it? Or there is a conversation?
It's absolutely a conversation and there's a real variety of asset manager approaches and levels of sophistication towards this, even on greenhouse gas emissions. This might seem surprising but given the speed at which this area has grown in importance, it means that naturally asset managers are competing to get their own best solutions in place. Especially given that clients are continually asking for data to understand the impact of each of their investments. But we do find that, in certain instances, we are educating asset managers on how we're considering emissions including the calculations.
In other instances they will calculate it themselves or have data providers who provide emissions data. The level of responsible investment due diligence that they do varies quite a bit. Some have been surprised by the speed at which asset owners may have implemented this.
We're demanding data that they haven't sourced. And, clearly, they can't in all instances, but we at least expect them to be giving a view on either the emissions that we calculate or the data that they're getting from an external provider, as to the credibility of that data.
And obviously an important area of work with asset managers is stewardship. We expect them to engage with companies that we invest in on our behalf.
It's a two-way conversation and a dialogue.