Knowing when to divest
Until new regulations arrive, investors should conduct a deep-dive analysis and engage with companies to determine which are not as sustainable as they appear.
The results of the Amazon 2021 sustainability report revealed a 40% rise in emissions between 2019 and 2021, contradicting its sustainability goals. Amazon isn’t the only company to veer off the track in meeting its net-zero targets, so investors must learn the signs if they want to avoid investing in companies that are not as sustainable as they appear to be and know when to divest.
Mandatory disclosures will help address the challenges of disclosures being inconsistent, as Patricia Pina, head of product research and Innovation at Clarity AI, notes.
“More than 40% of companies reporting Scopes 1 and 2 are still not reporting Scope 3,” she says. “In a recent study we conducted, we found that there is a 44% difference, on average, between Scope 3 emissions for verified and unverified reports. This data suggests significant underreporting of Scope 3 emissions in the absence of third-party verification.”
Mandatory disclosures will address the lack of transparency. But in the meantime, investors must engage with companies to understand more about their journey to net zero.
Spotting the signs
While a growing number of companies have announced net-zero targets, it is essential that investors analyse their pathways to understand how seriously they take this pledge.
Investors should consider whether the company has disclosed how it intends to get to net zero and whether it has interim targets. Meanwhile, investors should identify whether the company is breaking down how it will achieve net zero. For example, is it looking at energy efficiency or sourcing all its power needs from renewables, or is it using mostly carbon offsets?
Sophie Haas, head of sustainable investing at JP Morgan Private Bank, suggests companies should also ask about the quality of the company’s carbon offsets, explaining that “transparency is key when it comes to understanding and analysing net-zero targets”.
Meanwhile, Jennifer Wu, global head of sustainable investing at JP Morgan Asset Management, says it is important for investors to first understand the extent to which a sector should contribute.
Wu says: “The transition to a low-carbon economy is not a straight line. The pathway is very sector-dependent because of the unique role that each plays in reducing GHG emissions and removing carbon from the atmosphere.”
According to Wu, it’s not sufficient to only look at GHG emissions. To truly understand whether a company’s climate targets and plans are realistic and robust, metrics such as R&D expenditures, CAPEX and scenario analysis can provide investors with a useful perspective.
Knowing when to divest
Active engagement versus divestment is a constant dilemma for investors focusing on sustainability within their investment portfolios, so if a company’s management team is not receptive to engaging on ESG issues, that could be a red flag and time to consider divesting.
According to Haas, a red flag could potentially materialise through reputational risk or litigation risk in the long term.
“As ESG is about transparency through disclosure, and any company incorporating material ESG factors seriously in their business model should be comfortable to disclose them, happy to engage on them and work on ways to improve them,” she says.
For example, at JP Morgan Private Bank, an active engagement strategy is important in its due diligence process when selecting a sustainable or ESG strategy. However, when engagement is not producing results or a company is not receptive to the engagement, some investors or portfolio managers may choose to divest entirely from a company.
Haas adds: “It is not a decision to be taken lightly, but we may see this action more going forward as the world transitions to a lower-carbon economy and the leaders and laggards emerge in that transition.”
Climate-related disclosure at a company level have been on the rise, but Wu says that “given the voluntary nature of these disclosures, quality, consistency and comparability have been some of the primary issues for investors when assessing companies’ management of climate risks as well as the robustness of their GHG-reduction targets”.
Most targets do not include the entire value chain, such as Scope 3 emissions, which makes it difficult for investors to assess the alignment to net-zero pathways of such targets. However, regulators are now starting to announce requirements for mandatory disclosure in alignment with the Task Force on Climate-Related Financial Disclosures recommendations.
Wu concludes: “Until then, it is critical for investors to conduct deep-dive analysis and actively engage with company management on implementation progress. This will help investors to identify potential risks early on and know when to divest.”