Investors seeking exposure to the climate transition should use both active and passive investment strategies to ensure the best blend of risk and return in their portfolio.
“Climate investing does not have to be an either/or decision around index or active strategies,” said Altaf Kassam, EMEA head of investment strategy and research at SSGA. “As with many portfolio objectives, ESG investing aims can be addressed using indexed, active or a blend of approaches.”
The firm believes this to be increasingly important given the expanding spectrum of climate solutions. As a result, different investment approaches are needed to bring meaningful portfolio benefits from mitigation and adaptation by addressing both transition and physical risks.
“A combined approach provides a more nuanced way for investors to meet their investment as well as ESG objectives,” added Carlo Maximilian Funk, EMEA head of ESG investment strategy at SSGA.
Investing via indexes
Based on the backward-looking focus of indexed approaches, they have historically been considered better suited to mitigation efforts, such as avoiding and reducing emissions in a portfolio, or among portfolio companies.
More recently, indexed approaches have evolved to incorporate more forward-looking measures, such as the Paris-Aligned Benchmarks which include decarbonisation targets, and can also take into account corporate target setting.
“These more forward-looking measures can be combined with traditional index technology. And as more information becomes available that is relevant to climate investing, the opportunity to build transparent, systematic approaches based on that quantifiable data will expand,” explained Kassam.
Active allocations
From an active perspective, the ever-greater amount and availability of relevant climate-related data helps investors to better assess potential transition risk, as well as the possible effectiveness of companies’ adaptation efforts, even though these aspects are more subjective.
In a climate-focused world, climate transition planning and competency will become key areas of differentiation for companies – and key valuation drivers for all equities.
“In this evolving climate landscape there will be re-ratings, valuation dislocations and corporate winners and losers, creating an environment ripe for forward-looking, active stock selection,” added Funk.
Further, SSGA supports a discretionary active approach for investors who have more tolerance for tracking error, who want to access the cutting edge of climate transition and who are looking to gain exposure to new technologies that are well-positioned to be at the forefront of climate change in the future.
Stepping up stewardship
At the same time, investors looking to express climate-related views in their portfolios must also be focused on asset stewardship in both indexed and active contexts.
In line with this, SSGA believes engagement is the key and divestment only considered a measure of last resort, especially when it comes to the climate transition.
“Fundamentally, we believe divestment is not sufficient to create genuine climate impact by itself. With divestment, investors lose their impact to bring about positive and lasting change via voting and engagement,” Kassam said.
