investment viewpoints

Net-zero equities: resilience in an uncharted transition

Net-zero equities: resilience in an uncharted transition
Nicolas Mieszkalski - Portfolio Manager

Nicolas Mieszkalski

Portfolio Manager
Alexey Medvedev, PhD - Portfolio Manager

Alexey Medvedev, PhD

Portfolio Manager
Cheick Dembele, CFA - Portfolio Manager

Cheick Dembele, CFA

Portfolio Manager

Need to know:

  • Although 2023 in some ways brought a return to normality, higher global interest rates and costs weighed heavily on industries such as renewable energy  
  • Our investment approach and diversification helped shield our TNZ Equity strategies from adverse developments such as the dominance of technology stocks and stresses in the banking sector
  • Looking forward, we outline our expectations for 2024 and why we believe our strategies have yet to reach their full potential


2023 in review: mitigating macro effects on sustainable equities

The year 2023 in some ways brought a return to normality: slowing inflation, stabilising interest rates and, to some extent, more stable energy prices than in 2022. These positive developments fueled the strong performance of equity markets. However, not all the pieces lined up favourably. The combination of higher interest rates worldwide and China's lagging economic recovery stymied global economic growth and challenged certain industries in particular.

The Materials sector, especially metals, bore the brunt of high prices and China’s economy. The repercussions were felt across the value chain, with the initial impact on raw materials spreading to various industries. Renewable energy is an emblematic case. The industry faced the challenges resulting from elevated cost bases and high interest rates, which contributed to a difficult year and fueled investor doubts about sustainable investments. This environment weighed heavily on Alcoa1,2,3– our largest overweight – which ended the year down 25%. This company is well-aligned to the climate transition, being committed to improving the carbon efficiency of aluminum production.

A key highlight of 2023 was the relentless stellar performance of the ‘Magnificent Seven’,4,1 which led many active funds to underperform their benchmarks. Being well-diversified, our portfolios were shielded from this development. As we aim to invest in net zero without taking undesirable risks, we maintain tight limits on sector, country and stock deviations.

The year featured some unforeseen adverse events. Firstly, a number of regional banks in the US fell into bankruptcy, causing a deterioration in investor confidence that extended to Crédit Suisse, ultimately resulting in its takeover by UBS1. In February 2022, we introduced an explicit bank factor to our risk model, as well as tighter control of individual banks’ relative weights, to better manage macro risk related to inflation and interest rates. This also made the portfolio resilient to stresses on regional banks.

Secondly, the Israel-Hamas conflict led to a spike in instability in the Middle East. Along with the ongoing Russia-Ukraine war, this resulted in more pronounced oil price fluctuations. That being said, the oil price continued a downward trend over the year. As we tend to underweight the Energy sector, this helped the performance of our strategies.

Overall, 2023 brought no negative surprises in terms of performance. In fact, the vintage was rather good: the TargetNetZero Global Equity strategy ended the year only slightly below its benchmark (MSCI World ND), while the TargetNetZero Europe Equity strategy outperformed its benchmark (MSCI Europe ND index).5,3


Strategy enhancement: navigating decarbonisation uncertainties

We remained active in research throughout the year, with our efforts directed towards enhancing portfolio robustness. The construction of climate-aligned portfolios necessitates a forward-looking evaluation of companies’ decarbonisation paths, a challenging task given the uncertainties of projections.

This uncertainty is underscored by the clear discrepancies among data vendors regarding the alignment of individual companies with the climate transition. To address this, we incorporated model risk into our portfolio construction process, resulting in a more efficient achievement of the desired climate alignment. This approach led to more diversified overweights among what we refer to as ‘ice cubes’ — companies operating in carbon-intensive industries that we have identified as decarbonisation leaders.

See our insight: A tale of two risks: building robust portfolios aligned to net-zero.


Finding value in the race to net zero: time to review performance

In the race to meet the emissions reduction targets set by the Paris Agreement, governments across the world are implementing policies aimed at decarbonising their economies. Since the inception of TargetNetZero strategies in 2021, we have observed a notable surge in policy initiatives and regulations fostering transparency and the emergence of climate disclosure standards.6 Additionally, there has been a substantial increase in the number of companies and financial institutions adopting science-based targets.7 The momentum towards a net-zero future is clearly intensifying.

With nearly three years of a live track record, a key question is whether investing in the transition to net zero brings value. To address this, we will take a closer look at the performance of our strategies since inception, isolating the contribution of the NetZero component.

TargetNetZero performance comes from three sources: NetZero, Carbon reduction and Exclusions. The NetZero component is the core of our investment process. It implements our proprietary, forward-looking methodology that assesses alignment of portfolios to the climate transition in the form of Implied Temperature Rise (ITR). In accordance with the Paris Agreement, we maintain our portfolios so they are aligned to a below-2⁰C scenario. Carbon reduction further enhances a portfolio by targeting the immediate reduction of its emissions relative to the benchmark. Finally, exclusions are implemented to avoid investment in controversial businesses.

As we noted in our report last year, underweighting Energy hurt climate strategies in 2022 because of surging oil prices. Our strategy was no exception; however, the magnitude of the impact was contained through prudent risk control. To isolate the contribution of Energy, Figure 1 shows the performance of the NetZero component excluding this sector, as well as the sector on its own.

We note that NetZero ex-Energy has been largely flat since inception in both strategies, meaning that markets have not yet started pricing in the future implications of the climate transformation. We therefore believe that the full potential of our strategies lies ahead. As public policies to reduce carbon emissions intensify, the shift in market valuations will be fast and dramatic. In our previous publication, we estimated that the full pricing of the impact on companies’ long-term growth will result in a double-digit outperformance for our portfolios. We must stress, however, that this is just one of many channels through which the climate transition will impact market valuations.  


FIG 1. Performance of NetZero component since inception of TargetNetZero strategies


Source: LOIM. Past performance is not a reliable indicator of future results.


What lies in store for us in 2024

The combination of elevated inflation and higher interest rates in 2023 was probably one of the worst possible scenarios for renewable energy. However, there is cause for optimism that the situation will improve in the coming year. Our macro outlook for 2024 anticipates a shift towards a more favorable economic environment, marked by a gradual reduction in inflation, paving the way for central banks to adopt a policy of easing (What does 2024 hold for markets?).

This positive shift should encourage both the financial and corporate sectors to step up investments and accelerate decarbonisation through more affordable technologies such as solar and electric vehicles.                                                                        

2024 will also have its challenges. Given the sensitivity to geopolitical dynamics, the Oil & Gas sector is likely to experience heightened volatility in the foreseeable future.

These factors are collectively shaping the landscape of 2024, highlighting the importance of a rigorous investment approach and a truly diversified strategy for the transition to net zero.



[1] Any reference to a specific company or security does not constitute a recommendation to buy, sell, hold or directly invest in the company or securities.
[2] Holdings and/or allocations are subject to change.
[3] Past performance is not a reliable indicator of future results.
[4] Amazon, Apple, Google (Alphabet), Meta, Microsoft, Nvidia and Tesla.
[5] On a net basis.

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