Equities

3 years of TargetNetZero Equity: a genuine transition approach

3 years of TargetNetZero Equity: a genuine transition approach
Alexey Medvedev, PhD - Portfolio Manager

Alexey Medvedev, PhD

Portfolio Manager
Nicolas Mieszkalski -  Portfolio Manager

Nicolas Mieszkalski

Portfolio Manager

The TargetNetZero (TNZ) Equity strategies recently marked their three-year anniversary. Since they launched in late April 2021, we have sought opportunities beyond the obvious low-carbon sectors because we recognise that transitioning away from fossil fuels involves the entire economy. Our methodology pinpoints the companies that will have the largest and most effective impact on the shift, regardless of – and even because of – their current carbon footprints.

 

Need to know:

  • Since launching in 2021, our TargetNetZero Equity strategies have sought out the leaders of the climate transition in every industry, unlike peers that avoid high-carbon sectors
  • We do this using an in-house, forward-looking methodology developed by our sustainability research team
  • Does investing in the transition bring value? We take a closer look at the performance of our strategies since inception

 

Focusing on high-carbon sectors

The objective of the TNZ Equity strategies (Global and European) is to deliver portfolios aligned with the goals of the Paris Agreement to hold global warming well below 2˚C. Our process leverages an in-house methodology developed by our sustainability research team: the Implied Temperature Rise (ITR). This is a forward-looking metric that identifies which companies in our investment universe have credible decarbonisation plans (for more detail on ITR, click here). 

Using this assessment, we seek to find leaders of the climate transition in every industry, unlike peers that avoid high-carbon sectors. TNZ portfolios have a greater focus on high-carbon industries, where we overweight ‘ice cubes’ (companies helping to ‘cool’ the economy) and underweight ‘burning logs’ (high-carbon laggards). This allows us to capture opportunities in sectors vital to the climate transition, as climate leaders will be ultimately rewarded with higher valuations relative to laggards.

 

Maintaining diversification

A number of unforeseen adverse events have occurred since the TNZ Equity strategies launched, including post-Covid inflation and the conflict in Ukraine. We have refined the risk model we use for portfolio construction along the way, and our investment approach and diversification have helped shield our strategies from the turbulence.

In 2022, much of our competitors’ underperformance stemmed from being underexposed to energy amid surging oil prices, while being overexposed to information technology and having a bias towards growth stocks in general. In 2023, higher interest rates worldwide and China's lagging recovery stymied global growth and challenged industries such as Renewable Energy. The relentless stellar performance of the ‘Magnificent Seven’ led many active funds to underperform.

With our approach, we aim to invest in net zero without taking undesirable risks, and we maintain tight limits on sector, country and stock deviations, leading to a low tracking error (below 1% p.a.). Figure 1 reflects our general alignment with the benchmark in terms of sector rotation – an important differentiator from many of our peers.

 

FIG 1. Sector allocation of TNZ Equity strategies  

Source: Bloomberg, LOIM, as of 30 April 2024. Benchmarks: MSCI World ND and MSCI Europe ND. Portfolio holdings are subject to change. For illustrative purposes only.

 

Our track record

1. Faster emission cuts

We expect our portfolios will decarbonise relatively quickly as a result of integrating estimated emissions in our stock allocation process1. This is in contrast to Paris Aligned indices that pursue decarbonisation through rebalancing.

Nonetheless, despite employing advanced models, uncertainties persist. We have written before about the challenges involved in building climate-aligned portfolios given the uncertainties of forward-looking projections, as well as how we address them. Since 2023, we have integrated this consideration into our portfolio construction.

Figure 2 compares the decarbonisation of our two TNZ portfolios with their benchmarks over the past three years. This metric shows the change in portfolio emissions resulting from emissions changes at the constituents, rather than from rebalancing. Our portfolios have decarbonised faster than their benchmarks, and we expect this outperformance to expand in magnitude as the pace of emissions reductions accelerates2.

 

FIG 2. Decarbonisation comparison (from TNZ Equity strategy inception through March 2024)

Source: LOIM estimates based on scopes 1, 2 and 3 as at 12.04.2024. Benchmark is the MSCI World index. For illustrative purposes only. Past performance is not a reliable indicator of future returns.

 

2. Opportunities are still ahead

In the race to meet the Paris Agreement emissions targets, governments worldwide are implementing policies aimed at decarbonisation. The momentum towards a net-zero future is clearly intensifying.

A key question is, does investing in the transition bring value? To address this, let’s take a closer look at the performance of our strategies since inception.

 

FIG 3. Performance of NetZero component since inception of TargetNetZero strategies

As of 1 May 2024. For illustrative purposes only. Past performance is not a guarantee of future returns.

 

The TargetNetZero ex-Energy style has been largely flat since inception in both strategies, meaning that markets have not yet started pricing in the future implications of the climate transition. As a result, the total returns of our strategies have lagged their benchmarks since inception: the TargetNetZero Global Equity strategy generated a net annualised 4.8% relative to the 5.6% of its benchmark and the TargetNetZero Europe Equity strategy returned 7.3% against 8.1%3.

With the market yet to price in the climate transition, we believe that the full potential of our strategies lies ahead.  

In a previous publication, we estimated that the full pricing of the impact on companies’ long-term growth would potentially result in 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.  

 

Sources.

[1] Holdings and/or allocations are subject to change.
[2] Past performance is not a reliable indicator of future returns.
[3] Source: LOIM at 30 April 2024. Performance shown: the LO Funds – TargetNetZero Global Equity (USD NA) relative to its benchmark, the MSCI World ND USD, and LO – Funds TargetNetZero Europe Equity (EUR NA) share class against its benchmark, the MSCI Europe ND, from 30 April 2021 to 30 April 2024. Past performance is not a guarantee of future returns.
 
Learn more about our TargetNetZero equity strategy.

important information.

For professional investors use only

This document is a Corporate Communication and is intended for Professional Investors only. 

This document is a Corporate Communication for Professional Investors only and is not a marketing communication related to a fund, an investment product or investment services in your country. This document is not intended to provide investment, tax, accounting, professional or legal advice.

This document is issued by: 

Lombard Odier Asset Management (Europe) Limited (hereinafter the “Company”). The Company is authorised and regulated by the Financial Conduct Authority (the “FCA”), entered on the FCA register with registration number 515393. 

This document is approved at the date of the publishing. The Company is clustered within the Lombard Odier Investment Management Division (“LOIM”) of Lombard Odier Group which support in the preparation of this document and LOIM is a trade name.

Any opinions or forecasts provided are as of the date specified, may change without notice, do not predict future results and do not constitute a recommendation or offer of any investment product or investment services.

This document is the property of LOIM, is provided for information purposes only and is addressed for the recipient exclusively for its personal use. It may not be reproduced (in whole or in part), transmitted, modified, or used for any other purpose without the prior written permission of LOIM. It is not intended for distribution, publication, or used for any other purpose without the prior written permission of LOIM. 

The contents of this document are intended for persons who are professionals and who have been vetted by LOIM and assessed as suitable to the investment matters set out in this document and in respect of whom LOIM has received an assurance that they are capable of making their own investment decisions and understanding the risks involved in making investments of the type included in this document or other persons that LOIM has expressly confirmed as being appropriate recipients of this document. If you are not a person falling within the above categories, you are kindly asked to either return this document to LOIM or to destroy it and are expressly warned that you must not rely upon its contents or have regard to any of the matters set out in this document in relation to investment matters and must not transmit this document to any other person. This document contains the opinions of LOIM, as at the date of issue or completeness of the information contained in this document, nor does it accept any liability for any loss or damage resulting from its use. All information and opinions as well as the prices indicated may change without notice.

The contents of this document has not been reviewed by any regulatory authority in any jurisdictions and does not constitute an offer or a recommendation to subscribe for any securities or other financial instruments or products.   

It contains opinions of LOIM, as at the date of issue. These opinions and information contained herein in this document does not take into account all the specific circumstances of the addressee. Therefore, no representation is made that the information presented in this document are suitable or appropriate to the individual circumstances of any investors. Tax treatment depends on the individual circumstance of the investor and may be subject to change in the future. LOIM does not provide tax advice. 

The information and analysis contained herein are based on sources believed to be reliable. While LOIM uses its best efforts to ensure that the content is created in good faith and with greatest care, it does not guarantee the timeliness, accuracy, validity, reliability or completeness of the information contained in this document, neither does it warrant that the information is free from errors and omission not does it accept any liability for any loss or damage resulting from its use. All information and opinions as well as the prices indicated may change without notice. Particular contents of third parties are marked as such. LOIM assumes no liability for any indirect, incidental or consequential damages that are caused by or in connection with the use of such content. 

The Source of the data has been mentioned wherever it was available. Unless otherwise stated, the data is prepared by LOIM. 

Not for US Person: This corporate communication is not intended for any "U.S. Person" as defined in Regulation S of the Act, as amended or pursuant to the 1940 United States Investment Company Act as amended and will not be registered pursuant to the 1940 United States Investment Company Act as amended, or pursuant to other US federal laws. Neither this document nor any copy thereof may be sent, taken into, or distributed in the United States of America, any of its territories or possessions or areas subject to its jurisdiction, or to or for the benefit of a United States Person. For this purpose, the term "United States Person" shall mean any citizen, national or resident of the United States of America, partnership organized or existing in any state, territory or possession of the United States of America, a corporation organized under the laws of the United States or of any state, territory or possession thereof, or any estate or trust that is subject to United States Federal income tax regardless of the source of its income.
 
Data Protection: You may be receiving this Communication because you have provided us your contact details. If this is the case, note that we may process your personal data for direct marketing purposes. For more information on Lombard Odier’s data protection policy, please refer to 
www.lombardodier.com/privacy-policy 
 
©2024 Lombard Odier IM. All rights reserved.