For John Ploeg of PGIM, it is necessary to take into account not only the current and historical trends in an emitter’s emissions but also their future trajectory.
When it comes to sustainable investing, there are a multitude of approaches and criteria that are used to assess the extent to which a securities portfolio is aligned or not with the Paris Agreements. How to find your way there? According to John Ploeg, co-head of ESG research at PGIM Fixed Income, it is particularly useful to be able to have common tools such as the approach called “temperature alignment” which takes into account not only current and historical emissions trends of an emitter, but also expectations regarding the future trajectory of its emissions. He considers this approach more relevant than that which is based on measuring the “carbon footprint” alone. Explanations with the specialist in questions related to sustainable investment at PGIM.
What is PGIM’s investment approach designed to “align portfolios with Paris” and how has your investment selection approach evolved recently?
The approach often taken by investors to align their portfolios with Paris is to measure a “carbon footprint” – typically defined for a given company as its emissions divided by its enterprise value or revenue, before being aggregated at the portfolio level – and then set a target for reducing that footprint. However, we believe this approach lacks essential nuance and often leads more to sector rotations than to investments in companies that are organically decarbonizing.
“So we focus on the emitters that produce the most emissions, because that’s where our efforts are most cost-effective.”
For clients looking to align their portfolios to Paris, our preferred selection process is based on our proprietary temperature alignment tool. This tool takes into account not only current and historical trends in an emitter’s emissions, but also expectations regarding the future trajectory of its emissions. Initially, these expectations are based on the company’s stated objectives, then they are refined taking into account the credibility – or not – of these objectives. We finally try to compare this future trajectory to a relevant trajectory specific to the company’s sector and its starting point. This results in a temperature alignment “score” assigned to each company, which we believe is a better way to assess Paris alignment.
Are there other comparison criteria that are more relevant depending on the company’s profile or its specific sector of activity?
Of course, turnover is a criterion which has the advantage of making it easier to compare the volume of CO emissions.2 of any company with the size of its activities, even when it comes to companies that are active in very different fields. It is also possible to compare CO emissions2 in relation to a certain quantity of production of a given good or service, for example tonnes of concrete at cement manufacturers, the number of passengers carried in air transport, etc. However, in this case, the possibilities for comparison are limited within a sector and can only be made between companies active in relatively similar fields.
Is it relevant to compare the emissions of companies operating in areas as different as software, which is in principle low-polluting, and cement manufacturers, which are by definition major emitters of CO?2For example?
Setting targets for each sector would ideally be the most sensible approach. However, this approach is also problematic in practice when managing a portfolio if it is still based on carbon footprint: you can still miss critical nuances at the issuer level. This is why I think the approach called “temperature alignment” is a more appropriate tool, because it captures these nuances more completely.
Defining CO emissions reduction targets2 for given sectors or companies is it not itself subject to manipulation? Some companies might be tempted to set goals that are too easy to achieve, while others stick to more ambitious goals that are difficult to achieve or out of reach…
We of course look at the detailed content of the objectives defined by the companies and whether they are realistic or, on the contrary, too flexible. We do not place much importance on setting objectives alone but we ensure that these are adapted to the specific activities of each company. It is also important to take into account the trajectory of each company’s emissions and their credibility in relation to the targeted objectives. Generally speaking, we prefer that companies set realistic objectives, divided between different intermediate stages, rather than companies which display spectacular ambitions like “we will reach Net Zero in 2040” but which are not always credible, nor clearly measurable.
“We prefer that companies set realistic objectives, rather than companies that display spectacular ambitions but which are not always credible.”
This requires considerable evaluation work. How do you do it: do you use your own databases or do you use external research services?
We build our analysis from other research provided by third-party providers – paid or not. We then bring together all these data sources. When they are consistent and tell the same story, we are more confident. When there are discrepancies, however, we need to do more in-depth qualitative work. This may require extensive analysis for each issuer, sometimes including interviews to gather more information. We therefore focus on the emitters that produce the most emissions, because that is where our efforts are most cost-effective.
Today there are a host of initiatives, task forces or authorities that define different standards related to sustainability. How is it possible for a manager or individual investors to navigate this multitude of acronyms and different standards?
Some people describe this as the “ESG alphabet soup”. However, all of these approaches to sustainability contribute something; they all have their reasons for being. Now, as a manager or as an investor, it is important to decide which aspects are most important and to define the resources that can be mobilized for this purpose. That is why I think that determining and using a common concept such as the “Temperature Alignment” of a portfolio provides a very important help.
What will be the impact of changes in regulation, particularly in Europe with the new MiFid rules regarding ESG investments, to encourage the adoption of sustainable investments among more investors?
On this subject, we must distinguish between, on the one hand, the rules which concern the distribution of sustainable investments, or their adequacy with the wishes and preferences of clients, and the rules which concern the definition of what is sustainable or not and the impact of investments on the environment. MiFid concerns above all the first aspect.
