By Sarah Wilson, Head of ESG Integration at Nuveen, and Derek Jun, Head of Investment Risk at Nuveen, TIAA’s asset manager

It is now widely accepted that we need to shift to a low-carbon economy to mitigate climate change. If governments enact policy to accelerate this transition, there are significant transition risks to investments. Asset prices will reflect these risks, but timing is unpredictable. Regulators around the world are signaling a willingness to act, just as the Paris Agreement requires re-submission of national commitments in 2023 – or possibly even a year earlier under the Glasgow Climate Pact coming out of COP26.

While hedging climate risks can be tricky, it is up to investors to stay ahead of the curve. Understanding market implications and anticipating significant policy changes is a step in the right direction, but a net zero target approach can position investors to take a view on transition risks and help prepare them for the market’s reaction.

esg playbook

How Are Investors Thinking About Net Zero?

If an investor believes a swift transition to a low-carbon economy is inevitable and will happen soon, then it’s an investment risk that can be managed by decarbonizing their portfolios. If, however, they believe such a transition will not occur any time soon, or will manifest through existing market forces, then the risk is low and decarbonization may not seem necessary in the near term.

The truth is that the most likely outcome lies somewhere in the middle: an uneven and, at times, disorderly low-carbon transition. Some governments will act, but it won’t be in a consistent fashion, and others will not act at all. And in any circumstance, the rising threat of climate change poses a serious risk to investment performance in the future. In this context, investors can consider net zero as a way to contribute towards mitigating the long-term impact of physical risks from climate change as well as a way to protect against potential near-term transition risks.

Transitioning a Net Zero Commitment to a Net Zero Portfolio

There are many different paths to decarbonize institutional portfolios, with many unknown factors along those paths. The key is to fix the destination and be flexible in using the various investment decision levers available.

The first step is to understand the “why” behind the net zero commitment. This will affect the choice of carbon metric, which measures the progress, time period, interim targets, and the appetite for sacrificing any risk or return. These factors feed into the execution plan and into creating a portfolio that is on a path to net zero carbon.

At this stage, it’s also important to acknowledge some of the unknown factors. These include the appropriate carbon accounting standards, the future carbon intensity of economies or companies, and the potential trade-off between carbon intensity and return. Acknowledging these help investors understand any unintended consequences of potential portfolio actions and equip them with the necessary tools to move forward.

Levers to Achieve Net Zero

Nuveen has identified several levers that investors can use to decarbonize their portfolios. The first two are external, relying on other parties to achieve net zero goals. First, investors can individually and collectively engage with companies to set and achieve their own net zero carbon targets. If investors believe companies will achieve their net zero pledges, then owning these securities is consistent with a net zero target. Second, they can also engage with policymakers to encourage  economies to transition to net zero through policy actions, such as mandating grid improvements and changes to energy sources.

There are also internal levers that are likely familiar to most investors. Asset allocation and sector allocation involve re-allocating away from high carbon intensity assets and sectors to those with lower carbon intensity. Security selection means buying lower intensity investments within the asset class or sector. Fixed income portfolios can be rebalanced over time as bonds mature, but equity portfolios require a decision to sell something to rebalance.

Lastly, in cases where investors have control over companies, they can use their influence to make operational changes. For example, an investor could choose to spend money to source renewable energy, make energy efficient investments, or source lower carbon footprint materials. Using them needs to be part of a wider plan that incorporates desired portfolio objectives and constraints, similar to a traditional investment plan.

TIAA’s Commitment to Net Zero by 2050

There is no question that feasibility to implementation will involve a leap, but an informed one with the support of strong teamwork can help make it happen. This year, TIAA’s General Account announced its aim to be net zero carbon by 2050, a decision that resulted from years of work on climate issues by Nuveen’s responsible investing team and other partners.

To build out the confidence around setting this goal, an initial feasibility study indicated that building climate risk resilience does not have to come at the expense of income in the near term. And in fact, it may position investors, over the long run, to earn appropriate risk-adjusted returns once the impact of climate change’s transition risk and physical risk is accounted for.

To learn more about TIAA’s commitment to net zero, click here.

To learn more about Nuveen’s work with responsible investing, click here.