The core investment thesis is that CCAs will transition from an annual supply surplus to persistent deficits within the next one to two years, even without further supply tightening. In more mature carbon markets, such a shift has historically led to sharp price increases. Total program cumulative supply, including inventories, is expected to go into deficit between 2030 and 2035, with 2030 depletion estimates dependent on timely implementation of CARB’s supply reduction plan.

CCAs now trade near the 2025 price floor set by CARB, limiting downside risk. The floor price increases annually by 5% plus inflation, providing a steadily rising base. With the CCA price roughly 3% above the floor, the minimum return from the current purchase price is 2% plus inflation over the next year, and inflation plus 5% over subsequent years. Should anticipated catalysts materialize, prices could retrace its losses to around $40, a gain of nearly 50%.

While timing is uncertain, annual deficits will eventually drive prices to the first price containment tier, designed to slow carbon price increases. If covered entities need to buy CCAs beyond what remains in inventory and the allowance price containment reserve, CARB executes a price ceiling sale. The potential upside from such an eventuality is eyepopping. There are multiple price ceilings with set allowances in reserve, with the first at $60.47, increased by 5% plus inflation annually. As of May 2, prices are 143% below the first containment tier value for 2026. Accounting for the mandated price increases, if it takes three years to reach the containment tier, CCAs could deliver a 41% annualized return, and if five years, a 26% annualized return.

While the price floor limits downside, program elimination would render CCAs worthless. President Trump’s EO elevated concerns, even though the risk to the program is likely minimal. The order directs the US Attorney General to review state and local climate regulations, including California’s Cap-and-Trade Program, to determine if they are unconstitutional and obstruct US energy use or production by June 7. Legal counsel for managers participating in this market has consistently concluded the EO has no legal basis. The program has also survived court scrutiny, including by the current Supreme Court.

Following the EO, Governor Newsom and bipartisan state legislators have reaffirmed strong support for the CCA program and expressed intent to pass legislation extending it through 2045 this year. CARB has announced plans to implement program tightening soon after. These actions, if realized, would be significant catalysts for CCA prices, providing greater certainty and potentially accelerating the shift to a market deficit.

The upside potential for CCAs relative to the downside risk justifies an allocation, particularly when funded from global equities. For example, if global equity valuations revert to their historical median over three years, the annualized price return would be -8.3%. With CCA prices near the floor, the probability of program termination would need to be at least 20% for the probability-weighted downside to match that of equities reverting to their median valuation. In contrast, if CCAs recover to their prior highs of around $40, the annualized returns would be 14.4% over three years—a scenario requiring global equities to reach record-high valuations. Political risk is inherent in the CCA market and may not suit all investors. Overall, for investors comfortable with the unique risks, CCAs offer a compelling risk-reward profile that can enhance portfolio diversification and return potential.

Celia Dallas, Chief Investment Strategist

The post Are California Carbon Allowances an Attractive Investment? appeared first on Cambridge Associates.

• Of the 255 CA clients that responded to the 2024 survey, 157 reported engaging in Sustainable and Impact Investing (SII) (54%). A group of 49 institutions have consistently responded to three consecutive surveys in 2020, 2022, and 2024. From this group, we have seen a steady increase in SII integration from 45% in 2020 to 61% in 2022, and now 69% in 2024.
• The number of respondents to the survey increased by 111 institutions, representing a 77% increase from 2022.
• Religious institutions have the highest SII integration with 93% of respondents. Foundations, cultural/research institutions, and colleges & universities all have most respondents integrating SII with 64%, 61%, and 58%, respectively.
• Institutions that do not engage in sustainable and impact investing mainly cited they were not interested or that their mission is solely addressed via programmatic/philanthropic activities or perceived negative impact on financial performance. However, nearly one-quarter of these institutions anticipate engaging in sustainable and impact investing in the future.

Investment Structure

• The ways in which responding institutions incorporate sustainable and impact investing most often include: developing an Investment Policy Statement (IPS) that integrates SII priorities, principles, and decision criteria; engaging with advisors to implement; and informing their investment managers that SII/ESG is important.
• Approximately 63% of respondents engaged in sustainable and impact investing allocate more than 5% of their portfolio to sustainable and impact investments, with nearly one-third allocating more than 25%. Over the past five years, 78% of the respondents reported they increased their allocation to sustainable and impact investing. Approximately two-thirds of respondents reported plans to increase their allocation to sustainable and impact investing over the next five years.

Implementation Strategies

• Institutions continue to employ a range of strategies to achieve SII objectives, including ESG integration, impact investing, negative screening, and program-related investments. ESG integration remains the most commonly used tool.
• Respondents reported that anti-ESG/DEI sentiment and/or legislation had minimal impact on approach to SII with 93% reporting no effect.

Madeline Clark, Investment Director, Sustainable and Impact Investing

Ellie Bentley, Associate Investment Director, Sustainable and Impact Investing

Xade Wharton-Ali also contributed to this publication.

The post Sustainable and Impact Investing 2024: Insights and Perspectives appeared first on Cambridge Associates.

We believe one key reason is because the energy transition train has already left the station. Solar and wind, combined, generated more electricity than coal in the United States for the first time in 2024, and the growth rates of both renewable technologies outpaced the growth rate of gas generation. The transition has been—and will continue to be—driven by both market fundamentals and policy design. Cost, performance, and customer value proposition are still key factors. Most established clean energy sectors should still grow, though we recognize the pace of change may moderate in certain sectors, such as offshore wind. As we’ve previously noted, private capital should continue to flow to innovative, cost-effective, and scalable solutions that address energy needs globally.

Another reason we believe the transition remains intact is we have seen a version of this movie before. Despite the first Trump administration’s policies, global renewable energy production still grew at a pace 5.5x that of overall energy production. And despite the Biden administration’s pro-climate policies, the United States still became the largest oil & gas producer in the world. Market data also illustrate this apparent contradiction. For instance, the WilderHill Clean Energy Index outperformed the S&P 500 Energy Index by 516 percentage points (ppts) during Trump’s first presidency, only to underperform by 247 ppts in the Biden era. While conditions may be different this time, the point is that energy markets are driven by a host of factors, including technological advancement, economic growth, interest rates, and local dynamics, in addition to policy.

US power demand growth will also help fuel the transition. The recently announced Project Stargate set out plans to invest up to $500 billion by 2029 in data centers and energy infrastructure to support the American AI industry. While DeepSeek—the new AI language model that has captured the market’s attention in recent days—highlights that AI assumptions are indeed assumptions, many still expect US power demand to grow by 2.5%–3.0% annually for some time. This is a higher level compared to the 0.5% annual growth between 2001 and 2024. Solar, in particular, should benefit, given cost competitiveness compared to fossil power generation. According to Lazard, unsubsidized utility scale solar’s levelized cost of energy (LCOE) are $29/MWh to $92/MWh and onshore wind LCOE range from $27/MWh to $73/MWh. This compares favorably to gas-fired generation, which has LCOE of $45/MWh to $108/MWh.

Some transition investments likely do have a more difficult path, given the shift in policy. These include US wind (and, in particular, offshore wind), US electric vehicles (EV), and some newer technologies that depend on US governmental programs, such as the Department of Energy’s (DOE) Loan Programs Office to finance early projects. While the US executive branch will likely change fuel economy standards and freeze DOE funding, other actions such as repealing tax credits would require Congressional action. These actions still face an uncertain outcome since most new clean energy and EV manufacturing jobs are located in Republican districts. While policy shifts can present headwinds, they are one force in an industry driven by many forces.

Other less obvious energy technologies, such as geothermal and nuclear, as well as grid infrastructure may benefit. Geothermal and nuclear may also see tailwinds as sources of low-carbon baseload power, with the former having the additional benefit of employing fossil fuel industry skilled labor. With growing demands on the power grid, any focus on grid modernization and transmission infrastructure coupled with the Trump’s administration’s focus on reducing permitting bottlenecks, which have hindered development for all energy sectors, may unlock long-term boons for the clean energy sector.

Ultimately, we believe investors should continue to focus on unsubsidized unit economics and market fundamentals. Managers that underwrite investments with that lens should be well-positioned to deliver value regardless of near-term policy shifts. Also, investors should consider a comprehensive approach to the energy transition, especially since energy touches every sector in the economy, including agriculture, industrials, logistics, and technology. In every sector, there are value-creation opportunities to invest in innovative solutions to drive resource efficiency and to optimize existing systems. Indeed, investors need to navigate carefully and select managers that are clear-eyed, rigorous, and flexible in their approach. But the long-term thesis supporting energy transition investments should remain Trump-proof.

Liqian Ma, Head of Sustainable and Impact Investing Research

The post Do US President Trump’s Initial Policy Decisions Put Energy Transition Investments at Fundamental Risk? appeared first on Cambridge Associates.

California Carbon Allowances (CCAs) Should Retrace 2024 Losses in 2025

Celia Dallas, Chief Investment Strategist

CCAs fell from their $44 high at the start of 2024 to bottom out at $31 in August after news of program changes being delayed to 2026. Once the California Air Resources Board (CARB) finalizes the timing and path of CCA supply reductions, prices should retrace losses. Investors and covered entities are likely to purchase CCAs before program tightening pushes up prices more meaningfully.

Companies covered under California’s cap and trade program must purchase CCAs. Each allowance permits emission of one metric ton of carbon dioxide equivalent. Such programs initially provide excess allowance supply to give covered entities time to reduce emissions. Consequently, carbon prices were relatively flat in the program’s early years. CCA prices began rising as supply/demand balance improved. Following recovery from the COVID-related demand shock, CCA prices have been trending upward, especially as expectations grew that CARB would tighten supply to meet environmental targets. Prices fell in 2022 amid concerns that CCA demand would fall after California extended the Diablo Canyon nuclear plant’s life. However, these concerns faded as expectations for program tightening emerged in 2023.

We anticipate that final clarity on the program’s tightening path and timing of supply reductions will enable the market to recover lost ground in 2025. CARB proposed two potential supply reductions paths, resulting in a 10% to 14% annual decline in allowances, up from the current 4% annual decline, from 2026 to 2030. Even the slower decline path would see a 180 million reduction in CCAs between 2026 and 2030, equivalent to more than 50% of the current inventory surplus. Such a cut would push the program into a cumulative deficit as early as 2030, requiring covered entities to purchase CCAs held in reserve at prices indexed to increase at 5% plus inflation annually. The first tier of reserved allowances is expected to price at $86 in 2030 based on current inflation expectations. As details are finalized, CCA prices should recover in 2025, with significant upside potential into 2030 as the program moves into deficit.

Impact Flows Should Favor Strategies With Faster Distributions and Commercial Validation in 2025

Liqian Ma, Head of Sustainable and Impact Investing Research

Investors will enter 2025 marked by slower exits and distributions. While “patience is a virtue” still applies, private market investors focused on sustainability and impact also need to balance interim liquidity considerations and demonstrate validating proof points to achieve long-term success. Therefore, flows in 2025 should favor strategies that orient toward faster distributions. Managers that have both the intention and the skill to urgently drive commercial progress and liquidity for investors should benefit. Fortunately, an emerging set of tools should help investors achieve these goals even in a muted exit environment.

Impact strategies in areas such as climate tech and sustainable real assets can take years to prove out and generate liquidity. While climate-oriented strategies have seen hold periods comparable to those of the broader PE/VC market, the current environment is particularly challenging: follow-on capital is scarce and exit conditions remain subdued. As a result, allocators will likely prioritize new commitments to growth-stage, buyout, credit, and real assets strategies with inherently quicker-to-validate-and-exit models. Allocators will also increasingly hold all managers accountable for distributions in a more reasonable timeframe.

How can this be achieved? First, in the manager diligence and selection process, allocators will increasingly focus on managers’ competence in positioning companies for early validation and eventual exit. Some managers develop a differentiated understanding of what makes companies attractive to both strategic and financial acquirers, then position their portfolios accordingly. Others might sell shares as part of a follow-on or pre-IPO round or monetize parts of businesses, while developing others for upside optionality and impact. Finally, more impact managers are prudently using non-dilutive sources of financing and blended finance ¹ to reduce both the cost basis and risk of an investment. With the right strategies, managers, and toolkits, sustainable investors can effectively shorten distribution cycles in 2025 to navigate a challenging liquidity environment.

Headwinds for Private Diverse Manager Allocations Moderate in 2025

Jasmine Richards, Head of Diverse Manager Investing, and Carolina Gómez, Investment Director, Diverse Manager Investing

Until 2022, PE/VC firms experienced significant growth in fundraising due to low interest rates and increased risk appetite. Underrepresented fund managers also benefited, with diverse fund managers raising a decade high amount in 2021. However, fundraising declined sharply in 2023 and continued to decline in 2024. In 2025, ebullient markets may offer some relief, but the sizeable overhang of emerging funds could lead to consolidation or shutdowns.

Investments with diverse managers require both willingness and ability. Recent years have seen a decline in commitments, often attributed to decreased willingness. However, in a recent survey, more than half of LP respondents expressed that, despite recent US legislative resistance to DEI programs, these initiatives remain essential and will continue to be implemented and supported across their organizational portfolios. The pullback is more attributable to reduced ability. As US capital markets open, asset owners’ ability to commit to new funds should improve.

While investments in diverse funds are expected to increase, we do not anticipate the record levels seen in 2019–22. From 2019–22, diverse managers raised $127 billion across 198 PE and VC funds, with growth accelerating in 2020 after George Floyd’s murder, according to our data. Initiatives focused on increasing representation of women and people of color often favored new firms. Emerging managers (Funds I or II) accounted for 27% of capital, 51% of funds. Developing managers (Funds III and IV) represented 36% of capital, 31% of funds. By September 2024, these funds were about 75% called and may need to return to market in 2025, posing fundraising challenges. Established managers might withstand slower fundraising, but emerging and developing firms may face financial instability, leading to more consolidations or closures.

With $28 billion across 45 emerging and developing diverse-owned funds potentially returning to market, manager selection will be challenging for LPs with limited budgets. Fundraising momentum will become a key evaluation factor. Early commitments will be crucial in a slow fundraising market. LPs can use creative commitment structuring to support emerging diverse fund managers while mitigating risks from fundraising challenges.

Figure Notes

CCAs Have Recovered Rapidly From Previous Sell-Offs
Data are daily.

Hold Periods for Private Cleantech/Climate Companies Are in Line With Market
Number of companies from the initial investment to complete realization are indicated in parentheses.

New Managers Have Driven Peak Commitments in Recent Years
Private equity includes buyout and growth private equity. An emerging fund is defined as the first or second fund, a developing fund is the third or fourth fund, and an established fund is the fifth fund and beyond. Manager data include US and non-US managers. Data for 2024 are through September 30. Historical data are subject to revisions.

Footnotes

1. Blended finance is the use of concessional or catalytic capital to “crowd-in” private capital investment, while optimizing returns and impact. By leveraging concessional funding from philanthropic, governmental, and other sources, blended finance structures are able to “readjust” the risk/return profile of an investment strategy, making terms favorable for institutional investors.

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Nearly 20% of our clients by assets have included net zero objectives in their investment policy, which means they are also concerned with the impact of their portfolio on the climate.

They want to contribute to the solution, thus mitigating long-term damage to all portfolios and the economy as a whole. This report addresses how we are supporting those clients and helping others seeking to join them, through authentic and realistic policy setting as well as return-focused implementation.

We do not believe that clients have to choose between long-term portfolio returns and contributing to emissions reduction; rather, the two can be aligned.

Read the full report here.

Footnotes

1. Blended finance is the use of concessional or catalytic capital to “crowd-in” private capital investment, while optimizing returns and impact. By leveraging concessional funding from philanthropic, governmental, and other sources, blended finance structures are able to “readjust” the risk/return profile of an investment strategy, making terms favorable for institutional investors.

The post Net Zero Investment Consultants Initiative Progress Report, November 2024 appeared first on Cambridge Associates.

Long-term capital flows into climate solutions reflect market-driven structural tailwinds. The drivers of this increasing demand for climate solutions range from the rapidly growing demand for clean energy from artificial intelligence (AI) to the climate adaptation needs driven by increasingly volatile weather patterns. With power consumption from generative AI expected to skyrocket by 70% annually through 2027, ² companies are looking to sustainable infrastructure managers for reliable sources of renewable energy and to venture capitalists for promising early-stage technologies that improve energy efficiency. Meanwhile, the changing global climate has created an urgent need to adapt our existing built environment to withstand increasingly volatile and extreme weather.

In addition to market trends, governments have taken decisive actions to foster investment in climate solutions, policies that are not easily undone. The economic impacts of the Inflation Reduction Act (IRA) of 2022, along with the Infrastructure Investment and Jobs Act (IIJA) (2021) and CHIPs and Science Act (2022), have begun to be felt across the United States. More than $18.4 billion of federal investment ³ was deployed into clean energy and transportation projects in fiscal year 2023, which stimulated private investment in climate across manufacturing, energy, and industry. The total investment for these areas grew by 67% in 2023, compared to the 12% year-over-year increase in 2022. While these early indications are encouraging, most of the projected $1.2 trillion federal investment has yet to be spent and should further stimulate private investment flows. ⁴

The economic benefits of these climate policies have touched communities across geographic regions. More than three-quarters of announced clean energy investments have been made in Republican congressional districts, ⁵ and many are projects that some Republican lawmakers have indicated they will defend. ⁶ Full repeal of the IRA under a Trump administration is unlikely, given these attractive economic benefits and any amendment to the law must be passed by Congress. That being said, risk of amendment is higher under full Republican control of Congress. Provisions that likely have lower risk of amendment by a Republican-led Congress include solar and wind tax credits, as well as some technology tax credits (e.g., carbon capture, biofuels, and nuclear-related) with bipartisan support. Other tax credits and rebates (e.g., electric vehicles, energy efficiency) and loan/grant programs are likely at higher risk of amendment. Separately, a second Trump administration could weaken the IRA through interpretation and, subsequently, implementation. The US Supreme Court’s overturn of the 1984 Chevron Deference, which has substantially weakened the power of federal agencies, may further weaken IRA implementation. However, it is worth noting that 2020, the final year of the first Trump administration, marked the first time on record that renewable energy sources surpassed both nuclear and coal in the United States. ⁷

Regardless of the political environment, the landscape for climate-focused investors remains attractive, which should continue to encourage flows into the space. Well-positioned managers combine their technical expertise, operational experience, and investment discipline to invest in disruptive technologies that seek to replace incumbent processes on a purely economic basis. For example, Cruz Foam’s bio-based packaging materials seek to replace conventional single-use plastics in the multi-billion dollar packaging industry while being 30% cheaper. ⁸ Meanwhile, the latest Energy Innovation study finds that 99% of US coal plants are more expensive to operate compared to replacement by renewable energy. ⁹ In addition, demand from limited partners remains strong as investors have become increasingly focused on climate as an investment theme, with 77% of respondents to Cambridge Associate’s 2022 Sustainable and Impact Investing Survey investing in the theme compared to 38% in 2018.

Experienced long-term investors should remain committed to investing in climate solutions regardless of the short-term political shifts. Even with the uncertainty of an election year, US investors and businesses cannot afford to be left behind in the global energy transition. Given the market demand for climate solutions, supportive US government policies, and a robust investment landscape, we expect that private capital flows into climate solutions will remain strong in a second Trump administration.

Di Tang, Senior Investment Director, Sustainable and Impact Investing

Alice Blackorby, Senior Investment Associate, Sustainable and Impact Investing

Footnotes

1. Blended finance is the use of concessional or catalytic capital to “crowd-in” private capital investment, while optimizing returns and impact. By leveraging concessional funding from philanthropic, governmental, and other sources, blended finance structures are able to “readjust” the risk/return profile of an investment strategy, making terms favorable for institutional investors.
2. https://www.morganstanley.com/ideas/ai-energy-demand-infrastructure
3. Excluding retail investment; https://rhg.com/research/clean-investment-monitor-q4-2023-update/
4. https://www.markey.senate.gov/imo/media/doc/five_years_in_a_green_new_deal_world_-_020624pdf1.pdf
5. https://www.cnn.com/2024/06/16/climate/clean-energy-investment-republicans/index.html
6. https://www.bloomberg.com/news/articles/2024-08-05/red-state-republicans-say-they-ll-defend-biden-era-green-jobs?sref=IUS5JOJ3
7. https://www.eia.gov/todayinenergy/detail.php?id=48896
8. https://www.atoneventures.com/portfolio
9. https://energyinnovation.org/publication/the-coal-cost-crossover-3-0/

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It doesn’t need to be this hard. Investors can simplify net zero implementation by prioritizing practical and pragmatic steps towards real world emissions reduction. We provide both a feasible pathway to climate impact for investors with a mature portfolio and a template for building a net zero portfolio from scratch.

Our focus is mainly on the impact the portfolio can have on the climate since we have covered elsewhere how to manage the risks and opportunities climate change presents for the portfolio. As our 2023 paper explained, we see a ‘net zero portfolio’ as one that consciously contributes to decarbonisation of the real economy through the way it is invested. It might equally be described as a ‘climate impact portfolio’. Those GHG ¹⁰ emissions attributable to the portfolio itself are relevant but don’t necessarily indicate progress in the main goal. What matters is not so much the investors’ own footprint but how they use their influence in the real world.

Ambitious goals are not enough; credible investors need clarity on the actions necessary to meet them. This paper focuses on the decisions and actions investors can take today and how to prioritize limited time and attention where it really matters. Existing investor climate frameworks ¹¹ have focused on holdings level data and decisions but our primary audience is investors with $100m+ in a diversified portfolio of third-party managers. These investors delegate to their managers the tasks of investment selection and they exercise ownership rights (engagement, voting, etc.) so we emphasize instead measurement and targets for what those investors directly control, such as manager selection itself.

To unlock the potential for a pragmatic and efficient net zero approach it is also necessary to get the policy goal and principles right, set achievable targets, and monitor the right variables. Figure 1 summarizes our roadmap for building a portfolio that seeks to be good for the climate without sacrificing return potential.

Set the Right Goal

Recommended net zero strategies often emphasize portfolio emissions targets, probably because they represent the most commonly reported metrics. While net zero emissions by 2050 is the right collective global goal, it may not be the most appropriate target at the portfolio level. As our earlier paper explains, the only emission reductions that matter are those made today and in the future by the companies responsible. Portfolio emissions data are backward looking and can be manipulated by cutting exposure to managers exposed to high emissions sectors even if this has next to no impact on company behavior and disrupts the investment strategy to no purpose. This is why we recommend framing a high-level portfolio climate goal as:

“Contribute to the collective global goal of net zero emissions by 2050.”

This emphasizes an investor’s future impact rather than historic footprint and it requires each investor consider their own most effective points of leverage. But such a goal also needs ambition to be credible: A simple approach is to maximize contribution, subject to financial performance goals and a practical timeline, while tailored wording allows a flexible approach as there are various paths suitable for different investors, asset classes, and managers. Flexible language shouldn’t hide token efforts that lack proportionality or accountability; however, it needs to be paired with robust operational targets as discussed later.

Adopt a Set of Principles

Our goal in policy advice is to enable more investors to start the net zero journey and contribute as much as they believe practical and consistent with their other obligations. Over-emphasis on numerical rules and targets, especially for portfolio emissions, can get in the way when investors’ influence is indirect through external managers. To advance our goal of action over perfection, we propose a set of principles – not rules – slightly updated from our 2023 paper:

1. Focus where it matters: On assets, managers, and decisions where the potential impact on emissions is greatest.
2. Concentrate on contributing to real world emissions reduction rather than reported portfolio emissions.
3. Emphasize pragmatism; don’t make perfect the enemy of the good but plan for evolution and improvement.
4. Be open to using a variety of tools; different managers or assets can play different roles.
5. Consider the time value of carbon; mitigation today is worth more than mitigation in 20 years.
6. Focus metrics on ‘decision-useful’ information rather than data for data’s sake.
7. Require market competitive returns since the only scalable solutions are those with a path to profitability.
8. Create feedback loops; communicate to investment managers the importance of climate in investor’s decision making and listen to their perspective. Two-way constructive dialogue is important.

Applying these principles means each portfolio component, each manager, should be considered on its own terms: Can it make a contribution to net zero? In what way? Could it do more and if so, how? We expand on how to apply this below.

Assess, Engage, and Select Managers

Net zero’s end goal is for businesses to reduce the emissions associated with their activities as close as possible to zero. But the most effective way an investment manager can contribute to this single goal will depend on their strategy and asset class. A worthwhile contribution needs to be a robust ‘theory of change,’ supporting real world impact in the asset class concerned. Figure 2 shows our perspective on the nature and potential significance of climate action for a range of major asset classes while presenting a fuller taxonomy of potential contributions (Figure 3).

The investor must determine the most appropriate and reasonable contribution a manager can make, and whether the manager is living up to those expectations.

Assessing Managers for Net Zero Contribution

The first lever of impact investors have is selecting managers that will make the best contribution to net zero. To support this, we have developed an assessment framework (Figure 4) to classify any manager on a spectrum of contribution from ‘Not aligned, not climate aware’ to ‘Aligned’. There are different potential paths to alignment; while some elements are quantifiable, there is an unavoidable component of contextual judgement and investors should expect approaches to evolve and improve over time. They may choose to adopt their own assessment framework; the important thing is to apply it consistently. The outcome of assessment should be a ‘thesis’ regarding the manager’s specific assessed contribution to net zero goals, as well as any gap between current behaviour and reasonable potential. This can be used as part of ongoing monitoring and engagement.

If starting with an existing mature portfolio, all managers can be designated one of: Aligned or aligning, Not aligned ¹² , or Neutral. The non-aligned managers should be the focus of engagement towards aligning; if that is unsuccessful, the manager may be inappropriate for the portfolio. Pragmatism accepts that there may be non-aligned strategies that offer a unique and hard to replace source of alpha or diversification, in which case the rationale can be documented as an exception.

Prioritisation and Relevance (Importance of Theory of Change)

Manager evaluation and engagement may require a substantive two-way dialogue, so it is important to be consistent with Principle 1 (Focus where it matters): Some asset classes or strategies are just not that relevant for net zero. These we can label ‘Neutral’, which doesn’t mean there is no link to climate at all, but that there is no current robust theory of change to support a specific climate contribution. We believe an investor’s limited time and attention is better spent elsewhere.

Managers can be classed ‘Neutral’ either because their asset class offers no impact opportunity (government bonds and cash today) or because the strategy employed precludes it. The latter is illustrated by high (>100%) turnover strategies where the holding period is so short as to limit either engagement or a durable capital allocation effect. There are no hard and fast rules, however, and investors need to make their own pragmatic decision where to apply this classification. Further examples include bio-tech venture funds or macro strategies that invest mainly through index derivatives; in neither case is there a meaningful climate impact to be made because of either the sector or investment instrument chosen.

Labeling a manager ‘Neutral’ does not mean they are uninvestable, but simply that no time need be spent on further assessment or engagement. Neutral assets can be used where necessary to achieve diversification and risk tolerance or to access unique and exceptional alpha, but investors seeking to maximise net zero contributions should realise these assets represent an opportunity cost in terms of impact. For this reason, they should periodically review whether neutral is still appropriate or whether the same portfolio role could be played by a more impactful manager.

Engagement in Manager Assessment and Selection

The second lever net zero investors have is manager engagement, with the aim of encouraging and educating managers to make a bigger contribution to net zero goals consistent with both the reasonable impact their strategy might have, as well as their performance objectives. Engagement is also a tool to improve disclosure and general climate competence. Engagement can, and should, be an ongoing effort, but its importance is amplified when used as part of initial assessment and selection and when tied to a hire or retain decision.

Engagement as a Constructive Dialogue

Since there are many potential ways to advance net zero goals and a one-way conversation is unlikely to be persuasive, we emphasize the importance of a constructive dialogue that acknowledges the manager may have their own ideas of their best contribution. Investors can engage directly or through their advisor. To help set up this conversation for success we propose the following template (Figure 5).

Engagement can seem time consuming but prioritising it can offer an opportunity for deeper understanding and relationship building with managers. Integrating engagement with the selection and review process substantially limits the time requirement and may be more effective by tying it to an investment decision point.

Combining Engagement with Manager Selection in Practice

Figure 6 illustrates how an investor might triage limited availability and attention on manager engagement, ultimately deciding whether to pass or terminate if engagement is unsuccessful. ‘Priority’ refers to how much effort to give engagement; clearly managers that are not net zero relevant or are already a high contributor need less attention. The first decision branches according to the managers’ relevance to net zero with subsequent branches considering the degree of net zero contribution and the extent of the investor’s potential influence. The final stage considers a manager that is not making a reasonable net zero contribution and shows no desire to make one or consider the investor’s perspective. An investor with a net zero objective should set a high bar for the degree of unique diversification or alpha expected to justify such a manager in the portfolio.

Climate Solutions

Climate solutions are defined as investments that advance the development and deployment of technologies or practices that contribute to global emissions avoidance, reduction, or removal. This third lever of net zero impact has a particularly direct and powerful theory of change since investing capital in the innovation, scale up, and roll out of climate solutions is foundational to reducing emissions and decarbonising the economy. Solutions occupy a spectrum from infrastructure all the way to early-stage venture. They can be found in public and private markets, though there is reason to believe private vehicles that provide net new capital to climate solutions have more impact than buying shares of established businesses in the public market from a theory of change perspective. We propose that net zero investors set a target for exposure to managers that are predominantly (>50%) and intentionally targeting that area, though there is no perfect classification, and investors may choose a definition that better suits their beliefs and strategy. Climate solutions may fit within one of several asset classes, as illustrated in Figure 7.

Collaborate With Asset Managers and Owners

Why Collaborate?

Collaboration amongst asset managers and asset owners is the final lever of impact. It is an efficient and necessary approach to coordinate a shared and targeted net zero agenda, consolidate expertise across a larger share of voices, and reduce duplicative efforts leading to higher-quality conversations with engagement targets.

Joining coalitions provides a forum to engage with a variety of stakeholders from companies to policymakers to regulators to the broader financial services ecosystem, depending on the coalition objective.

What Does Collaboration Look Like?

Collaboration can be undertaken through formal coalitions (e.g., CA100+, PRI, Spring, ShareAction, UKSIF, IIGCC) or informal partnerships. Lower-touch actions within coalitions can include signing joint letters and using insight gained from collaborative groups to have richer discussions with managers. Higher-touch actions can include (co-)leading deeper discussions to participating in working groups on a topic the investor may be especially knowledgeable in.

We propose that asset owners reflect on their capacity and comparative strengths beyond simply assets under management that can magnify the reach of their collaboration. A foundation can leverage its reputation and moral standing. A pension with a large membership can leverage its reach with its constituents. Families with a recognisable name can draw attention to an issue, and those with an operating business can add strategic value through their industry networks and insights.

Set Portfolio Targets and Restrictions

Policy Targets

We propose investors emphasize targets that are directly in their control and are primarily manager based, thus forward looking. (By contrast, rearranging the portfolio to make reported emissions look lower is like driving through the rear-view mirror). Important targets can be for exposure to ‘aligned and aligning’ managers and to climate solutions managers. Restrictions can also be placed on the maximum number of non-aligned or neutral managers. The way target expectations are paced should reflect whether the goal is for a mature portfolio, which will take time to thoughtfully transition, or to define a new portfolio from scratch. Example policy metrics in terms of targets for neutral, non-aligned, or solulations investments are shown in Figure 7 as part of a simple portfolio monitoring dashboard. These targets should be calibrated against the baseline and achievability for the investor.

Operational Targets

As well as longer-term policy targets, a practical net zero strategy benefits from shorter-term operational goals revised on an annual basis that reflect specific steps on the journey. For example:

• Complete alignment assessment of all managers by 12.202x (for an existing portfolio taking on a NZ goal).
• Review at least three potential climate solutions managers by 12.202x.
• Complete engagement process and retention decision for managers X and Y by 12.202x.

Fossil Fuels

Climate-focused investors should adopt a careful and pragmatic approach to fossil fuel exposure. Even under net zero scenarios, fossil fuels will continue to be used until 2050 and beyond, but their use needs to decline steadily to a small fraction of current levels. State-owned national oil companies may be the last to exit the sector, putting an earlier squeeze on private businesses. Investors would be prudent to ensure their managers assess the risks of holding long-duration fossil fuel assets and incorporate the need for a “managed phase-out” into their valuation and engagement strategies. We do not consider fossil fuel divestment necessary for a credible net zero strategy and to avoid tokenism, it is important to be clear on the theory of change supporting any divestment decisions.

Investors that have made a policy decision to completely exclude fossil fuel exposure need to identify existing exposure and set a pragmatic hierarchy of actions for liquid managers (switching share classes, engaging with managers, or terminating and switching, if necessary), allowing time for implementation. We strongly encourage a de-minimis exception and it is reasonable to rule some funds and managers as ‘out of scope’ for exclusion owing to limited impact (e.g., high turnover quantitative strategies which may own incidental fossil fuel exposure for short periods). Private fund due diligence should incorporate an assessment of fossil fuel exposure risk.

Legacy Assets

An existing portfolio adopting a net zero target should assess and categorise all managers. For liquid managers, decisions to retain or exit are straightforward. However, for private fund holdings that are non-aligned or otherwise exceed restrictions (e.g., through fossil fuel exposure), these should be allowed to run off over the funds natural life and can be ‘neutralized’ in terms of policy targets and restrictions.

Monitor Regularly

Progress against climate goals should be reviewed on an annual basis and judged against the adopted principles. This timing can confirm the strategy is meeting the desired level of ambition and to set tactical goals for the following year. As part of this review, holdings data can be gathered from managers to inform discussion of alignment and manager engagement, and to hold managers accountable.

Holdings Level Climate Data Reporting

Portfolio-financed emissions are not a variable under the investor’s direct control and are backward looking. Moreover, reducing portfolio emissions doesn’t necessarily represent a contribution to real-world emission reduction. Nevertheless, they can be a helpful diagnostic to understand managers’ strategies, risks, and net zero progress. More forward looking is the extent to which portfolio companies have adopted science-based decarbonisation targets (SBTs), preferably with external validation ¹³ .

Accordingly, where holdings level data are available (public equity and credit), it is helpful to gather the following information on an annual basis: Scope 1 & 2 ¹⁴ (and where possible Scope 3) greenhouse gas emissions data along with the number of portfolio holdings who have SBTs ¹⁵ . This can be aggregated at the manager, asset class, and portfolio level (only scopes 1 & 2 aggregated) as follows:

• Total emissions per $ invested.
• Proportion of holdings (by value) with SBTs.
• Proportion of total emissions attributable to companies with SBTs.

The emissions of concern are those from companies without credible targets to reduce them. Understanding this exposure in a manager’s portfolio can inform a useful conversation on their attitude to emissions and how their voting and engagement supports portfolio companies to adopt SBTs.

Holdings level emission and SBT data is not yet available for most private investments so emissions can be proxied using sector exposure for asset class and portfolio level aggregation. Alternatively, the investor can make a qualitative view on a fund’s alignment based on its strategy and approach.

The above data can be compared with the following reference scenario that approximates market wide progress in line with Paris goals:

By 2025, 70% of portfolio emissions from in-scope assets are from holdings aligned/aligning with net zero or held by managers whose voting and engagement policies support alignment, and rising to 90% in 2030.

While quantitative look through data helps hold managers accountable, we consider the most important monitoring effort to be an annual review of the ambition of the strategy, achievement of tactical goals and managers’ delivery against the expectations defined for them. This then informs the setting of new tactical goals, and prioritises manager selection and engagement efforts.

Summary & Conclusion

A successful net zero investor will not just be ambitious in the targets they set but also be clear on the actions that are necessary to meet them. Our approach to net zero investing is grounded in pragmatism and flexibility, with a focus on real-world outcomes in an intrinsically messy world. Good practice will continue to evolve, but by focusing on high-impact areas, engaging with managers, allocating capital to climate solutions, and participating in collective initiatives, investors can start making a meaningful contribution to the global goal of net zero emissions by 2050. This framework helps to provide a structured yet adaptable path for investors to navigate the complexities of net zero investing while seeking to maintain competitive returns. Through continuous monitoring and engagement, we believe investors can ensure their portfolios are aligned with their climate objectives, driving real-world emissions reduction and fostering a sustainable future.

Simon Hallett, Head of Climate Strategy

Footnotes

1. Blended finance is the use of concessional or catalytic capital to “crowd-in” private capital investment, while optimizing returns and impact. By leveraging concessional funding from philanthropic, governmental, and other sources, blended finance structures are able to “readjust” the risk/return profile of an investment strategy, making terms favorable for institutional investors.
2. https://www.morganstanley.com/ideas/ai-energy-demand-infrastructure
3. Excluding retail investment; https://rhg.com/research/clean-investment-monitor-q4-2023-update/
4. https://www.markey.senate.gov/imo/media/doc/five_years_in_a_green_new_deal_world_-_020624pdf1.pdf
5. https://www.cnn.com/2024/06/16/climate/clean-energy-investment-republicans/index.html
6. https://www.bloomberg.com/news/articles/2024-08-05/red-state-republicans-say-they-ll-defend-biden-era-green-jobs?sref=IUS5JOJ3
7. https://www.eia.gov/todayinenergy/detail.php?id=48896
8. https://www.atoneventures.com/portfolio
9. https://energyinnovation.org/publication/the-coal-cost-crossover-3-0/
10. Greenhouse gas emissions, principally CO2 and Methane.
11. Such as the Institutional Investor Group on Climate Change’s Net Zero Investment Framework (NZIF).
12. For simplicity, the first three stages of alignment from Not aligned/not aware to Committed to aligning can be grouped together as ‘not aligned’, though they may offer different potential for engagement.
13. The Science Based Targets Initiative (SBTi) is the principle standard setter and validator of corporate climate targets and the source of most data thereon.
14. For an accessible definition of scope 1, 2 & 3 emissions, see https://climate.mit.edu/explainers/scope-1-2-and-3-emissions
15. For more background see https://www.myclimate.org/en/information/faq/faq-detail/what-are-science-based-targets-sbt/

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2024 Should Be the Year of the “Transition Plan”

Simon Hallett, Head of Climate Strategy

Last year we forecast that net zero–oriented investors would shift from portfolio decarbonization toward driving real world change. As they do so, the hunt is on for data that can help them prioritize their effort, for example tracking whether companies have aligned their business plans with net zero by setting science-based targets (SBTs).

More and more companies are setting SBTs, but they may not be the right companies; it is easier to set an ambitious target if your core activities are not emissions intensive to start with. What really matters for the climate is that the most emissions-intensive companies adopt SBTs. A key portfolio metric is not what portion of companies have SBTs but what portion of emissions come from those companies.

The aggregate data are striking: 39% of MSCI ACWI market value is represented by companies that have set SBTs, but these companies represent only 19% of index emissions. The vast majority (81%) of emissions come from companies with no plans to align with net zero. We, therefore, expect to see investors increasingly prioritize persuading their highest emission holdings to adopt SBTs.

Setting targets is one thing; delivery is another. As more companies set SBTs, investors will then want to hold them accountable for executing a credible strategy—a
“transition plan”—to deliver their targets. Transition plans are not the same as SBTs but will explain how those targets will be met. The International Sustainability Standards Board, the United Kingdom’s Transition Plan Taskforce, and Glasgow Financial Alliance for Net Zero are advancing a standard for transition plans and cooperating closely with one another to ensure inter-operability. These will give investors the opportunity to judge companies by the credibility of their plans.

We expect 2024 will see more companies setting SBTs, including a growing portion of the higher emitters. This will be accompanied by those same companies starting to publish transition plans. Investors will start to evaluate those plans and incorporate them into investment decisions using good old-fashioned fundamental analysis.

California Carbon Allowances Should Outperform Global Equities in 2024

Celia Dallas, Chief Investment Strategist

In 2024, we expect supply of California carbon allowances (CCAs) to decline and demand for such allowances to recover. In late July, the California Air Resources Board (CARB) made it clear that it expects to reduce CCA supply to meet the state’s 2030 emission reduction targets. Furthermore, demand for CCAs is expected to improve in 2024. Such conditions reinforce our recommendation to overweight CCAs relative to global equities, as carbon pricing is driven by supply and demand dynamics.

Cap-and-trade programs seek to reduce carbon emissions by putting a price on carbon and requiring covered entities to purchase allowances to offset emissions. The most attractive time to invest in these markets has been as supply starts to fall short of demand, pushing up prices. The California cap-and-trade program budgets a 4% annual CCA supply reduction. CARB’s review revealed that it would need to reduce CCA supply by 7.7% annually from 2025–30 to meet its current 2030 emissions reduction target of 40% relative to 1990. Should CARB raise the bar to a 48% reduction, as some analysts think is likely, supply would need to fall by 11.1% a year.

The magnitude of proposed cuts surprised investors, propelling CCA prices 11.4% between late July and its November 16 peak. CARB expects that tightening supply will push up prices and will likely increase price containment and price ceiling levels that exist to slow down the pace of price increases. The program is expected to be in deficit this year. The expected supply cuts will also draw down the cumulative excess supply relative to demand.

Demand for CCAs is tied to economic growth and progress in transitioning the economy away from carbon. Late 2022 and early 2023 data for the state are consistent with recessionary conditions of falling employment, incomes, and consumer spending. While it is unclear when conditions will recover, weak demand will simply slow down the pace of CCA supply tightening relative to demand, not eliminate it.

Fundraising by Natural Capital Strategies Should Hit a Record High in 2024

JP Gibbons, Senior Investment Director, Sustainable & Impact Investing

Natural capital strategies support land-based investments in sustainable agriculture and forestry, oceans and fresh waters, and other ecosystem services. These investments support a healthier planet and are needed to fight climate change. We expect fundraising for natural capital investment strategies will hit a record level in 2024 due to government and public demand, which continues to strengthen the opportunity set.

Government policy, particularly in developed markets, is creating attractive investment environments. A new framework adopted by 196 countries at the 2022 United Nations Biodiversity Conference put forth several ambitious environmental commitments, complementary to the climate change goals of the 2015 Paris Agreement. Targets include the restoration and protection of 30% of the earth’s land and sea, substantial reductions in harmful subsidies for agriculture and fishing, significant financial support to developing countries, and new reporting requirements regarding corporate influence on nature. Changes in policy should follow to stimulate momentum toward the commitments and create favorable investment opportunities.

Additional momentum has come from the general public’s demand for healthier food, cleaner waters, and thriving natural landscapes. Particularly in jurisdictions where regulation is opaque, the private sector has filled the gap through market-based tools that influence business decisions toward nature-positive projects. Feeling the urgency to act, responsible corporations have bolstered mechanisms through investment in voluntary carbon and biodiversity credits, water conservation, and organic premiums.

Recognizing the value of nature is not a new concept, but until recently it wasn’t clear how to monetize that value. These are still early days for natural capital investments, and challenges (i.e., measurement and valuation) need to be navigated. However, investment in the sector—estimated at $3 billion per year in 2022 according to the United Nations Environment Programme—is realizing significant growth, boosted by tailwinds like regulation and market demand. Managers are converting more traditional strategies to nature positive and identifying new investment themes. Investors are leaning into the favorable investment environment while mitigating exposure to nature-related risks. The amount of investment dollars raised for natural capital will grow significantly from years past as the world recognizes the need and value in protecting our natural resources.

Footnotes

1. Blended finance is the use of concessional or catalytic capital to “crowd-in” private capital investment, while optimizing returns and impact. By leveraging concessional funding from philanthropic, governmental, and other sources, blended finance structures are able to “readjust” the risk/return profile of an investment strategy, making terms favorable for institutional investors.
2. https://www.morganstanley.com/ideas/ai-energy-demand-infrastructure
3. Excluding retail investment; https://rhg.com/research/clean-investment-monitor-q4-2023-update/
4. https://www.markey.senate.gov/imo/media/doc/five_years_in_a_green_new_deal_world_-_020624pdf1.pdf
5. https://www.cnn.com/2024/06/16/climate/clean-energy-investment-republicans/index.html
6. https://www.bloomberg.com/news/articles/2024-08-05/red-state-republicans-say-they-ll-defend-biden-era-green-jobs?sref=IUS5JOJ3
7. https://www.eia.gov/todayinenergy/detail.php?id=48896
8. https://www.atoneventures.com/portfolio
9. https://energyinnovation.org/publication/the-coal-cost-crossover-3-0/
10. Greenhouse gas emissions, principally CO2 and Methane.
11. Such as the Institutional Investor Group on Climate Change’s Net Zero Investment Framework (NZIF).
12. For simplicity, the first three stages of alignment from Not aligned/not aware to Committed to aligning can be grouped together as ‘not aligned’, though they may offer different potential for engagement.
13. The Science Based Targets Initiative (SBTi) is the principle standard setter and validator of corporate climate targets and the source of most data thereon.
14. For an accessible definition of scope 1, 2 & 3 emissions, see https://climate.mit.edu/explainers/scope-1-2-and-3-emissions
15. For more background see https://www.myclimate.org/en/information/faq/faq-detail/what-are-science-based-targets-sbt/

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