A decade ago, fossil-fuel free investing,² which largely avoids the energy sector, was among just a few options for investors seeking to express their views on climate risk.

Today, there is growing international alignment with a net zero GHG goal by 2050 among governments. The UN COP28 agreement explicitly calls for “transitioning away from fossil fuels in energy systems, in a just, orderly and equitable manner, accelerating action in this critical decade.”

The transition would occur in a way that gets the world to net zero greenhouse gas (GHG) emissions in 2050. Many regulations are in place that mandate transitions to net zero across economic sectors.³ More companies are charting and executing transition plans. Increasingly, some consumers are choosing clean energy alternatives.

While there is legitimate concern about the adequacy and pace of transition from carbon, the fact is that net-zero pledges by nations, regions, cities, and companies cover 92 percent of global gross domestic product and 88 percent of emissions worldwide, as of November 30, 2023.⁴ Of about $2.8 trillion of energy investments globally in 2023, more than $1.7 trillion is targeted to clean technologies.⁵ The International Energy Agency noted investment in solar during 2023 is set to overtake the amount invested in oil production for the first time.

Investors can engage in the trend away from carbon through a net zero strategy in two meaningful ways. First, we believe the transition brings investment opportunities among companies pursuing climate solutions. Second, we believe the transition mitigates investment risks related to climate change.⁶

Breckinridge launched a net zero customization that includes company-level net zero alignment assessments, as assigned by our investment team, across all economic sectors, including energy companies, because we are convinced that they can yield benefits in the long run for investors and the planet.

Our investment premise, briefly stated, is that companies on the pathway to net zero emissions are positioning themselves to thrive over the long term. Companies that are less prepared, ill-equipped, or behind the transition curve will become more exposed to potential operational, regulatory, and reputational risks; risks that over time likely will impair profits, growth, and, ultimately, their existence.

There are those who are skeptical of the case for net zero investing models. They will contend that it is irresponsible to forego potential near-term investment returns, even those generated by companies lacking plans for an energy transition and making little effort to change. We view this as an overemphasis on short-term gains at the expense of long-term performance.

Precisely because our heritage is as bond investors, we analyze a debt issuer’s ability to make interest payments over the entire term of the bond and return full principal at maturity. We seek to invest in companies that set transition plans and report progress along the transition pathway because we believe they are best positioned to meet their bondholder obligations.

Through their strategic plans and regulatory reporting, companies are demonstrating to investors that they are preparing for a transition. We believe these companies are less likely to encounter operational, reputational, or regulatory risks and costs than their unprepared peers. Those peers will remain at greater risk unless and until they take the steps to prepare for a transition to net zero.

Our concern is that companies that delay transition plans and that defer GHG reductions may have to accelerate an energy transition in the future. A transition pursued in haste may result in a disorderly process that increases costs and decreases the room for error. Balance sheets subject to the increased costs associated with these risks will weaken the issuer’s capacity to meet bondholder obligations over the long term.

History tells us it will be nearly impossible to predict when market and investor sentiment toward underprepared companies may turn negative, but experience tells us that as with any major investment risk, there will be companies that are beneficiaries and those that are poorly positioned. A discerning and analytical assessment can provide a clearer view into the climate transition plans of companies and ultimately better mitigate the investment risks associated with climate change.

That is why we favor companies with stronger commitments to GHG reductions today. We favor companies that can clearly communicate intentional GHG emission reductions goals and clean energy investments in addition to documenting progress on the net zero pathway.

Our net zero approach invests in the bonds of companies that are leading the transition to a low- or no-carbon economy. Bond financing also affords us direct access to engage with corporate leaders about their net zero strategies and progress. Our investments empower progress on the net zero pathway. Our direct engagement enables participation in its achievement.

Continued scrutiny of our collective progress on a path to a low- or no-carbon future is essential because each year the climate crisis grows more dire and climate-related disasters are more common.

We believe our net zero investment customization is well suited to investors who prefer a constructive, active, and comprehensive approach to mitigating climate risks and advancing towards a clean energy future.

 
[1] Net zero is defined as the state at which the rate of emissions produced are in balance with the rate at which they are being removed from the atmosphere. 

[2] Breckinridge’s Fossil Fuel Free composite is a customization that can be applied to our sector focused and multi sector strategies that employs our fully integrated fundamental and environmental, social and governance (ESG) research and excludes investment in companies with significant proven fossil fuel reserves and municipal utilities with carbon intensive generation assets.

[3] The majority (15 out of 20) of members the Group of 20 (G20: an intergovernmental forum comprising 19 sovereign countries, the European Union, and the African Union) have implemented regulations in at least one of four tracked regulatory domains. They are: a) claims and financial product standards, b) disclosure, c) procurement, d) transition plans. Additionally. all of the countries that are yet to regulate have instruments under development, indicating ongoing efforts towards regulation. For more information, visit: https://netzeroclimate.org/regulation-tracking/#:~:text=NET%20ZERO%20REGULATION%20STOCKTAKE%3A%20What,to%20a%20low%2Dcarbon%20economy.

[4] The Science Based Targets initiative drives climate action in the private sector by enabling organizations to set science-based emissions reduction targets.

[5] IEA (2023), World Energy Investment 2023, IEA, Paris https://www.iea.org/reports/world-energy-investment-2023, License: CC BY 4.0

[6] Rating agencies are alerting investors to the risks facing companies that are failing to make the transition. For example, Fitch Ratings said that 50 percent of companies that are exposed to climate-related downgrades of one or more notches by 2035 are investment grade. The energy sector is most at risk due to tightening emission requirements, followed by utilities with coal-fired electricity generation, as well as building materials and industrial companies (“Over Half of Corporates Facing Climate-Related Downgrades by 2035 Are Investment Grade,” Fitch Ratings, October 24, 2023). Additionally, Moody’s Investors Service said that companies that take “early action” during the 2020s can reduce their probability of default in half versus companies that neglect the looming risks (“Ready or Not? Sector Performance in a Zero Carbon World,” Moody’s Investors Service, Inc., November 2021.

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DISCLAIMERS

This material provides general and/or educational information and should not be construed as legal, tax or investment advice. It does not include all of the information necessary to make a decision to invest with Breckinridge. The content is current as of the time of writing or as designated within the material. All information, including the opinions and views of Breckinridge, is subject to change without notice.

All investments involve risk, including loss of principal. Diversification cannot assure a profit or protect against loss. Fixed income investments have varying degrees of credit risk, interest rate risk, default risk, and prepayment and extension risk. In general, bond prices rise when interest rates fall and vice versa. This effect is usually more pronounced for longer-term securities. Income from municipal bonds can be declared taxable because of unfavorable changes in tax laws, adverse interpretations by the IRS or state tax authorities, or noncompliant conduct of a bond issuer. There is no assurance that the customization or the approach will meet their objectives.

Breckinridge believes that the assessment of ESG risks, including those associated with climate change, can improve overall risk analysis. When integrating ESG analysis with traditional financial analysis, Breckinridge’s investment team will consider ESG factors but may conclude that other attributes outweigh the ESG considerations when making investment decisions.

There is no guarantee that integrating ESG analysis will improve risk-adjusted returns, lower portfolio volatility over any specific time period, or outperform the broader market or other strategies that do not utilize ESG analysis when selecting investments. The consideration of ESG factors may limit investment opportunities available to a portfolio. In addition, ESG data often lacks standardization, consistency, and transparency and for certain companies such data may not be available, complete or accurate.

Breckinridge’s ESG analysis is based on third party data and Breckinridge analysts’ internal analysis. Analysts will review a variety of sources such as corporate sustainability reports, data subscriptions, and research reports to obtain available metrics for internally developed ESG frameworks. Qualitative ESG information is obtained from corporate sustainability reports, engagement discussion with corporate management teams, among others. A high sustainability rating does not mean it will be included in a portfolio, nor does it mean that a bond will provide profits or avoid losses.

Net Zero alignment and classifications are defined by Breckinridge and are subjective in nature. Although our classification methodology is informed by the Net Zero Investment Framework Implementation Guide as outlined by the Institutional Investors Group on Climate Change, it may not align with the methodology or definition used by other companies or advisors. Breckinridge is a member of the Partnership for Carbon Accounting Financials and uses the financed emissions methodology to track, monitor and allocate emissions. These differences should be considered when comparing Net Zero application and strategies.

Targets and goals for Net Zero can change over time and could differ from individual client portfolios. Breckinridge will continue to invest in companies with exposure to fossil fuels; however, we may adjust our exposure to these types of investments based on net zero alignment and classifications over time.

Any specific securities mentioned are for illustrative and example only. They do not necessarily represent actual investments in any client portfolio.

The content may contain information taken from unaffiliated third-party sources. Breckinridge believes the data provided by unaffiliated third parties to be reliable but investors should conduct their own independent verification prior to use. Some economic and market conditions contained herein have been obtained from published sources and/or prepared by third parties, and in certain cases have not been updated through the date hereof. All information contained herein is subject to revision. Any third-party websites included in the content has been provided for reference only.