Investors seeking to express climate-related investment views have more choices today, as there are a variety of approaches ranging from full divestment of the energy sector to emissions reduction pathways with the goal of achieving net zero emissions over time. In our opinion, an increasing number of investors believe each approach can drive progress in the transition to a lower-carbon economy, while pursuing competitive risk-adjusted investment returns over time.

Invested assets in these approaches represent substantial capital. In 2023, U.S. SIF estimated that institutional asset owners had adopted fossil fuel divestment or restriction policies for $2.3 trillion in assets. In 2021, Net Zero Asset Manager initiative (NZAM) signatories reported about $4.2 trillion managed in line with achieving net zero greenhouse gas (GHG) emissions by 2050.

The Materiality of Climate Transition Risks Underlies These Approaches

We view climate change as a material, systemic investment risk—particularly for high GHG emitting sectors—that is impacting financial markets today and will likely accelerate in scale over time. We believe that climate transition risk analysis is a natural extension of our research process, as it is grounded in financial materiality.

For example, if future progress is made under the terms of Paris Agreement, the consumption of fossil fuels may fall. As result, companies with reserves may be forced to leave some or all of them in the ground rather than mine or pump, leaving behind what is known as “stranded assets.”¹

In this case, writing down the value of these assets potentially could hurt profitability and impede long-term credit worthiness. Overweighting investments to those companies that are taking steps that might potentially mitigate climate risks and possibly better prepare for transition could reduce the overall carbon footprint of the portfolio. 

Other examples include insurance companies that experience physical climate risks that are spurring higher claims due to wildfires and adverse weather conditions such as hurricanes and severe storms. Some railroad issuers are increasing capital spending in an effort to address risks from flooding tracks. Seeking out investments in companies that are reporting how they are leaning into opportunities intended to mitigate climate risks—by producing more sustainable plastics or lithium batteries, for example—may help investors to identify issuers that are on a path to achieving net zero operations.

Breckinridge’s Three Primary Approaches to Managing Portfolio Transition Risk

Breckinridge integrates bottom-up climate transition risk analysis and aims to accommodates client requests for managing the climate transition risk of the corporate holdings in portfolios in three ways: 1) through our Net Zero customization, 2) through our fossil-fuel-free customization and additional related screens, and 3) by avoiding investment in the energy sector more broadly. The approaches are summarized in Figure 1.  

Net Zero Customization: 

We work to assist clients in managing their portfolio carbon exposure through our net zero emissions customization. This process utilizes an analytical and actively managed approach that combines these elements intended to advance net zero goals:

• Corporate issuers bottom-up climate transition risk analysis and alignment toward the goals of the Paris Agreement.
• Measurement and reporting of Scope 1 & 2 portfolio financed emissions intensity.  
• Portfolio customization to favor corporate issuers aligning or better to the goals of the Paris Agreement and financed emissions intensity on a targeted pathway.
• Strategic engagement with select security issuers, and
• A commitment to methodology transparency and reporting.

We employ our corporate climate transition risk framework to assign company-level net zero alignment categorizations through a quantitative and qualitative analytical process.

Fossil Fuel Free:

Another approach to managing climate transition risk is our fossil fuel free customization. It excludes companies with reserves in fossil fuels or coal, potential emissions from coal or natural gas, or revenues derived from thermal coal. It also excludes municipal electric utilities. As of September 13, 2024, assets under management in this customization totaled $1.8 billion. If asked by a client, we can remove from the investable universe in the energy sector using the MSCI Business Involvement Screening Tool. An example is a request to avoid producers of tar or oil sands, a carbon intensive form of energy.

Avoiding the Entire Energy Sector:

Finally, clients concerned by climate change have asked to screen out the entire sector. This represents the most restrictive of our available approaches. It involves not only removing the companies holding fossil fuel reserves but also additional players across the energy value chain, including midstream or pipeline operators.

Combining Customizations:

We can also combine other customizations we offer with one of these methods for transition risk mitigation. For example, we have clients that have selected our sustainable or best-in-class overlay with the energy sector screen. In addition, some Catholic clients may utilize both our customization aligned with the United States Conference for Catholic Bishops (USCCB) responsible investing and our fossil-fuel-free customization should they wish to incorporate the Church’s latest writing on the risks of climate change.

The management of climate transition risk in the corporate holdings of our clients’ portfolios follows our longstanding capability to customize portfolio parameters. Breckinridge collaborates extensively to determine how we can aim to achieve our clients’ needs, working with clients and their advisors and consultants to customize portfolios to appropriately align with each client’s objectives, risk tolerances, income objectives, and liquidity requirements.

[1] Stranded assets are oil, gas and coal reserves that are left unburnable without expensive carbon capture technology, which itself alters fossil fuel economics, per speech from Mark Carney, governor of the Bank of England, September 2015.

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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.

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