A new project to develop a more reliable approach to understanding climate investment risk marks an ambitious attempt by Aegon to escape the inconsistencies in carbon data and climate risk definitions that make comparisons difficult.
Aegon already addresses sustainability risks by integrating environment, social and governments (ESG) aspects into its investment analysis," explains Harald Walkate, Head of Responsible Investment at Aegon Asset Management.
"But in our work focusing on climate change, we identified a number of issues that must be addressed before the risks can be clearly understood and managed."
Carbon footprinting: a useful first step?
One issue is the 'carbon footprint' methodology. This is an approach widely used by investors to identify climate change investment risk. Under the "Montreal Carbon Pledge" 120 investors have committed to calculate their footprint on an annual basis, and publish the results.
Aegon Asset Management feels however, that the carbon footprint is not the clear risk indicator that many claim it is. "Carbon footprint data depends largely on self-reporting by companies, which is unreliable," explains Walkate. "Furthermore, footprint results for an investment portfolio can vary significantly between providers."
But most importantly, Walkate says, calculating a carbon footprint can give a false sense of security.
"Investors who are concerned about climate change want to show that they're doing something about the problem, and I can relate to that. But I think people tend to confuse the carbon footprint of a company with investment risk.
"Intuitively, I understand this – as most carbon intensive companies and industries will suffer from increased government regulation, and competition from renewable energy sources. Still, we think this doesn't do justice to the complexities and uncertainties."
It is inconsistencies and limitations like these that prompted the responsible investment team at Aegon Asset Management to analyze the issue more deeply. "People are often still focused on the easily measureable things in responsible investment," says Larina Baird, from Aegon Asset Management's portfolio risk management team.
"For example, if a client says they don't want their money invested in tobacco companies, that's a fairly easy mandate to manage, using data that is readily available to asset managers. Climate change is of an entirely different scope and scale.
We felt it would be useful to bring together subject matter experts from a number of different functions to discuss the short- and long-term aspects of climate change and the potential impact to our investments and processes."
The new project group, led by Walkate and Baird, consists of 15 internal experts from different Aegon Asset Management units: investment analysts, investment portfolio managers, client-facing staff, and risk managers.
Each member of the group was selected individually based on their function in the company and how it relates to investments and risk. Knowledge of climate change related issues such as the COP 21 conference in Paris last year, the concept of 'stranded assets' (energy companies' assets that can no longer be sold at a profit), and the technological change required for the energy transition was not a criterion but was strongly preferred.
South Pole Group
To support the project Aegon Asset Management brought the South Pole Group on board. They are global sustainability consultants who can provide additional insight and guidance, and challenge Aegon throughout the project.
South Pole Group will also introduce the project group to external climate change experts and make recommendations on certain directions to take.
Maximilian Horster, Partner and Financial Industry Lead at South Pole Group, commented on the work it is doing with Aegon. "In terms of addressing climate risk, a carbon footprint is a proxy and a good starting point, but it is just a snapshot in time.
"We think a better proxy is to follow companies over time and determine if they have a real climate strategy. This allows you to deal with gradual changes and understand if they are '2 degree compatible' and whether or not they present investment risks."
Talking about the scope of the project Walkate explains that it's as much of an organizational challenge as a data challenge. "We're looking at how should we be organized in terms of functions involved, learning, and access to information, to follow the developments as they evolve, so that we can continuously ask ourselves 'How does this change the picture? How does this impact us as an investor?'."
It's an ambitious undertaking, but thinking hard about these issues will, at a minimum, deliver tangible benefits by allowing Aegon Asset Management to respond more effectively to future regulatory requests.
As an example, in early 2016 the California Insurance Commissioner asked all insurance companies doing business in California to voluntarily divest from their investments in thermal coal. Many companies manufacture coal, but it is not always the primary business.
California defined it as a company that derives at least 30% of its revenue from coal manufacturing. California was the first US state to adopt this type of climate change initiative and it will likely not be the last.
An update on the project will be provided in Aegon Asset Management's 2016 Responsible Investment Report which will be published in the second quarter of 2017.