Net-Zero Investing: Solutions for Benchmarks, Incentives, and Time Horizons

Asset owners are adopting net-zero investment programs to address portfolio climate-change risks and support the global goal of net-zero greenhouse gas emissions by 2050. These programs aim to reduce portfolio emissions, invest in climate solutions, and use engagement and advocacy to drive real-world change. However, asset owners and asset managers face new challenges as they aim to achieve net-zero goals while maintaining investment performance.

“Net-Zero Investing: Solutions for Benchmarks, Incentives, and Time Horizons” discusses the challenges of adding net-zero objectives and climate-risk management to a traditional investment program. The paper aims to provide guidance for choosing relevant net-zero benchmarks, incentivizing actions needed to achieve net-zero objectives, and determining appropriate time horizons over which progress can be measured. It explores how traditional benchmarks, incentives, and time horizons hinder progress toward net-zero goals.

The authors say that net-zero investing requires a systems approach, because it impacts various elements of an investment program, including objectives, risk management, benchmarks, incentives, and time horizons. These elements are interconnected, which means that changes in one element affect others. A “systems thinking” approach helps align all components of a program, increasing the likelihood of success in meeting both net-zero and investment objectives.

The following are some of the paper’s key takeaways:

• Balancing Net Zero with Investment Goals — A net-zero objective should coexist with an asset owner’s risk, return, and actuarial goals without compromising them.
• Evolving Climate Risk Management — Current risk management tools are insufficient for measuring climate risk. While climate-risk management is evolving, asset owners can take practical steps to reduce these risks in the interim.
• A Need for Net-Zero Metrics and Benchmarks — Metrics specific to net-zero goals are essential but should complement, not replace, existing investment benchmarks.
• Incentives for Decarbonization and Climate Solutions — Effective net-zero investment programs should include incentives that encourage portfolio decarbonization and investment in climate solutions.
• Setting Interim Targets for Long-Term Success — Achieving net zero by 2050 requires meeting short- and medium-term targets.

The paper emphasizes that when net-zero investing aims to reduce portfolio risk and improve returns, it aligns with fiduciary duties to improve outcomes for beneficiaries.

For a net-zero investment program to succeed, the authors say, it is crucial to secure organizational commitment and ensure that internal and external managers have the requisite resources and expertise. Traditional performance evaluations, focused narrowly on short-term returns, are likely to hinder net-zero efforts. Asset owners should instead evaluate performance using a scorecard that tracks risk-and-return and net-zero metrics, with incentives aligned to include long-term climate goals as well as investment goals.

Looking forward, net-zero investing is expected to grow as better tools for measuring and managing climate risks emerge. The global shift toward addressing climate change is driving one of the largest economic transitions in history, and the opportunities for investing in climate solutions will continue to expand.

CFA Institute aims to educate and support investors who are interested in net-zero investing. The work on net zero published by CFA Institute is guided by principles and positions that reflect the organization’s mission, vision, and values. CFA Institute aims to fill the gap in education on net zero, promote and develop best practices, and support policy development in this area, acknowledging that investment objectives ultimately lie with the end client.