Improvers Rather Than Exclusions - How Portfolio Decarbonisation is Changing

23 March 2023

DiversificationGatekeepersIntegrationInvestmentsMeeting of MindsPortfoliossustainable

Expert: John Teahan, Redwheel Facilitator: Ian Saunders


  1. The decarbonising narrative is what has dominated the investment sector, backed up by performance (growth)
  2. Diversifying a portfolio reduces risk and from a regulatory perspective SFDR is more about inclusivity and improvement, this is demonstrated in the new SFDR proposed product labels
  3. The Red Wheel vision is very much driven from an investment perspective rather than from a political or moral perspective but also in-line with the very real-world events surrounding the global energy transition away from fossil fuels towards lower carbon energy

Discussion points:

The asset class that the presentation was directed towards was UK equities. This is very topical in light of the on-going discussions relating to the future of investment into energy production and the relevance of the current less “clean” types of energy that despite their green credentials, which are still in very high demand.

The real-world landscape:
It was explained that dating back to the Stranded Assets Report of 2013 mindsets were very much orientated to an investment transition happening many years into the future with the risks attached to a transition placed over the horizon.

What was not realised at the time was that the global awareness of climate change was growing rapidly and this has directly affected the investment community of today.

This presentation is about the investment community’s immediate reaction to this investor awareness and pressure driving the exclusion of “dirty” companies from portfolios resulting in a lack of innovation and a reduction in sector specific investment.

The power of a narrative:
From 2018 the SRI index in Europe shows growth outperforming value and how exclusions tilted many portfolios towards growth demonstrating a self-fulfilling prophecy which has subsequently been followed by more investment, more products and more regulation.

An example of this is the EU Sustainable Finance Disclosure Regulations (SFDR) reinforcing this exclusion philosophy in particular with the implementation of Article 9, the article with the highest level of sustainability requirements and highlighting those funds that are demonstrating significant levels of green revenues.

The Red Wheel UK Climate Engagement Fund is located in SFDR Article 8 whereby they are taking brown activities within companies and making them green, an investment activity that is now attracting an increasing level of funds due to a new narrative from the major sustainability “players”, referring to the importance of investor pressure from within the high carbon emitting companies to drive sustainable change.

The power of performance:
Performance is what ultimately supports a narrative, the MSCI report from 2022 by sector showed that only one sector gave positive returns within that year, the energy sector by 40%, proving that exclusions are not working.

New SFDR proposed product labels:

  • Sustainable focus - for products investing in assets that are environmentally or socially sustainable
  • Sustainable improvers - for products investment in assets to improve the environmental or social sustainability over time, including in response to the stewardship influence of the firm.
  • Sustainable impact - for products investing in solutions to environmental or social problems to achieve positive, measurable real-world impact)

The labels are all underpinned by objective qualifying criteria and assess products on the sustainability objective they are seeking to achieve.

The criteria are also designed to provide flexibility to accommodate different sustainability objectives for continued evolution and innovation in the market within clear guardrails.

The aim of introducing these regulations is to protect the investor and guard against greenwashing.

Understanding the complexities of a company’s performance in relation to their ethics:
The definition of sustainability and how it is intrenched in different mindsets makes it difficult for asset managers to hold companies to account on their commitments to environmental and ethical compliance on the ground.

The major energy companies who are under pressure to divest will sell off “dirty” assets in an attempt to decarbonise, they sell to smaller companies that have far less transparency and capacity to clean these assets resulting in a negative impact migration rather than and improvement of an environmental or ethical threat.

In addition, if pressure on the major western energy suppliers is too intense their ability to meet western demands is curtailed, leaving the producers in Russia, Iran and China to fill the gaps where there is less regulation and oversight.

Cleaning carbon intensive companies:
The speaker presented this question: Is an approach to changing high carbon producing companies and excuse for holding them?

It was answered that engagement is the best approach to engineering change, it is slow and behind the scenes, however bodies such as Climate Action 100, have made impact at the board levels of some of the most carbon intensive companies, raising awareness and educating board members about the complexities and risks of climate change with a view to changing board thinking, oversight, narrative and ultimately commitments and paths to more sustainable activities.

Activities such as management scenario analysis and more open reporting better inform boards and investors about risk and opportunity.

Strategies for influencing change can include engaging with such organisations as the Science Based Target Initiate, an organisation that can evaluate a company’s environmental impact using scientific research so that asset managers such as Red Wheel can proactively monitor their performance on behalf of their investors.

Another approach is ensuring that the UN Principles for Responsible Investment are trickling down through the asset managers to the companies on the ground.

The following further questions were asked:
What about the commitment of companies to be more sustainable in reply the speaker reinforced the need for engagement and the capacity of asset managers to recruit the expertise that can meet the challenges set by applying sustainable practices?

Just how active these companies actually are in their sustainable and off-setting practices in particular taking plastic out of the oceans as well as reducing carbon footprints?

In reply the speaker stated that new and innovative ways are being implemented primarily for reducing carbon footprints. One example was to remove a number of people working on an offshore oil-rig resulting in less helicopter movement, less human waste etc. in line with addressing their Scope 1,2 and more difficult Scope 3 emissions.

What about reducing carbon footprints through offsetting and maintaining the capacity of an off-set over time and in parallel with the level of on-going emissions produced by the investment”?

In reply the Red Wheel presenter stated that they did not like to engage in off-setting as a process to reduce a carbon footprint due to the industry itself suffering from a myriad of challenges and would prefer to reduce carbon at source using different technology or practices if and when available.

Are the EU are doing enough to regulate? It was explained how the EU Emissions Trading System (ETS) worked, how it was affected by the financial crash and how it has adapted to fluctuations

It was also explained how in essence it relates to buying a permission to pollute through an allowance, there have been problems in its application but it is improving over time.

A BP case-study:
BP were slow to embrace the sustainable transition in relation to other similar European major energy companies until they changed their CEO. Major US energy companies are lagging even further behind in their sustainable strategies.

BP made a statement in 2020 that they were going to cut hydrocarbon production by 40% by 2030. In 2023 BP changed their statement to a reduction of 25% resulting in a huge reputational backlash. The new sustainable Red Wheel UK Climate Engagement Fund has BP as its largest holding and so was affected by this untimely announcement. The narratives surrounding this change in strategy were varied: i) some said that BP were never true transition believers, ii) some said career risk was a factor - the new CEOs strategy of pro-transition was wrong which was demonstrated by underperformance, the pressure was to fire him iii) some said that US shareholders are becoming too influential as they are more willing to invest into oil and gas and away from transition, and iv) BP stated that this move was driven by their low carbon strategy becoming more effective.

BPs original strategy of reducing hydrocarbon production by 40% was driven by divestment, selling their high producing hydrocarbon assets to less transitional companies. Their new strategy involves not divesting those assets to more climate harmful companies despite it looking like that they have revoked on a more sustainable strategy. BP still invested $8bn into low carbon businesses. – is this a climate positive or climate negative action?

It was also stated that the top UK institutions have reduced BPs position by an average of 30% since Feb 2020. This is primarily driven by outflows from UK equities to US buyers which has changed the balance of influence within BP.

Red Wheel have not sold but are engaging with BP, divestment is an admission that they have failed in influencing a major so they are continuing to engage and ensure greater alignment with the energy transition.

The speaker was then asked about balancing remuneration across the markets where in the US it might be higher than in the UK/EU. The speaker replied that this was a difficult but important aspect of utilising their influence and it is ongoing, there is also exploratory discussion about linking remuneration and climate performance with metrics that are relevant and stretch a company’s performance to actually drive down emissions without divestment.

A question was made from the table about what regulation and pressure is actually making the transition more effective.

In answering, the presenter stated that making investments more stakeholder than shareholder centric will mean changing the articles of the business which is difficult however, there are new articles in the UK directors act (2006) that promotes the relevance of stakeholders that directors will have to reflect upon.

The UN Global Compact is useful as a soft law, when a company signs up to its standards of good behaviour, they have made a statement that by reputation they have to adhere to.

How well-equipped should asset managers be in understanding about the impact of the money that they are investing on behalf of their clients has on the ground? This raised discussion on the power given to asset managers and indeed shareholders and whether they are equipped to wield it?

This issue was taken further in discussion with the raising of how votes can be influenced by popularism and the role of the governance teams in larger companies and the integration of all relevant practitioners within the investment team and the promotion of well-informed discussion

Key takeaways:

  • A case study example was given about how Red Wheel engaged with a significant banking client on a particular investor action plan to demonstrate how detailed their preparation is prior to the engagement process - and how impactful that level of detailed knowledge can be