Climate strategies in the global equity portfolio

Sectors of particular importance to the climate transition include energy, power generation, raw materials and transport. AP4 therefore performs fundamental equity management for these sectors.

“We focus on these high-emissions sectors and select the companies that we believe will both provide a better return than their benchmark index and contribute to the energy transition. We invest in companies that have plans and targets that are aligned with the Paris Agreement,” explains Pontus Lidbrink, Head of Thematic Strategies and Implementation, and continues:

“This results in a much more concentrated portfolio, where AP4 increases its shareholding in the companies we choose to continue to be invested in, which provides greater opportunity for influencing the companies to make the transition. For other sectors in the internally managed global equity portfolio and for AP4’s external fund investments, companies are instead selected using equity strategies based on quantitative factors.

Pontus Lidbrink,  Head of Thematic Strategies & Implementation at AP4. Photo: Peter Knutson 

“We have been making this type of investment since 2012 and have developed and broadened these strategies as a proportion of the portfolio. The strategies we have chosen have helped us to cut the portfolio’s carbon emissions by more than half, but that is not enough for us. Our goal is to achieve net zero in the portfolio by 2040 and to halve our emissions again by 2030, measured from 2020.”

In this work, AP4 uses both traditional metrics for climate investments, the companies’ own direct emissions (Scope 1) and their indirect emissions from the purchase of energy (Scope 2).

“We also use forward-looking carbon dioxide metrics to find companies that already have climate plans in place and have begun their journey of change. We do this using a scenario analysis for carbon pricing as well as assessments of how well companies are aligned with the 2-degree target. Based on this information, we create a ‘sustainability screen’, or AP4 Alignment score, which we use to build our equity portfolios,” explains Pontus.

Scenario analysis for carbon pricing

Achieving the environmental objectives set requires the gradual phasing out of burning fossil fuels through taxation. Sweden and the rest of the EU already have a carbon tax, but this is not the case in much of the rest of the world.

“If the global temperature increase is to be kept below 2 degrees, a carbon price of USD 70–140 per tonne of carbon dioxide is needed. In our equity models, we assume an increasing carbon price, depending on the sector and countries in which the companies operate, and then adjust their future margins accordingly. We then reduce our holdings in those companies that have a large negative impact on their margins.”

Adapting to the 2-degree target

Another important component is how well companies and their operations are aligned with the 2-degree target.

“At AP4, we use a developed metric for the companies’ estimated future emissions relative to a carbon budget for each individual company that will keep the global temperature increase below 2 degrees. We also take into account in this assessment which companies are most essential to the climate transition. When assessing individual companies, we look at their future emissions targets and consider whether they are realistic. We also monitor how companies have adjusted their emissions historically and ensure that they have begun their journey of change. It is not enough for the company’s management to have set a net zero target for 2050 if they have not also demonstrated that they are already taking action to reduce their emissions.”

The estimated future emissions for each individual company are then compared with the emissions required in each sub-sector to keep the temperature increase below 2 degrees. This results in a residual carbon budget for each company that can be either positive or negative. A negative value shows that the company is projected to have lower carbon dioxide emissions than required in the future, while the opposite is true for a positive value.

AP4 Alignment score

The data points referred to above are then combined to form an AP4 Alignment score, which gives a good picture of how well the companies are aligned with the energy transition.

“We want to shift the portfolio weighting towards those companies that are helping to achieve the goals of the Paris Agreement and that actively strive to improve their sustainability work. This strategy has a major impact on our investments outside traditionally high-emissions sectors. For example, among consumer companies, there are major differences in how the companies position themselves.”

Use of Scope 3

Scope 3 refers to indirect carbon emissions caused by companies. These in turn can be divided into upstream and downstream emissions, depending on where in the value chain these emissions occur. Upstream emissions are produced by the company’s suppliers and downstream emissions primarily by the use of the companies’ products. Scope 3 results in the double counting of carbon emissions and these are difficult to estimate, particularly in relation to downstream emissions. Scope 3 does, however, provide a picture of companies’ exposure to climate change.

“At AP4, we measure direct emissions (i.e. Scope 1 and 2) as well as the first level of upstream emissions. This means that we also take into account the emissions of the companies’ suppliers, but not of those who supply their suppliers.” Pontus further explains:

“The reason why we do not look at the full spectrum of Scope 3 emissions is that there is currently not enough reliable data to construct robust equity strategies. The way in which Scope 3 is currently calculated also includes double counting, by definition, as the same emissions are counted for both producers and consumers. We are working to develop our strategies within this area.”

Sectors where indirect emissions are of greater relevance include the energy sector and the automotive industry.