By Richard Bradley, Investment Consultant and Pete Smith, Principal and Head of Sustainable Investment at Barnett Waddingham
This has led to several asset owners setting emissions reduction targets, thereby minimising the climate risk exposure of their portfolios. The most common emissions reduction target is 'net zero'. A net zero target aligns with global efforts such as the Paris Agreement, but portfolio decarbonisation and real-world decarbonisation must not be conflated. One is an exercise in emissions accounting, focused on managing risks associated with future policy changes; the other is about creating a more sustainable real world – and, with it, more sustainable investment returns.
Real assets: The clear opportunity
Physical, or real, assets like property and infrastructure are common components of institutional portfolios. They have associated emissions and follow a more predictable pathway than, say, equities, which are influenced by both investment manager and company actions. For those with a net-zero commitment, the more controllable nature of emissions from real assets gives institutional investors a practical opportunity to reduce both portfolio and real-world emissions before addressing other, less certain areas.
Property in focus: Control, clarity, and carbon
Property provides a compelling case study. Emissions associated with property holdings are predominantly from the operational carbon footprint – i.e. energy consumption in heating, cooling, lighting, and other building services. This operational carbon footprint can be tracked, measured, and managed with reasonable certainty. In contrast, emissions from publicly traded companies are often opaque due to complex supply chains and third-party data.
By controlling real assets directly or through a fund manager, asset owners likely have a clearer picture of their energy use, operational emissions, and – crucially – actions they can take to reduce them.
This clarity creates a unique opportunity. With access to detailed emissions data from this element of their portfolios, asset owners can implement targeted strategies to reduce their carbon footprints – for example, improving energy efficiency, utilising renewable energy, and adopting sustainable construction practices. These measures are essential for aligning with broader decarbonisation goals and the UK's net-zero emissions target by 2050.
Carbon offsets: Complementing the path to net zero
While reducing emissions through operational improvements is crucial, it is unlikely institutional asset owners can completely eliminate emissions from property holdings in the short term. Therefore – depending on your interpretation of fiduciary duty – credible carbon offsets form a critical part of the equation. For emissions that cannot be avoided, offsets offer a way to balance the impact by investing in projects that reduce or remove greenhouse gases from the atmosphere.
"Forestry assets have a long track record of providing sustainable and uncorrelated returns, addressing fiduciary duty considerations."
Offset projects come in many forms, including renewable energy, methane capture, and reforestation. Among currently investible opportunities, forestry assets are one of the most prominent. In addition to traditional risk and return characteristics, they serve as carbon sinks. The creation of offset credits can provide a potential return source and help counterbalance emissions from property operations. These projects offer measurable carbon sequestration benefits and support sustainability goals.
Forestry: Financial returns and climate alignment
This additional benefit of forestry is gaining traction among institutional investors.
It enables direct engagement with nature-based solutions that offer measurable emissions reductions.
Forestry often delivers long-term co-benefits such as biodiversity, soil quality, and sustainable timber production.
Forestry and timber offer return and diversification benefits that appeal to institutional investors.
Forestry assets have a long track record of providing sustainable and uncorrelated returns, addressing fiduciary duty considerations. This allows asset owners, in effect, to "have their cake and eat it." However, for offsets to be credible, forestry projects must meet recognised standards, such as the Verified Carbon Standard (VCS) or verification by the Woodland Trust in the UK.
UK property regulations: A wake-up call for owners
In the UK, momentum has been building around improving energy performance in buildings. Currently, landlords of commercial properties in England and Wales are prevented from granting new leases unless their properties have an EPC rating of E or higher. The new Labour government has reiterated its commitment to raising this standard – to C by 2027 and B by 2030. For private residential properties, the expectation is for a minimum EPC rating of C by 2030.
For institutional owners with large UK property portfolios, these regulations represent both risk and opportunity. Properties with low EPC ratings will become less attractive as energy efficiency increasingly influences asset value. Failure to meet new standards could result in stranded assets – buildings that are no longer viable due to high operating costs and poor environmental performance. Conversely, by investing early to improve energy credentials, asset owners may attract higher-quality tenants and command higher rental values per square foot to offset upgrade costs.
Real assets as the net-zero starting line
The transparency and control over emissions in real assets make them a natural starting point for asset owners pursuing both portfolio and real-world decarbonisation. These assets offer a more practical entry point than complex, less tangible listed equities and fixed income holdings. We've also highlighted the potential to improve return profiles by addressing environmental performance and attracting premium tenants.
"The transparency and control over emissions in real assets make them a natural starting point for asset owners pursuing both portfolio and real-world decarbonisation."
However, achieving net-zero emissions will almost certainly require carbon offsets, with forestry assets offering a viable route for managing residual emissions. By starting with real assets, institutional asset owners can ensure their portfolios are not only aligned with sustainability goals but also resilient and financially sound for the future.
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