Our firm is committed to achieving net zero emissions by 2050. At the same time, we decline to pretend that decarbonising portfolios is the same as decarbonising the real world.

Take the standard MSCI index of global equities. A portfolio manager needs to simply double the weight of Apple, Amazon, and Facebook to achieve the 7.6% annual reduction demanded by the most ambitious UN scenario. On the other hand, doubling allocations to three of the largest clean energy solution providers in the world—Enel, Nextera, and Iberdrola—would actually increase emissions by 5%. In both cases, I am referring to Scope 1 and 2 emissions.

Blunt net zero targets are not just perverse at the sector level. Worryingly, they are strongly correlated with regional allocations, and therefore disproportionately burden emerging markets (EM). Doubling the weight to EM stocks increases emissions by 10%. Doing the same thing in sovereign bond indices increases emissions per GDP by 22%. With those results, the temptation will be to halve and quarter allocations instead. 

This problem only gets harder since 90% of future emissions growth is coming from the developing world. It becomes tragic when one observes that even within emerging markets, wealth and ESG scores are linked. East Europe scores are higher than Southeast Asia, which has higher scores than Sub-Saharan Africa. 

If “sell Nigeria, buy Poland” is the approach to net zero the financial sector takes, global decarbonisation in large parts of the world will simply not happen. We will have created an investment concept that creates swathes of green assets in the richest countries, depriving everywhere else of green capital and leaving a permanent fog of grey — all while patting ourselves on the back.  

The $2.5 trillion in annual investment that EMs need to decarbonise will not arrive; instead capital will cluster timidly in US tech stocks and the richest emerging markets. In effect, the places that need it least. Meanwhile, most of the world’s 7.9 billion people will be starved of investment. This partial net zero, of course, is no net zero at all.

The unintended consequences of such an approach are already starting to materialise. Incentivised by asset managers and asset owners, a number of listed companies have divested their carbon-heavy assets at fire-sale prices and to less environmentally conscious owners. These carbon-heavy businesses continue to operate but outside the public eye. Anglo American is demerging its South African thermal coal assets into a new company, Thungela. Anglo has cleansed itself of coal but Thungela will continue to mine coal. This does not reduce one ounce of carbon even though Anglo management will have one less headache. 

Similarly, some countries are “offshoring” carbon emissions to other countries without changing domestic consumption patterns—as if production has nothing to do with consumption.

Then there is the principled case for changing course. We know that some minerals, such as lithium, nickel, and cobalt will be critical to meet climate goals, and the vast majority of these minerals are mined in emerging markets. For electric vehicle-related minerals, demand will increase by 45 times by 2050. 

In effect, poorer countries will increase carbon footprints to allow richer countries to decarbonise, and then rich country investors will penalise them for those emissions. Even Swift could not have devised a better satire.  

Every climate conference has a panel on ”a just transition” but what is the financial sector actually going to do to support the redeployment of Coal India’s quarter of a million employees to other industries? In my native South Africa, unemployment even before the pandemic was a quarter of the labour force and over 100,000 people worked in extractive industries and electricity generation. 

Finally, even if rich countries do not like to be reminded of it, emerging markets have not forgotten that this problem was caused by the countries who industrialised first. Data show that the largest source of cumulative historical emissions remain Europe and the United States, despite a strong recent showing by China. Finger-pointing is not right but neither is historical amnesia. In our view, developed economies have an obvious obligation to support emerging markets through their transition. 

The good news is that ultimately it is in their interests too.  Since carbon is the ultimate global public good, today’s grandchildren in Europe and the United States will live better or worse lives depending on whether and how quickly emerging markets decarbonise.

What must be done today? The solution is clearly not a wholesale rejection of the net zero aspiration—we all want to get there. Rather, net zero targets must reward both improvement and end-states, not just the latter. 

To do this, they need to be calculated in a way that does not drive capital away from the sectors and regions which need to transition

In other words, net zero targets for portfolios must always be rooted in the reality of progress in the physical world. This would be sustainability with substance.

In a sense, asset managers must make their own lives more difficult by applying net zero targets in a more nuanced and data-intensive way. They must challenge themselves to do ESG better. Anyone claiming success today is not taking the problem seriously enough. 

Our net zero solutions need to include all 7.9 billion people on earth and they need to focus on the transition rather than the easy option of exclusion. DM/BM

This article was written by Hendrik du Toit, Founder & CEO, Ninety One