Insights
We have introduced two changes to NZIF 2.0 to help investors set and implement net zero targets. The Portfolio Decarbonisation Reference Target has been repositioned as an ‘Objective’, and the Portfolio Coverage Target has been renamed the ‘Asset Alignment Target’.
Released in June 2024, NZIF 2.0 incorporates lessons learned by investors across three years of implementation. It brings together new asset class components as well as supplementary guidance on areas such as climate solutions, supported by more than 200 suggested action points.
NZIF is non-hierarchical and there is no set order of implementation. Instead, it presents the latest thinking on each of the main levers of change available to investors, with real economy emissions reductions the overarching goal. Investors then decide which elements best support their individual net zero strategies as part of the due diligence process.
For most, setting net zero objectives and targets is a core feature of any net zero strategy or transition plan. This helps to monitor progress, communicate climate goals and report back to clients and beneficiaries.
NZIF recommends that investors set two objectives at the portfolio level and two targets at the asset class level, with an ‘implement or explain’ basis to allow for flexibility based on independent fiduciary duties.
Target to objective
Portfolio Decarbonisation Reference Objective: An emissions reduction objective aligned with a net zero pathway.
This portfolio-level objective sets the ambition for an investor’s portfolio across the short-, medium- and long-term. It can act as a benchmark to assess whether actions at the asset level, such as engagement with corporates, are producing the portfolio-level emissions reductions required to be consistent with the investor's climate goals.
The terminology change from ‘target’ to ‘objective’ builds on this to emphasise the importance of a dashboard approach to measurement - encouraging investors to include an absolute emissions metric and at least one intensity-based metric.
Setting asset-level targets and monitoring emissions changes within the portfolio are recommended as part of this approach, helping to build the clearest picture possible. Doing so helps to reduce any unintended consequences which can occur when using financed emissions metrics alone – an industry measurement of the carbon emissions associated with the investments made by an organisation.
This comes after some members reported that balancing emissions reduction targets and increasing investment in climate solutions or emerging markets presented a challenge, with one constricting the other.
In pursuit of linear, year-on-year financed emissions reductions, investors might feel constrained and therefore unable to invest in projects like wind turbines or solar panels, which represent an upfront ‘cost’ in portfolio emissions. Yet over the long term they will lead to more substantial emissions reductions in the real economy.
There is a further risk that emissions reduction targets in isolation may be contradictory to the global objective of tripling renewable capacity by 2030, agreed at COP28.
This terminology tweak is designed to encourage longer-term planning at the portfolio level, which will in turn inform action at the asset level under the investor’s chosen net zero strategy and individual circumstances.
Clarifying asset alignment
Asset Alignment Target: A target for increasing the proportion of assets under management or financed emissions considered aligned with net zero.
This target aims to capture changes in the net zero alignment of assets over time using metrics that reflect backward, current and forward-looking alignment to net zero pathways. The target focuses on achieving net zero alignment at the asset level through real economy emissions reductions.
Over time, an increasing number of assets should meet the NZIF alignment criteria as more create and implement robust transition plans, decarbonising in line with regional and sectoral net zero pathways. We renamed this target to better reflect its purpose and recommendations.
NZIF 2.0 offers new measurement options for the target, allowing investors to decide on using a percentage of assets under management or a financed emissions metric.
Table 1 shows a fictional growing portfolio, assessing alignment based on assets under management. The proportion of assets achieving net zero increases as assets implement transition plans.
Using financed emissions can support investors who seek to increase the net zero alignment of the heaviest-emitting assets within their portfolios. For many investors, their financed emissions are highly concentrated into a relatively small number of industries and holdings, meaning it can be more resource-effective to channel engagement to those assets.
Table 2 shows the same portfolio but uses financed emissions to assess alignment to net zero.
The overarching intention of NZIF 2.0 is to encourage a broader, long-term perspective on emissions reductions, including self-assed investor attribution analysis to monitor and understand emissions changes at the portfolio level. Doing so can help investors to better balance short and long-term emissions reductions, considering an allocation to climate solutions, transition assets and emerging markets as best fits their unique net zero strategies.
Each target and objective is designed to support the overarching NZIF 2.0 principle of financing reduced emissions, not reducing financed emissions.
AP7 case study
AP7, a Swedish pension fund, reports on the carbon footprint of its equity portfolio each year. Since 2021, its footprint reporting includes ‘performance allocation’, which differentiates between emission changes due to changes in holdings vs changes in companies’ emissions.
AP7 expects the carbon footprint to decrease over time because of reductions in company emissions. However, it does not set targets relating to portfolio emissions because the investor considers it a poor metric for tracking progress toward net zero in the short term. Carbon footprint is backward-facing and does not evaluate an issuer’s plans, policies and investments.
AP7 instead uses that data to prioritise companies for enhanced active ownership measures - read the Paris Aligned Asset Owners case study.
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