Schroders Capital: LP interest in climate crosses asset class lines

This article is sponsored by Schroders Capital

Which investor types are creating specific climate allocations, and how are they deploying them?

Emily Pollock: We see interest across all segments of the investor base, and that interest is growing. At Schroders Capital, we segment our investor types across pensions, insurance, long-term asset owners, and wealth, and currently it is the pensions segment that is most active.

There, we are seeing specific climate and decarbonisation commitments. Those investors are also subject to the most onerous regulations from a reporting standpoint. We often see the institutional pension market leading the way with investment trends, and we are also noticing growing interest from the defined contribution (DC) market.

Insurance is a growing segment, while long-term asset owners, including family offices, foundations, endowments and sovereign wealth funds, also have an allocation. Particularly the foundations and endowments have historically been big investors in venture capital and large backers of emerging managers, so they are well positioned to commit to newer segments of climate investment. For wealth, private markets is a newer but growing segment.

When it comes to deployment, investors are accessing the market in a few different ways, with some starting from their core allocation and others establishing impact buckets or allocations that target certain sub-themes.

There is increasing recognition of the need for capital in emerging markets, and generally investors have commitments around long-term net zero or decarbonisation that encourage asset allocation.

Holly Turner: We see two real drivers of action in the short term. First, there are a lot of climate-related industry initiatives that ask investors to make specific commitments, focusing on issues such as portfolio decarbonisation, active ownership or specifically committing an amount of capital to climate solutions. Second is climate-related regulation. From an investor perspective, that means increasingly looking at risks and opportunities related to climate in more detail, which encourages greater consideration.

The climate crisis is giving rise to strategies that don’t fit neatly into asset class buckets. What are you observing around the development of thematic and multi-asset funds?

EP: The growth of private markets has been staggering, with a proliferation of funds specialising in different industries, geographies and investment types. For example, the infrastructure industry has grown from a handful of core/core-plus managers to a full spectrum of debt and equity, along with core through to private equity like returns.

Over the same period, we see the rise of new open-end fund structures and semi-liquid alternatives enabled by the growth of the secondaries market, along with new investors coming in from the DC market and retail, and an increase in co-investment and GP-led secondaries, creating more access points and risk-return options.

As that relates to climate, we see more of those funds being thematic, focused on outcomes rather than asset classes. Still, complexity and competition mean specialisation is key. This is not a market for generalists.

What are Schroders’ core climate impact themes? 

HT: We split our climate impact themes into four broad buckets: climate mitigation; climate adaptation; social vulnerabilities; and natural capital and biodiversity.

Investors are interested from an outcome and access perspective, so that could be targeting investments that are already low carbon, looking at companies that include climate action or transition in their objectives, or backing companies delivering products or services that offer climate solutions, like climate change mitigation or adaptation tools. That final category of climate solutions is currently a big focus within private markets.

Which climate solutions strategies are most compelling today?

EP: The three most attractive climate solutions strategies that we see today focus on renewable energy and wider energy transition infrastructure; energy transition linked to sustainable transportation, which may include both renewable infrastructure and private equity funding; and resource management and circularity, which is mainly a PE strategy.

HT: The focus here is on activities that enable the avoidance or removal of emissions, as distinct from transition assets. Themes can evolve and change over time, so for example, once a building has decarbonised and reached the status of a green building, it can move from a climate transition strategy into climate solutions, which we consider to be the end state.

Are private markets investors tapping into promising new strands of climate solutions?

HT: Given the scale of the opportunity set, private investors can approach this in many ways, via theme, asset class, returns, geography or impact. In the private asset classes, private equity and infrastructure have a dominant position, but natural capital, which is a much smaller allocation, also has the potential to create a significant impact.

We see a lot of interest from investors in targeting hydrogen versus traditional renewable power, and natural resource management. Another new strand we think is important is climate adaptation, which is helping communities become more resilient to the impact of climate change and is largely an emerging markets opportunity.

It is critical for investors to consider the balance between promising new strands of climate solutions versus the roll-out of existing viable technologies, and not get caught up in new and flashy areas.

What developments are you seeing around nature-based solutions?

EP: Natural capital is a topic that institutional investors are increasingly exploring as an important pillar of climate mitigation. As we think about investors looking to achieve net zero, sequestering carbon can be done through nature-based solutions or through technology, but the technology still has some way to go.

Nature-based solutions are actions that help protect, restore or manage natural assets – looking at conservation, restoration and afforestation projects, which from an investible universe perspective tends to expand the natural capital core buckets of forestry, agriculture and ecosystem services.

Forestry and agriculture have been investible for many years, evolving over time to consider elements like carbon and biodiversity beyond simply the yield of the commoditised product. Ecosystem services includes newer concepts like early carbon credit and offset markets, working to add environmental impact into new revenue streams.

HT: We hear a lot of interest from investors about nature-based opportunities relating to climate change resiliency or adaptation, along with climate change mitigation, but accessibility for institutional capital is still quite tricky and we are in a deep exploration phase. Developments around track record, reporting and new mechanisms could open up the opportunity, which is important considering the location of many critical ecosystems within emerging markets.

How important is it for investors to understand the impact of their climate investments, and how much progress has been made on measurement?

EP: A lot of progress has been made. Many investors choose climate investments for their risk-return characteristics, but where the allocation is linked to a specific commitment or objective, impact measurement becomes very important.

HT: We look at the quantification of the climate impact of investments in two ways, considering impact measurement overall but also specific climate-related metrics, like avoided emissions, sequestered carbon or biodiversity. There is still a lot more work to do on all of those, but it is encouraging that there is a growing volume of guidance and regulation around disclosure. That will only assist with the climate-related reporting that financial institutions are looking to achieve moving forward.

Emily Pollock is a client director, solutions, at Schroders Capital and Holly Turner is a climate specialist at the firm