Structural mega-trends underpin demand for real assets, and asset owners face the challenge of decarbonising real estate as the world population grows, said Abi Dean, global head of strategic insights, at Nuveen Real Assets. 

With the global population set to exceed 9 billion by 2050, demand will only grow for agriculture and housing, Dean said. Additionally, 68 per cent of the population in 2050 is predicted to live in urban areas compared to 55 per cent today, further driving demand for real estate and energy in areas that need to be decarbonised.

“We need to feed a growing world population and growing middle classes as well, and we need to do that whilst reducing carbon emissions, so there is a key transition that needs to take place there,” Dean said.

Nuveen is one of the largest investment managers in the world, with about $1.1 trillion of assets under management. Speaking at the Sustainability in Practice conference, organised by top1000funds.com and held at Oxford University, Dean said demand for more agricultural land alongside the need for greater biodiversity and zero deforestation will drive investment in responsible land management practices and natural capital.

There is also a need for investment in renewable energy, green buildings and sequestration to decarbonise, while increasing affordable housing and ensuring a just transition.

“So I think all of these things kind of mutually reinforce each other,” Dean said, noting that around 80 per cent of the built environment of 2050–the deadline for net zero emissions–is already built today.

“So we can’t build our way out of this problem with new buildings,” Dean said. “We have to adapt what’s already there, and we need to see about a 95 per cent reduction in carbon emissions on the 1.5 degrees scenario of that existing built environment.”

A massive increase in renewable energy enables some of this decarbonisation, she said, and the more renewable energy there is available in a grid, “the less steeply you have to go on the energy efficiency measures that you have to put in place [in buildings].”

Efficient heat pumps that don’t rely on fossil fuels are a major factor in decarbonising real estate, she said.

Regulation plays a major role in ensuring transparency and a range of performance standards, Dean said. So is the ongoing increase in allocation decisions being based on meeting decarbonisation goals. There is also a rising trend of net zero carbon goals informing space requirements, which “will be quite transformative in the years ahead,” she said.

Data shows green credentials increasingly affecting asset pricing as organisations think ahead about reducing their carbon footprints and assess the expenses involved in bringing buildings up to par, Dean said.

Marc deBree, managing director, head of real estate and alternatives, general account, at TIAA in the United States, said despite negative press about struggling commercial real estate, a lot of sectors of the market are doing very well. These include anchored retail strips selling daily use groceries, and industrial logistics.

However the office market is struggling, with changes to how offices are used, and increasing demands for energy efficiency. Older offices that need an expensive retrofit are harder to lease, he said.

A lot of dollars are being allocated to alternative real estate assets like storage, medical offices, and affordable housing, he said.

Jen Bishop, deputy chief investment officer and head of responsible investment at Coal Pension Trustees in the United Kingdom, said there is a need to re-think land use in areas such as the intersection between real estate and infrastructure, with opportunities to use land more efficiently.

Coal Pension Trustees manages around £20 billion of assets on behalf of two pension funds for legacy workers of the UK coal industry.

BlueOrchard and Schroders Capital’s impact investing veteran, Maria Teresa Zappia, isn’t a fan of using ESG performance to evaluate her portfolios, suggesting that investors are limiting their options if they are not willing to consider companies with lesser ratings. Echoing the sentiment, PGGM’s Piet Klop said the pension manager also lost its faith in ESG marks long ago.

ESG is not necessarily a stepping stone for impact investment according deputy chief executive at BlueOrchard and head of sustainability and impact of Schroders Capital, Maria Teresa Zappia, who said investors are limiting their options if they are not willing to consider companies with lesser ratings for their impact portfolios.

Zappia, who is an impact investing veteran of 20 years, told Sustainability in Practice at Oxford University this month that ESG is often treated by the industry as “the stepping stone” for impact, but that connection doesn’t always exist in reality.

Schroders has a US-based listed equity strategy team that focuses on local small caps and it has an impact assessment to evaluate proposed stocks from the team based on two things: how crucial impact is to their business models and how innovative these companies are.

“Very often they [companies in impact portfolio] have average governance, just started to look into their own scope one and scope two emissions, and they probably don’t excel in terms of diversity and gender representation,” Zappia told the delegates.

“They are not necessarily very advanced in their sustainability journey; it could be sometimes exactly the opposite. But the products and services they have in the market are innovative – they increase access and generally push for cost efficiency and affordability. I think this is really where that the impact comes from.”

It is a sentiment echoed by Piet Klop, head of responsible investment at PGGM, the €228 billion pension manager for the Netherland’s second-largest pension fund.

PGGM defined its own “solution universe” to inform its impact investing method in 2015, consisting of listed companies that generate market-rate financial returns and have a positive impact on its four themes of climate, healthcare, food security and water scarcity – a revenue rather than ESG ratings-based approach.

“We tried to bring a little more method to the madness, away from the mish mash of ESG ratings where everybody’s throwing in all sorts of data points,” Klop said. “At the end of the line, you can’t really make sense of which tobacco company came on top of many sustainability rankings.”

“That’s where we lost our belief in ESG ratings, because there must be a distinction between doing the thing right, and doing the right thing. A tobacco company can run its company perfectly well, but ultimately, it’s not a solution to anything.”

In May, the Global Impact Investing Network (GIIN) released the new guidance for pursuing impact in listed equities. It revolves around four pillars – strategy, portfolio design, engagement and data usage. It saw the disappearance of concepts like additionality from impact investing’s definition, which was described by the organization as “the positive impact that would not have occurred anyway without the investment”.

Klop said measuring impact using additionality was “probably too high of a bar” for most investors anyway. “It’s super hard to prove that something good would not have happened without you. Nor does anybody particularly care as long as the impact is being generated.”

Zappia said the process of coming to the new impact investing definition has been a healthy exercise which challenged the industry to think about the real purpose and outcome of impact investing. “For example, there were key questions such as are you [as an investor] looking really for impact, or are you obsessed with being aligned to a benchmark?”

In terms of setting impact measurement targets from here, Zappia’s word of advice for listed equity managers is to make full use of the information available to them. But remember they should always invest with one ultimate factor in mind.

“There is a lot of information that can be tracked [in listed equities]. We created our own impact assessment tool – a really very detailed scorecard to capture as much as possible about the baseline and an end target.

“Also engage with the management of these [portfolio] companies to see how key achieving impact is to their business model, which I think is the most important part.”

CalPERS has already had 55 applicants for its vacant CIO position, far more than the same point in its last recruitment drive to fill the position and with the advertisement only recently gone live.

The $461.8 billion pension fund’s last two CIOs, Ben Meng and Nicole Musicco, each lasted in the post for about a year and a half, with Musicco announcing her resignation in September. CalPERS hopes to onboard a new CIO in early 2024 and has budgeted $300,000 for the hunt, including all search fees.

“The number of people reaching out to us is higher quality [than last time],” said Charles Dore, founder of global executive search group Dore Partnership, which also assisted in placing Musicco and is hunting for potential candidates at asset owners, GPs and asset managers; unearthing people on career breaks and rising CIOs.

“We are quietly enthusiastic about the quality and diversity in the field. The quantity and quality of people reaching out to us is refreshing.”

The search comes during a very competitive time in the financial industry with CIO openings at several high-profile organisations.

A specially convened CIO selection sub-committee went through the long list of skills the role requires, top of which sits relevant investment experience. CalPERS’ next CIO must have a track record of investing capital, able to identify where they’ve added value and what they’ve learnt from hands-on investment.

But in a reflection of both the deeply political organisation and the strategic role of many CIOs, a wish-list of other accomplishments comes swiftly on the heels of investment expertise. The sub-committee stressed the importance of CalPERS next CIO being an adept leader, a skill that demands more than simply managing people. It requires inspiring all stakeholders, bringing out the best in each person and helping build a pipeline of talent so that when the pension fund comes to recruit, it can tap high-quality internal candidates.

“We want someone who can see themselves at CalPERS for years to come,” said CEO Marcie Frost.

Under that same leadership banner, the sub-committee is hunting for a candidate with cultural competence to navigate and rally the pension fund’s many diverse stakeholders and constituents. “Leadership also means an ability to effectively listen,” added sub-committee member Lisa Middleton.

Communication skills are also vital – particularly the ability to explain “the why” so that everyone understands the reasoning behind a decision, even if they don’t agree with it.

“There are times we are going to be divided,” said Frost.

Leadership requires emotional intelligence, the ability to read the room; present in a way that doesn’t cause a furore or that is insensitive to CalPERS diverse culture. The board would also like the new CIO to agree to receiving mentorship.

Another essential attribute is fitness for public role – an aspect of the highly visible job that turned out to be a “surprise” to previous incumbents despite the rigorous interview and onboarding process. This  requires an ability to sift through “what matters and what doesn’t” and not let criticism get in the way of the job. CalPERS doesn’t want someone in the media on a weekly basis, but when it has a story to tell it will “get the CIO out there” to talk on strategy, said Frost.

Applicants should have a keen sense of mission. CalPERS is a “mission first” organisation where the welfare of the two million Californian workers the pension fund serves is front and centre. This requires energy, innovation, resilience and humility.

The search process is global, systematic and reference driven and candidates that apply direct, as per CalPERS’ own policies, will go through the same process as those hunted down by Dore. The reference-led process includes both formal and informal references and the offer phase is followed by a multitude of 30-40 checks including background and reference checks; credit checks, social media checks, and criminal and federal background checks.

Investors and corporations will arrive in Dubai for COP28 later this month, and the world is depending on them to recognize and address a paradox: ordinary net zero 2050 commitments are one of the biggest threats to achieving net zero carbon emissions in 2050.

While paradoxical, this is quite simple to understand. On their own, net-zero commitments reward divestment, and that merely changes the ownership of dirty assets, not emissions into the atmosphere. We will only lessen emissions in the atmosphere by long-term investors and companies owning and cleaning dirty assets.

We have to clean up our mess, not hide it.

Take it from Ontario Teachers’ Pension Plan. Jonathan Hausman, executive managing director of global investment strategy, recently remarked, “We need to use the levers of investment that we have to make an impact well beyond the portfolio footprint of Ontario Teachers, and that is something that we call ‘high carbon intensity transition assets’.”

Ontario Teachers’ intends to allocate around C$5 billion to such assets – high-emitting companies with credible decarbonisation plans that can be accelerated via capital and expertise. OTPP is doing this in the context of its net zero 2050 commitment and interim targets, and this effort to decarbonise, rather than divest, is what makes their commitment practical and meaningful.

The hard part is actually cleaning up dirty assets.

Long-term investors and companies see private markets as offering a special pathway to success. Private ownership is more concentrated, long duration, and prepared for this type of risk compared to the diffuse, high-turnover, and volatility-sensitive shareholders in public markets. All of these are advantages when the investment strategy depends on a big transition like decarbonisation.

Still, the work is hard, in part because limited partners (LPs) have deep concerns about allocating to general partners’ (GPs) transition strategies. LP concerns can range from greenwashing on the impact portion of the strategy to concessionary performance on the financial portion of the strategy.

We know this because long-term investors brought these realities to us in the larger context of FCLTGlobal’s effort to develop tools that allow LPs and GPs commit together to grey-to-green strategies.

Fee provisions are an example of these tools. In the course of this effort, LPs and GPs together identified sample fee and expense terms, such as including an emission-reduction target in the hurdle rate, putting carbon performance targets into the carry, and expensing offsets out of the management fee for any carbon underperformance.

And fees are just one example. Mandate terms are the centerpiece of any relationship between clients and managers and, in a deeper toolkit for top-down portfolio decarbonization, a similar group of owners and managers offer carbon-related mandate provisions for benchmarking, contract term, redemptions, projections, and reporting.

Long-term investors can come to COP28 ready to talk about how they are putting tools like these to work. Hausman continued, “We have one [high carbon transition asset] that we’ve worked on already, but we want to do more at a bigger scale.”

OTPP is in good company with this approach to decarbonisation. CDPQ has allocated C$10 billion to decarbonisation investments, and AIMCo is doing similarly, as chief executive Evan Siddall has stated explicitly: “We’re a long-term investor, so unlike public markets that tend to operate quarter to quarter with much shorter-term horizons, we can look to a transition into 2030 and see the path to earning a return on decarbonisation.”

There are limits to this sort of strategy, of course, just as there are for any investment. Two are particularly relevant to climate.

Transition strategies require trust. For asset owners, the sponsor has to trust that the fund can handle the usual financial aspects of an investment while simultaneously pulling off a highly-technical, scientific transition. For asset managers, the same trust is required from their clients. Trust is earned before it is applied, so the only agents in a position to accept this opportunity cost are those that have prepared their principals for it well in advance.

Relatedly, transition strategies test investors’ willingness to tolerate a bumpy ride. Ordinary net zero 2050 commitments with interim targets are appealing in part because they promise a smooth and foreseeable path to a clear destination. Transition strategies promise that the investor’s carbon footprint will get worse before it gets better. Emissions will go up every time the investor brings a dirty asset onto the books, it will take years for each to decarbonise, and the exact moment when those results begin to appear is very uncertain.

OTPP, CDPQ, AIMCo, and other long-term investors are committing to transition strategies nonetheless because they have the tools, they understand the long-term financial appeal, and that this is what it will take to get to planetary net zero 2050. That is what COP is about, and all of us are depending on this approach scaling at COP28.

Matthew Leatherman is managing director, research strategist at FCLTGlobal.

The world is shifting from a regime where climate change is viewed as a shared burden or a hot potato to pass around, to one where it is a “business opportunity that everyone should be scrambling to make money from,” according to University of Oxford Professor J. Doyne Farmer, citing probabilistic assessments by his team.

Drawing from complexity and systems theory, Farmer pointed to the growing deployment of technologies like solar energy, P2X fuel and batteries, and the falling cost of their usage over a long period of time.

“We have batteries coming down in cost quickly, we have windmills coming down in cost quickly, we have hydrogen-based fuels coming down quickly,” Farmer said. “So we have the technologies we really need dropping in price just when we really need them to deal with climate change.”

Technological change is “very inertial,” Farmer said. “Once a technology starts improving at a certain rate, it’s likely to keep improving at that rate for a long time.”

Professor J. Doyne Farmer is the director of the Complexity Economics programme at the Institute for New Economic Thinking at the Oxford Martin School, Baillie Gifford Professor in the Mathematical Institute at the University of Oxford, and an external professor at the Santa Fe Institute. 

He was speaking with Stephen Kotkin, senior fellow at Stanford’s Freeman Spogli Institute for International Studies, and the Kleinheinz Senior Fellow at the Hoover Institution, at the Sustainability in Practice conference held at the University of Oxford this month, organised by Top1000funds.com. 

The topic of the discussion was empirically validated probabilistic forecasts of energy technology costs, and the trillions of net savings that could result in a rapid green energy transition.

A range of predictions about technological change have turned out to be true, Farmer noted. Moore’s law from 1965 predicted computers would improve exponentially through time. Another observation from Theodore Wright from 1936 was that airplanes from a given factory drop in cost of production by about 20% every time the cumulative production of the factory doubles. 

“This law turns out to be true for lots of technologies and not just at the level of factories, it turns out to be true globally as well,” Farmer said.

These laws can be used to predict the future behaviour and performance of technologies, “even if you can’t predict the innovations that will enhance future performance,” Farmer said.

Drawing from these findings, Farmer and his team developed a probabilistic method for forecasting technology costs based on historical data, by collecting data on 50 technologies, “pretending we were at some point in the past and making 6000 forecasts for different points in the future.”

They then applied their findings to three different scenarios for the green energy transition: one scenario being business as usual, one being a slow transition, and one being a fast transition. 

Despite roadblocks such as political hurdles and land use issues, “greener energy will be widespread and substantially cheaper than energy has ever been in 20 years, with reasonable likelihood,” Farmer said.

“So this will bring us a lot of benefits. We’re going to have cheaper energy than we’ve ever had. We’re going to have lower volatility for energy prices. We’re going to have better energy security. We’re going to have low pollution. We’re going to have lower environmental impact and better sustainability. And most of all, no or minimal greenhouse gas emissions.”

By contrast, the “mainstream” way of doing forecasts practiced by the International Energy Agency and “integrated assessment modellers” has proved consistently wrong over time, Farmer said. “They just consistently were too pessimistic about how quickly the cost of renewables will drop and pessimistic about how quickly they would be deployed, even though the historical data should have been screaming at them.”

Net zero emission targets may cover most of the global economy, but the world is not going to deliver on its net zero promises, warned Oxford University’s Cameron Hepburn, speaking at Sustainability in Practice.

Hepburn, who is Battcock Professor of Environmental Economics and  director of the Economics of Sustainability Programme at Oxford’s Institute of New Economic Thinking, said there is not enough accountability or transparency to hold governments and corporations to their net zero promises.

“We are not holding each other to account,” he said, adding that if the world stopped burning coal, invested in renewables and electrified heating and transport systems, it would be possible to cap warming although 1.5 degrees is now “a huge stretch.”

The scale of the problem

Hepburn said it was difficult to electrify an entire economy. It requires trillions of capital not only going into renewable energy production but also industries like plastics, and food systems. Society also needs to tackle legacy emissions, taking carbon out of the atmosphere not just by planting trees and natural solutions but also putting carbon into depleted oil wells, for example.

Indeed, Hepburn flagged that consideration of electricity storage lags, and society has not understood the “storage challenge.”

Investment in the transition is also complicated because the dynamics are not linear and investment can trigger unexpected events. It involves understanding where the tipping points are in the system, and where investors have the opportunity to make a difference. The explosion in solar energy shows that progress is rarely linear.

“Solar is no longer an expensive joke,” he said.  He said to expect similar leaps forward in diet as the world moves from a traditional food system.

He warned that investors are holding stranded assets, and that assets are mispriced. “It is important that we have an orderly transition and start pricing assets correctly for financial stability.” He said an orderly transition is within our control, diversification is possible to prevent value being destroyed and urged for a tighter connection between climate and science.

Hepburn said change was dependent on leadership. He said it would be possible to run the entire UK economy on wind and solar.

Change is possible

When change happens, the global system will move into a new dynamic. This could see billions of market capitalization wiped out, and financial shifts moving large amounts of value around the market. Beliefs, incentives, and new laws will also start to move capital and systems, he said.

“Beliefs will change the status quo because if enough people believe it can happen it will be self fulfilling,” he said. He said the way technology and beliefs penetrate a system can cause sudden changes and shifts.

He stressed the urgency of new policies. But said in the absence of policy, investors should use their heft to put pressure on regulators to move the needle on policies. These policies will then allow investors to tap climate alpha when they invest in solutions. “The door will slide opend as the government becomes more amenable and moves the needle on the regulatory side.”

He said moving forward requires credible targets and corporates are floundering on how to make progress. “I hear board after board ask how do we make money with doing what we know we have to do?”

He called for more granular modelling in the financial system and said many of the today’s tools are ill-equipped, warning that often data doesn’t say anything useful

He said that if nuclear is to have a significant role it needs to come down the cost structure and deliver cheaper power.

Some 150 countries now have a net zero target. Of those Hepburn estimated 20 per cent have enshrined those targets into law resulting in governments getting punished if they fail to deliver. “Laws can be changed, but it gives a sign of strong confidence,” he said. “Countries that don’t have this as their baseline scenario don’t know what they are doing. We are just at the starting point where this takes off.”

He said that nature-based solutions are not permanent solutions. Nature based solutions involving managing the land and reducing biodiversity loss can deliver a great deal but they really only “buy time.” “They are very valuable because time is valuable, but they are not solving the problem in one go – they are storing it up for others to deal with.”