Thu Ha Chow | Head of Fixed Income Asia, Portfolio Manager
The word ‘transition’ by its very nature implies moving from one place to another. Importantly it indicates a state of change. And change is not easy. The fact we find ourselves grappling with the complexities of moving the entire world to the 2050 goal of net zero is not surprising. Energy is a fundamental driver for the economy, but the shift to renewable energy is having wide-ranging reverberations on companies and countries.
Nonetheless, the energy transition is in full swing, with regulations and technologies increasingly being the driving forces. Yet, we are not moving fast enough to mitigate the impending climate changes that scientists are warning us about. So, what should we do?
The starting point is to understand the problem we are trying to solve. We asked Thu Ha Chow, Head of Fixed Income Asia, to break down the complexities of the transition by explaining where we are now, how we got here, and what we, as asset managers, are doing about it.
Where has transition investing come from?
“Sustainable investing was the starting point. Here, we emphasized investing in companies and sectors that were green, usually defined as building low-emission alternatives such as renewable energy. However, if we look at the International Energy Agency’s (IEA) policy pathway,1 building low-emission structures only represents 15-20% of the reduction needed. The problem is, as we can see below, the bulk of the work is required in the yellow section: ‘make dirty cleaner’. This calls for transition investing, which focuses on supporting companies and sectors in improving processes to create greener practices.”
Figure 1: Emissions reductions for net zero emissions (NZE) by 2050 relative to the Stated Policies Scenario (STEPS)
Source: International Energy Agency
“Yet without sufficient clarity of what would be classified as transition activities, there was a gap in funding for fear of greenwashing. The publication of the G20 Transitional Finance Framework2 in 2022 was instrumental in establishing international guidelines and, subsequently, confidence. On the heels of this in early 2023, ICMA3 published a transition handbook, outlining a framework for how green, social and sustainability (GSS) bonds could be used not only as ‘sustainable’ investments but also as a part of the toolkit to enable companies and sovereigns that are not yet fully decarbonized to transition from brown to green. Thus, the term ‘transition investing’ arose to clarify and channel funding more effectively toward achieving net zero.”
Why start with a focus on Asia and emerging markets?
“We started in Asia and EM as this is where the funding gap is greatest, and where the harder-to-abate sectors reside, given these markets are resource and manufacturing hubs. However, the transition needs to happen globally if we are to reach net zero.”
So, if we recognize that transition investing is essential, what do we do next?
“Once we accept that transition is already in motion, as an asset manager we need to embrace transition investing as a part of sustainable investing. I like to use the analogy of a difficult car journey, so it might involve some off-road driving, you might end up on the beach, there will be deep crevices to cross. We might have to change tires halfway to tackle bumpy terrain. We might have to release the tire pressure to drive through thick sand.”
“
The energy transition impacts every aspect of our economy, from inflation to geopolitics
“We need a navigation plan in place and a starting point, but before we set off, we need to be prepared and we must expect the unexpected on route. The road ahead is unclear and there will be new challenges along the way.”
“You could say we are experiencing some bumps now with pushback from different areas on ESG investing, but this is just a part of the journey as we grapple with the reality of the transition. As asset managers navigating this brave new world, we need additional tools to navigate the transition landscape and we must keep thinking about how to refine or develop our toolkit.”
Where do we begin?
“We start by being adaptive, that is the nature of any good investing strategy. We have adapted before: we did it with the dotcom boom, and what we learned then was that we had to invest in more than just the hardware, we also needed to invest in the logistics companies, and software providers too. It is the same thing this time around. We need to tackle the financing of the transition with a broad-based approach.”
“The traditional investment lens, with our current economic models, doesn’t cover this. And we must recognize that the impact is not just a concern for sectors directly affected by policy, such as energy or transport; it extends to second and third-order impacts. The energy transition is impacting every aspect of our economy, from inflation to geopolitics.”
What is our role as asset managers?
“We need to finance adaptation and finance the change. By supporting businesses that are changing, we are supporting more resilient businesses. And as asset managers we can be the solution providers, undertaking the work to navigate and support the transition.
The speed and pathway toward the energy transition will shape the investment risks and returns for decades to come, so it is imperative to have an approach to manage this transition.”
And what approach should we take?
“When we thought about how to create the solutions, we came up with three key criteria that a good solution should meet:
We needed to develop a framework to identify transition opportunities using forward-looking metrics.
We had to recognize the multiple dimensions of the transition and the regional differences.
We should incorporate the philosophy that transition is the journey into the investment process, with the understanding that sustainability is the destination.
We believe that if a solution addresses these criteria, investors can identify the different opportunities across asset classes and regions as they emerge.
“
Our method is dynamic, allowing investors to capture alpha opportunities
It acknowledges that the interplay between the energy transition and various economic, financial, social, and political dynamics can result in multiple outcomes. This method is designed to be dynamic, allowing investors to capture alpha opportunities while steering clear of potential risks.”
Lastly, what solutions do we have at Robeco?
“To meet our criteria for an effective solution (forward-looking, region-specific, multifaceted, and facilitating the transition journey), we needed to offer a variety of approaches. Therefore, we started with two credit strategies and two equity strategies, each with distinct features.”
“And if we return to the car analogy: in the case of equities, the car they are taking on this journey is equipped to go fast, investing in solutions and technologies that are leading the transition. For example, they might invest in new technologies that are climate providers.
“Whereas for fixed income, we are taking a more cautious and slower route by investing in more traditional companies that are leading the transition through adoption of innovative technologies. We are confident that these solutions will initiate the journey, and ultimately, we see having diverse opportunities as advantageous.”