Governments worldwide are enacting regulatory measures, such as carbon taxes, subsidies for electric vehicles (EVs), and plans for green infrastructure development. Businesses are committing to net-zero emissions, setting science-based targets, and encouraging their supply chains to adopt more sustainable practices. Consumers are increasingly favouring sustainable products, altering their spending patterns accordingly.

Meanwhile, some investors are advocating for action, heightening their focus on climate-related risks and setting minimum climate standards, which in turn influences portfolio allocations.

A climate strategy that yields both environmental and financial returns, moving beyond traditional approaches, is gaining traction, generally strategies focused solely on low emissions often rely on historical data without adequately accounting for shifts in business models or the tangible impacts on the environment.

Similarly, when it comes to the fixed income asset class, while green bond strategies contribute to funding eco-friendly projects, a strategy exclusively centred on green bonds may suffer from limited diversification, lower yield return, and extended durations.

Such traditional methodologies do not sufficiently address the physical consequences of climate change, nor do they focus adequately on adaptation. Current policies place us on a trajectory towards a 2.4-degree Celsius increase in global temperatures, according to Climate research group Climate Action Tracker, a scenario corroborated by our climate analysis. This warming path is likely to exacerbate weather volatility and temperature extremes, affecting both society at large and asset values.

Real-world impact through a climate lens

At the heart of a favourable solution is the conviction that climate outcomes should prioritise real-world emissions reduction, support the transition to a low-carbon economy, and facilitate adaptation to the inevitable impacts of climate change. Every investment decision should be made through a climate lens, necessitating a bespoke framework.

Out of the developed world, climate transition in Asia will likely be core to the outcomes that are achieved on a global level considering the size of the population in the region, the projected economic growth, the exposure to higher emitting industries, and the opportunity to potentially leapfrog high emitting technologies and adopt low-carbon solutions.

Asian companies are often national, regional or even global leaders in their respective industries, which could translate to meaningful impact when they adopt more sustainable trajectories.

Globally, there is a shift towards identifying and investing in ambitious companies that are leading the charge in their respective industries. These trailblazers are making significant strides in real-world decarbonisation, disrupting traditional business models, pioneering innovative technologies, and responding proactively to evolving consumer demands.

Three types of companies are worth considering:

• Those in high-emitting sectors that are setting the standard for emissions reduction.

• Innovators who are developing the technologies and products essential for the world's decarbonisation efforts.

• Entities that assist societies in adjusting to the impacts of climate change, thereby contributing to global climate resilience.

Fixed Income instruments, including green and municipal bonds, are pivotal in channelling funds towards projects aimed at enhancing climate resilience. A comprehensive fixed income strategy should span across markets—covering investment-grade, high-yield, and emerging market segments—and support companies across various industries in their transition towards a more sustainable and climate-resilient future.

Specific for Asia, one additional nuance within the Asian bond universe is the presence of large state-owned enterprises that are focused on delivering policy objectives instead of solely profit, allowing bond investors the opportunity to lend to issuers that are involved in national infrastructure projects that are part of the government’s strategy to move towards a low-carbon economy.

There are changes happening in Asia, including the renewable energy space, EVs and its corresponding value chain, as well as large corporates that are adopting more sustainable ways of manufacturing their products.

With the rapid change in Asia, and adoption of new technologies, the potential pipeline from Asia could continue to grow and could span a wide variety of opportunities including low carbon materials production and climate adaptation.

Vital role of active company selection

Selecting the right theme is merely the beginning. Active company selection becomes crucial in ensuring that investments genuinely enhance the portfolio's value.

For credit investors, the application of Environmental, Social, and Governance (ESG) standards across all issuers requires careful consideration, especially given the disparities between high-yield and investment-grade issuers.

High-yield issuers, often smaller or newer companies, may not have the luxury of dedicated ESG teams, established green-bond frameworks, or the capacity to generate comprehensive sustainability reports. Consequently, companies genuinely committed to sustainability might be overlooked due to their inability to showcase their ESG credentials prominently.

A recent example highlights this, a US listed global producer of infinitely recyclable metal drinks cans. Until recently, the company lagged in ESG disclosures despite its strong alignment with sustainability, particularly within the circular economy and waste reduction sectors.

In 2022, its recycling initiatives were estimated to have avoided more than three million metric tons of CO2 equivalent emissions compared to using virgin materials. This case highlights that ESG assessment should transcend mere box-ticking; there's no substitute for thorough research. Investors adept at identifying firms with commendable ESG practices, albeit with limited disclosure, stand to gain by investing ahead of the curve, before enhanced transparency garners wider market recognition.

Tick-box ESG investing can lead to unintended consequences by overlooking companies that are making significant positive impacts but do not meet rigid, standardised criteria.

Take, for example, a private Indian renewable energy company with public debt that lacks formal emission reduction targets. Despite not having these targets, the company plays a crucial role in supplying clean energy to a grid that is predominantly reliant on coal.

By focusing solely on the absence of specific ESG metrics, certain sustainable investment strategies might overlook this company, failing to recognise the material impact it has on improving clean energy generation and reducing air pollution in India.

Shouldn't our approach to sustainable investing prioritise the tangible, positive outcomes a company contributes, rather than just a checklist of criteria?

Growing investment focus

Climate change investing looks set to continue, due to the escalating global emphasis on environmental sustainability. Despite concerns, the burgeoning demand for climate-related investments will not alone lead to overvaluation. The arena of climate transition presents a vast and perpetually evolving investment landscape, far from being exhausted by current interest levels.

Most importantly, climate change investment strategy should have a dual objective —achieving meaningful climate impact alongside robust financial returns.

Furthermore, this investing transcends mere trend-following. It's about pinpointing and supporting innovative companies that lead the charge in industry transformation and real-world decarbonisation efforts.

It should emphasise backing ambitious companies across an array of sectors and geographies.

A diversified strategy ensures resilience against potential overvaluation in any single region, sector or asset class by spreading exposure across the varied facets of climate transition.

The domain of climate transition is characterised by its dynamic nature, fuelled by advances in technology, shifts in regulatory landscapes, and changes in consumer behaviour. Consequently, the field of climate change investing can retain its vibrancy and potential for growth and innovation, making the prospect of overvaluation due solely to rising demand unlikely.

This article is also published by the Business Times Singapore.