Backtracking on net zero

For some time, the move to net zero has appeared inexorable, but as global powers reconvene for the COP 28 conference at the end of November, they are likely to conclude that progress on decarbonisation has been slow. There has also been a rising backlash against the move to net zero. The UK, for example, has rolled back on electric vehicle targets. A lot of the discussions have been about the potential cost of net zero. However, too often these same discussions neglect to quantify the cost of doing nothing. Climate change is having a significant economic toll in different parts of the world. Equally, there is also little talk of the potential benefits, which include job creation and investment. Ultimately, we believe governments will look at the opinion polls and recognise their electorates care about climate change. Many governments continue to pour considerable sums into decarbonisation efforts through the Inflation Reduction Act in the US or Fit for 55 in Europe. Equally, we see companies willing to invest, providing they have sufficient policy stability. The costs of green technologies are falling, consumer interest is growing and – beyond the political noise – the direction of regulation is clear. While the signs of rolling back get a lot of headlines, we see decarbonisation as a necessity and companies need to manage this risk effectively.

What is the Trust’s position on oil?

Oil has been in the headlines, with a surge in pricing since June this year. However, while this can boost profitability for oil companies in the short-term, this is still an area where DIGIT has limited exposure. We are looking for companies that can deliver resilient earnings through the cycle, and often oil and gas companies fail this key test of quality. We also have a number of environmental protection screens designed to minimise the fund’s exposure to the long-term risks that come from fossil fuel production. However, energy companies do have strong cash generation and generous income distributions, which can have a place in an income portfolio. As such, we look at the energy sector on a case by case basis, bringing together the portfolio management team, sector analysts and ESG experts. This helps us develop a 360-degree view on company exposures and how they are managing their business for the future, allowing us to judge the materiality of environmental issues to each energy company. Engagement is also an important part of that analysis. Can we effect real change through a long-term relationship with these companies? Total Energies is currently the only oil and gas company held in the portfolio. In recent years, Total has had the highest investment in low carbon energies of all its peers and the largest installed capacity for renewable energy, it also generates more than 50% of its upstream revenues from low carbon fuels and renewables. It has set out ambitious targets for future investment into renewables and has been transparent about how it tests the resilience of its oil business. We continue to engage with the group, and support their ambition and commitment.

Bringing in new holdings

We introduced National Grid to the portfolio recently. The company is an electricity and gas transmission and distribution business with assets in the UK and US. It is becoming an increasingly important part of the energy transition, while also helping build the UK’s energy security. Most importantly, the ESG rationale is the same as the investment rationale. There is a need to upgrade the grid infrastructure across the UK and US to create increased electricity capacity. For the UK to meet its offshore wind targets, a huge amount of investment is required to bring electricity from where it is generated – mostly in Scotland – to where it is consumed – mostly in the South of England. This investment will also create asset growth and higher earnings for the company. This gives it a powerful and resilient outlook. It should also help it sustain an attractive yield over time. It ticks the boxes of providing some defensiveness, a high yield and structural growth, while also fitting into our sustainability approach. We are also working with National Grid to communicate our expectations. These new transmission lines may have to go through new areas, which could impact local populations and the environment. We need to make sure this is done sensitively to secure public consent. We want reassurance that these non-financial factors are valued and dealt with correctly, so projects don’t get delayed.

ESG priorities for the year ahead

For the next 12 months, we will continue to work on the material ESG factors for companies in the portfolio. In particular, we are placing a growing emphasis on social factors. The nature of our approach means that many of the companies we invest in are ‘people businesses’ that rely on talent to drive innovation, sales, deliver growth in earnings, cash and distributions. The UK labour market is tight, and it is more important than ever for companies to be able to attract and retain the right talent. We are developing our frameworks to build a better understanding of how companies are managing human capital. For example, we hold UK IT reseller Softcat, where the group’s culture has been an important part of its success. With this in mind, a lot of our engagement with the company is focused on ensuring it maintains that advantage, looking at turnover, development, and diversity and inclusion. We are also looking at how companies are responding to any signs of wavering political support, particularly against a backdrop of weaker economic growth in the UK. That means dedicating more time to understanding how companies are responding to climate change, or water-related risks. This is already impacting people and profits and we need to see whether companies are adequately prepared.

Companies selected for illustrative purposes only to demonstrate the investment management style described herein and not as an investment recommendation or indication of future performance.

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Issued by abrdn Investments Limited, registered in England and Wales (740118) at 280 Bishopsgate, London EC2M 4AG. abrdn Investments Limited, registered in Scotland (No. 108419), 10 Queen’s Terrace, Aberdeen AB10 1XL. Both companies are authorised and regulated by the Financial Conduct Authority in the UK.

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