Tools Used by System-Level Investors in Their Net-Zero Initiatives

Introduction

This chapter examines the tools used by system-level investors in their journey to net zero. System-level investing (SLI)1 inherently focuses on the health of the environmental, social, and financial systems because they affect the capital markets, and so many system-level investors have adopted net-zero or other climate goals. This chapter examines some of the attributes of those investors and the tools they use.

System-level investors tend to be either large investors with liabilities (e.g., asset owners such as pension funds)—and, therefore, more concerned with total return than with market-relative returns—or early adopters with long-term investment horizons (e.g., some major asset managers and foundations). The twin hallmarks of SLI are the beliefs that (1) the general price level of the capital markets is based on the health of the economy and the environmental, financial, and social systems on which it relies and (2) the general price level of capital markets determines 75%–94% of the variability in an investor’s return, meaning that security selection and portfolio construction contribute only 25%, at most.2 

For these total-return-focused investors, beta is salient, which is quite unlike those seeking relative return success (alpha), for whom beta is silent. Modern portfolio theory assumes that beta is exogenous, but system-level investors do not. They try to affect it. Because beta risk is universal and nondiversifiable, risk management is not limited to the capital market tools used to diversify or hedge idiosyncratic, security-specific risk. Focusing on systemic risks means these investors act both in the capital markets and in the wider world to mitigate risks to the financial, environmental, and social systems, with reducing climate risk atop many system-level investors’ priorities list. 

We find several commonalities in these investors’ approaches.3

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