Asset owners grapple with complex transition investing needs
The race to decarbonise is accelerating, but for asset owners, navigating the complexities of transition assets remains a tricky balancing act.
“An uncertain macroeconomic backdrop has created short-term challenges for transitions assets,” shared Luke Layfield, head of portfolio management, private markets at Aviva Investors.
Transition assets—investments that support the shift from carbon-intensive to greener, more sustainable economies—offer significant potential.
"High inflation has rendered redevelopment projects more expensive, and elevated interest rates have put pressure on borrowers, leading to a sharp repricing of real estate in some markets,” Layfield told AsianInvestor.
A World Economic Forum study supports this observation. Oil and gas as well as metals and mining companies are less exposed to higher rates than renewable energy.
Source: World Economic Forum Paper of June 2024
The financial headwinds are compounded by regulatory challenges, which make it difficult for investors to move beyond traditional asset classes. In many cases, decarbonisation opportunities, such as projects in emerging markets, are difficult to access due to risk premiums and the associated higher regulatory capital requirements, according to Tatjana Greil-Castro, portfolio manager at Muzinich & Co
"The biggest impact would come from funding the transition in emerging markets, where future emissions will predominantly come from. But regulatory issues make it hard for asset owners to go there," she told AsianInvestor.
“These markets typically carry lower credit ratings, which makes them challenging for institutional investors,” she added.
This creates a problem for institutional investors who are keen to contribute to global decarbonisation but are restrained by a need to balance returns with risk.
According to Greil-Castro, one way to navigate this challenge is by structuring investments to reduce risk, for example, by using junior capital to de-risk assets. However, even such solutions can be complicated by securitisation rules, adding another layer of complexity.
LACK OF CLARITY
David Smith, senior investment director of Asian equities at abrdn, said the lack of standardisation around transition assets is a key issue.
“There’s a growing recognition that transition assets are not only important from a social and environmental perspective but also potentially interesting from a return perspective,” he told AsianInvestor.
“What holds many back is a lack of common understanding of what ‘transition’ means and a framework to inform both investment and engagement activities,” he added.
He noted that frameworks like the newly released Singapore Taxonomy—which provides clear guidelines on how to evaluate transition assets—are a positive step toward addressing these challenges.
“As the Taxonomy, and other similar frameworks, gain traction, we’ll likely see more focus on transition from both asset owners and managers,” he said.
Aviva Investors’s Layfield echoed these concerns, particularly around measuring outcomes.
“When it comes to measurable outcomes at Aviva Investors, all assets have their carbon emissions estimated in line with 'whole-life' carbon accounting, which models emissions for construction, operation and end-of-life. This is important, as focusing solely on operational emissions can have unintended consequences.,” he said.
For instance, while a wind farm contributes to avoiding emissions during its operational life, the activity of manufacturing, transporting, and installing the turbines generates carbon emissions due to the involvement of industries that have not yet been decarbonised, he noted.
"This holistic approach enables us to incorporate such nuances into our decisions," he said.
Further complicating the landscape is the inconsistency of carbon pricing across regions, which makes it difficult for asset owners to accurately assess the costs of investing in decarbonisation.
According to a World Bank report in 2023, only about 24% of global greenhouse gas emissions were covered by carbon pricing mechanisms, leading to significant variations in costs for investors depending on the region.
Source: World Bank
CLOSING THE GAP
The road to integrating transition assets into portfolios may be long, but solutions are emerging.
Muzinich’s Greil-Castro emphasised the importance of building strong partnerships.
“You need a community of diverse partners who have the expertise and resources across different regions to source and originate opportunities,” she said.
“It’s not just about renewable energy or clean transportation. Transition includes greening cities, making real estate more carbon-efficient, and even nature-based solutions like mangrove restoration to protect against floods,” she added.
This article has been updated with revised quotes on Aviva Investors's carbon accounting approach.