Will 1.5° Die in Dubai?

Recently, a panel of Morningstar experts* answered questions from the UK financial media at an event in London. The topic was the COP28 conference in Dubai.

Here are the five key themes that emerged.

Degrees Matter

Delegates will be focused on whether the 1.5 °C global warming target, agreed in Paris at COP21 in 2015, is still feasible. As such, a global "stocktake" of carbon emissions will be revealed at the summit, and there's growing consensus that the "world is losing the race" to meet the target, says Hortense Bioy, Morningstar's global director of sustainability Research.

She says there's a chance that 1.5 °C may "die in the desert in Dubai", having been kept alive at COP26 and put on life support at COP27 in Egypt last year. Indeed, Morningstar data shows 87% of companies are heading towards a global temperature rise of 2.1%. So delegates and the world's media will be focused on the overshoot.

That said, there's also a danger the focus will be too narrow, argues Anya Solovieva, global head of climate solutions, Morningstar Sustainalytics. OECD countries are already aligned on net zero targets, she argues, so arguing over 1.5° or 1.6° seems rather reductive.

The Perils of Pessimism

The tone has already been set, then. But Bioy also argues against undue pessimism: "it is important we do not succumb to doomism. Doomism leads to disengagement, which only favours bad actors who favour a business-as-usual approach," she says.

If the world is off course in terms of targets, surely it's time to relax them and adjust the Paris target to something more realistic? Bioy says this could be counterproductive in terms of the knock-on effects on existing and future investment plans. Complacency is the enemy.

"Shifting the goalpost could cause the private sector to delay necessary investments to decarbonise their businesses faster," she argues. And that includes technological developments such as carbon capture, storage and direct air capture (DAC), which involves CO2 being removed from the atmosphere. Even the fossil fuel sector is demanding more investment to manage the transition.

Companies still have time to invest in low-carbon technology, she argues.

Let's Talk Business

Recent COP summits have repeatedly highlighted the importance of business and finance in meeting net zero. The conversation has already shifted towards how finance can lead climate change mitigation and adaptation, says Lindsey Stewart, Morningstar's director of investment stewardship research.

With climate change already with us in the form of extreme heat in 2022 and 2023, the focus is now on what we can do to adapt to the current situation.

"Adaptation will be a key watchword at COP28 and investors have a role to play," he says. But he argues finance, policymakers and government now need to focus on delivering on promises already made.

For the finance community, targets are important as well as pinning down what investors are expecting from the process, Stewart says. For Morningstar Sustainalytics' Solovieva this is an urgent conversation investors are having today – it’s no longer enough to know a climate change target is in place.

"[Investors need to know] what are the actions that companies are taking today to given them confidence the company is on track to meet their future commitments," she says.

Climate risk exposure is a key part of that conversation, she says, and one that will reverberate after the conference has closed.

Practical Matters, Passive Products

ESG issues are already a material part of the investment process, says Rob Edwards, director of product management, Morningstar Indexes. That was a key finding of a recent asset owners survey conducted by Morningstar. And it's also where indices and benchmarks can be useful in ascertaining whether companies are off target. Forward-looking climate metrics are important because much of the science behind climate change measurement is backward-looking, he adds.

At COP28 he expects a renewed focus on passive investment's role in financing the push to net zero. That will tilt the debate once more towards issues like biodiversity and water risks. Products are evolving quickly as the regulatory burden increases, he adds.

Investors Get Wise

Speaking of sustainable funds and stocks, both enjoyed a boom in the pandemic era. But sustainable investing is not a simple case of jumping on a moving train and hoping it's heading in the right direction – as we saw with last year's ESG performance figures.

Part of this is down to uncertainty about what the future will look like, how bad the effects of climate change will be and how effective our attempts to mitigate them might be. So scenario planning remains important for equity and bond investors, says Nicolo Bragazza, portfolio manager, Morningstar Investment Management Europe.

"We don't know exactly what the future will look like," he says. So the path to net zero presents opportunities and challenges to investors. Alternative energy stocks have underperformed since the Paris Agreement in 2015, he notes, which is counterintuitive considering the global push to tackle climate change.

"Growth opportunities don't always translate to investment opportunities," he says. Investors need to focus on traditional finance metrics like valuations and not overpaying for assets.

"They also need to think about the overall robustness of their portfolios, balancing investment and climate risk considerations based on clients' objectives," he notes.

Another factor is that investors have become more realistic about the hit to gross domestic product from tackling climate change. "The path to net zero is going to be very expensive," he says.

As we saw with last year's event, with war in Europe, sustainable investing is not immune to global events. Bioy agrees, saying the Ukraine war exposed many of the contradictions in the ESG movement, some of which will be played out at this COP conference once more.

The "S" of the ESG could now be considered as "security", she says. As geopolitics comes to the fore once more, its role as a help or hindrance is yet to be determined.

* Our panel included:

Hortense Bioy, Global Director of Sustainability Research, Morningstar

Rob Edwards, Director of Product Management, Morningstar Indexes 

Lindsey Stewart, Director, Investment Stewardship Research, Morningstar

Anya Solovieva, Global Head of Climate Solutions, Morningstar Sustainalytics

Nicolo Bragazza, Portfolio Manager, Morningstar Investment Management Europe