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Transition investing is tipped to form the next generation of ESG investing, according to a new analysis from Berenberg Bank.

2024 could see a tranche of new companies viewed more favourably under ESG standards, as the UK will soon update its Sustainable Disclosure Requirements (SDR).

The changes are expected to be released before the end of the year, and Berenberg looks for them to provide the next generation of ESG fund labels, including transition and enabler categories.

"We believe that this could allow for the inclusion into UK ESG funds of higher carbon footprint stocks that are steadily decarbonising or are providing decarbonisation products," says Lauma Kalns-Timans, an analyst at Berenberg.

Until now, these types of stocks have been difficult for ESG investors to justify including in their portfolios. Typically, companies with a low score on any ESG factor are sold or need a documented justification from the portfolio manager of ESG investment trusts.

However, impending changes mean previously excluded companies can now find favour as transition investing looks to be a significant trend for 2024, according to Kalns-Timans.

"If, historically, sustainable investing was simply negative, exclusionary-based screening. Now, much of the sustainable investment community invests through best-in-class screening, sustainability themes or stocks that have a large impact on defined goals. We expect a new type of investing to gain greater acceptance in ESG in 2024: transition investing," she explains.

Transition investing will mean funds can hold and engage with companies that have a credible decarbonisation path and are following it.

Berenberg eyes three potential names that would fit the bill of the new regime:

DCC: This company is a fuel provider for off-grid customers that aims to transition itself lower carbon energy solutions. Year to date, nearly 50% of its acquisitions by value have been related to low-carbon energy management services.

Rotork: A methane leak fixer is one of Berenberg's "controversial ESG top picks" with 44% of its FY22 revenue earned from the upstream oil and gas sector, where it provides electric actuators to cut methane that is leaking from existing gas pipelines.

But 40% of human-linked methane emissions come from the oil and gas sector and the International Energy Agency (IEA) estimates that 75% of emissions could be cut by using existing technology.

"Greater demand for these electric actuators is expected as the US Inflation Reduction Act will start to impose fines of $900/tonne of methane leaked from 2024," explains Kalns-Timans.

SSE: Having set reasonable decarbonisation targets and appearing to be on track to meet those, SSE recently increased its five-year clean energy and network investment targets.

Berenberg forecasts that SSE’s share of low carbon capacity will grow by 25ppt – from 36% in FY22/23A, to 61% by FY27/28.