Low carbon portfolios don’t have to mean low returns

Samama, Frederic_700x450Savers are increasingly aware of the economic risk of climate change and the direct threat to their investment returns. A growing number of institutional investors are taking climate change seriously and examining the impact it may have on their port-folios. The State of California has even legislated the big state pension schemes to divest from some carbon-intensive industries.

The bald fact is that climate change-related risks are not priced into asset prices in the same way as the financial crisis, unemployment, data fraud or cyber-attacks. Valuations must be adjusted accordingly. All investors have a duty to maximise returns and this leads many to reallocate capital away from carbon-intensive companies: companies that either pollute or that are exposed to so-called “stranded assets”, including carbon
reserves such as coal and oil that they will never be able to bring to market and sell.

Decarbonising funds are building track records that hedge the risk of future regulation, which will be borne by carbon industries, at no cost, while paving the way for higher returns. In the unlikely event there turns out not to be any climate change impact, investment performance should match the benchmark. If climate change does take effect, the investment strategy can be expected to outperform.

“Decarbonising funds are building track records that hedge against future regulation”

The big question is how to go about low carbon investing?  Some investors simply “decarbonise” their holdings and will end up holding no carbon-intensive companies. The Church of England has chosen this route for its £9bn fund by excluding all coal and tar sand companies. But that investor no longer has any influence on how those companies behave.

Another approach has been adopted by index providers such as MSCI, which launched its Low Carbon Leaders indexes. The indexes’ methodology aims to achieve at least a 50 per cent reduction in the level of carbon emissions from the companies and assets making up the index, taking into account present emissions and reserves representing potential future emissions, compared to the parent indexes, the MSCI World and the MSCI Europe, while minimising the tracking error relative to them.

The indexes’ structure excludes one-fifth of stocks in the parent index universe, based on the weight of carbon emissions and measured by tons of CO2, of a company relative to market capitalisation. There is a maximum exclusion of 30 per cent for each sector market capitalisation. They also exclude the largest owners of carbon reserves per dollar of market capitalisation, representing at least 50 per cent of the reserves in the parent
index. The structure therefore rewards the least polluting companies in each sector and penalises, through exclusion, the most polluting companies.


For example, a heavy-polluting steelmaker that emits large amounts of CO2 compared with its competitors is more likely to be excluded than, say, a more energy efficient (compared with its competitors) cement maker. Likewise, large oil majors heavily valued on the basis of their energy reserves will have a reduced weighting in the indexes.

The 70 per cent floor for any sector means investors do not withdraw completely from that sector, they merely reduce their exposure to it, and particularly to the least efficient companies in each sector.

An approach that combines engagement and exclusion projects a clear message to companies to reduce their pollution and to diversify their business away from carbon reserves. It also gives them time to adopt these strategies. Institutions that are concerned about climate change manage or represent $92trn, more than five times the entire GDP of the US.

If those investors decided to decarbonise just 0.05 per cent of their port-folio, it would amount to reallocating nearly $50bn in capital from high polluting companies towards more carbon efficient companies.

Frederic Samama is deputy global head of institutional and sovereign clients at Amundi.