Carbon risks reduced by good stock selection

Asset managers can dramatically reduce the carbon footprints of their funds through stock selection without the need to alter sector weightings or their overall investment strategy, according to a report by Mercer and Trucost for the WWF, that also found asset owners could encourage the active management of carbon risk in portfolios.

The report, Carbon Risks in UK Equity Funds, highlighted some of the actions asset owners could take, such as incorporating climate change criteria into their investment policies, looking for new investment opportunities and supporting mandatory emission disclosure initiatives.

The report outlines the results of Mercer and Trucost’s analysis of the greenhouse gas emissions of 118 UK-based equity funds with £206 billion (US$331 billion) in assets under management, exposing a seven-fold difference in the carbon footprints of institutional equity portfolios in the UK.

It found that greenhouse gas emissions from these portfolios range from 209 to 1,487 tonnes per million pounds invested. A wide variation of carbon exposure was identified between companies in the same carbon-intensive sectors such as utilities, basic resources, construction and materials, oil and gas, and food and beverage.

The report also found that asset managers could engage with portfolio companies and support government introduction of mandatory reporting requirements for corporate greenhouse gas emissions that would make carbon management easier and more effective.

Chief executive of Trucost, an independent environmental research organisation, Simon Thomas, said the potential exposure of earnings to carbon costs across investment portfolios could have a knock-on effect on pension fund returns.

And according to Danyelle Guyatt, principal in the responsible investment group at Mercer, climate change presents new challenges and opportunities for institutional investors, not only in terms of the possible physical impact over the very long-term but, more immediately, through the dramatic changes that are unfolding in government policies and regulations around the world.

“The results of our research with WWF and Trucost indicate that the investment management industry has a long way to go before pension funds can feel reassured that sufficient attention is being paid to the investment implications of the shift to a low carbon economy,” she said. “It is important for pension funds to be aware of these potential risks and opportunities, and to manage these proactively through their strategic asset allocation decisions and the way they review and select fund managers.”

The research found climate change to be of little importance in fund managers’ investment decisions. The main reason cited was a lack of confidence in government polices to address greenhouse gas emissions – despite emerging greenhouse gas regulations in major economies such as Europe and the US. Short-term pressures to generate returns and a lack of standardised costing and reporting frameworks for company emissions were also reasons why managers do not actively consider greenhouse gas emissions as part of their investment processes.

However, the report outlines how fund manager complacency on corporate carbon performance could put pension fund assets at risk as carbon-intensive companies face rising carbon costs and their company valuations fall in the short-term in anticipation of future carbon risk. It also highlights the potential to use existing available
GHG data in financial analysis and decision-making.