There has long been a certain class of investor that has paid close attention to the risks posed to their investments by climate change but they have been very much in the minority and have had few tools to help them.
Help is now at hand. MSCI, the index provider, has launched a range of low-carbon indices, and other providers such as Standard & Poor’s are reporting increased interest in more established low-carbon products. Companies such as Amundi are creating investment products based on the indices.
This is a sign of things to come, says Jane Goodland, co-head of sustainable investment at Towers Watson. “Investors have been looking for some time for ways to express their views around climate change risks. Low-carbon indices provide investors with an efficient, low-cost and transparent way of doing so.”
One of the most emphatic signs of this came at the UN climate summit in New York in September, where investors representing more than $24tn in assets released a statement saying that “stronger political leadership and more ambitious policies are needed in order for us to scale up our investments”.
The signatories, who included some of the world’s biggest investors including BlackRock, Calpers, Calstrs, PGGM and Allianz, added that they would play their part and “identify and evaluate low carbon investment opportunities …consider investment vehicles that invest in low carbon assets …and develop our capacity to assess the risks and opportunities presented by climate change and climate policy to our investment portfolios, and integrate, where appropriate, this information into our investment decisions.”
These are not niche players, says Remy Briand, global head of index and ESG research at MSCI. “You can see that investors are getting serious about climate change and its impact on future capital flows.”
Indices will be crucial to this effort. For a long while, ESG (environmental, social and governance) investors did not have a benchmark, says Alka Banerjee, managing director of Global Equities at Standard & Poor’s, which launched a carbon-efficient US index as far back as 2009. “They hoped for higher returns but there was no guarantee that they would not lose money by making climate-friendly investments.”
S&P was ahead of its time in launching the index, Ms Banerjee says, because there was at the time still a lot of scepticism about climate change, which was not helped by the disastrous Copenhagen climate conference at the end of that the index’s launch year. “Now there is no controversy about climate change and people realise we have to do something about it.”
MSCI, too, was discussing low-carbon indices six years ago, says Mr Briand. What has changed, he says, is that “people recognise that the problem is a bit more immediate than they initially thought and the debate has focused a lot more on the idea of stranded assets such as coal or other fossil fuel reserves, or power stations owned by utilities. If these assets cannot be fully used, they will have to be written off, which we have seen happening in Europe with companies such as Eon and GDF Suez. These write-offs are happening now, not in 10 years’ time.”
The other reason for growing interest is that there have been advances in the indexing world, he says. “We have solutions that are more sophisticated. Innovation in creating factor indices has grown and we understand much more how to create indices that create a tilt towards the desired factor – in this case low carbon intensity – but manage other dimensions such as tracking error. Asset owners already have factor allocation to minimise issues such as volatility so there is a greater level of comfort.”
There are a number of variants of the low-carbon investing approach, from total exclusion of fossil fuels at one end to under- and overweighting of indices at the other, says Ms Goodland. “I am pleasantly surprised by the fact that there is a range of approaches to choose from. Investors have different needs, so we need all these different products.”
One of the benefits of indices is that they can be set up to provide market-like returns. “This means investors are getting market-like returns now but over the longer term, as climate policies start having a real impact, these indices are well-placed to provide outperformance relative to the benchmark. It’s good for investors because they don’t have to take much risk,” says Ms Goodland.
“Some investors are very much about divesting from fossil fuels while others want to build a portfolio that reflects the risks of increasing regulation of emissions. For some investors, it’s about making more money while some want to protect themselves from downside risks. However, many investors who start in the risk space quickly see there an upside potential.”
This is important, says Matthew Fitzmaurice, chief executive at EcoAlpha, because “to achieve the intended aims of low carbon indexing – using capital to combat climate change – the necessary action involves more than simply denying money to companies that are part of the problem. It requires allocating investment dollars to companies that are providing a solution.
“Compared with investing in solutions, low carbon indexing is a less effective tool to combat a very real problem. Threats such as climate change require action, not just reaction. Investors looking to move the needle on carbon are realising that to maximise impact, they must direct the power of their capital not just away from fossil fuels, but also towards the solutions.”
Get alerts on Passive Investing when a new story is published