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Low-carbon investing in vogue after Paris climate talks
INSTITUTIONAL interest in low-carbon investing has been growing since the Paris climate change agreement last year. And while Western investors have taken the lead in this so far, it is only a matter of time before this takes off in Asia as well, said a fund manager.
At the heart of the low-carbon investment strategy is the idea that climate change is a risk that global investors face across multiple sectors, said Frederic Samama, deputy global head of institutional and sovereign clients at Amundi Asset Management.
"Now people, especially long-term investors, are recognising that climate change is a financial risk," he told The Business Times in an interview. "There is a clear understanding that there is a market failure, and that markets are short term-oriented."
"If you invest for the next five, 10 or 15 years, then can you make the bet that polluting companies can never be penalised? (The impact) can be 15, 30, 50 per cent, but if it is priced at zero it means you have mispriced risks in your portfolio," he said.
This extends to companies outside the oil and gas and power generation companies, as others such as aviation and shipping could also be affected by tougher laws to control carbon emissions, for instance, by requiring firms to pay for emissions allowances or carbon taxes.
The risk approach represents a "total shift" in how investment managers think about climate change, Mr Samama said. "We don't talk anymore about trying to invest in wind, solar, etc. People are saying that maybe in my portfolio I have companies that might suffer."
Low-carbon indexes have proliferated in recent years to help manage these risks.
Amundi, for instance, worked with index provider MSCI to launch a Low Carbon Leaders Index series in May last year. Although aimed at a longer time horizon, the low-carbon indices have slightly outperformed their respective benchmarks so far, said Mr Samama.
Rival asset manager Blackrock has similarly partnered index provider Stoxx to create an index suite of four low-carbon indices in February this year.
Many of these indices are built in a similar fashion. They do not deviate much from main benchmarks, carrying similar weighting of sectors and geographies so as to minimise tracking error, but at the same time have lower or zero exposure to companies with high emissions.
"So you can switch to the low carbon version, and for years it would track the parent index until polluting companies are getting penalised, which would bring the parent index down. If you have excluded some of these stocks, you would outperform," explained Mr Samama.
The chances of this happening are highly contingent on the bet that governments will introduce carbon pricing, he conceded.
But with minimal tracking error, investing in the low-carbon index is a "free option", he said. "You don't know how big (the climate change risk) is, but the cost is almost zero."
In his view, the reason why investors have not been involved in the fight against climate change in the past 20 years, leaving it to only governments and non-governmental groups, is three-fold.
For one thing, climate change is an issue that goes beyond standard investment horizons. Secondly, renewable energy represents a complex market, and thirdly, there was a lack of scalable investment solutions.
Low-carbon indices therefore represent a "game-changer" for investors, said Mr Samama. "Suddenly investors have a very easy-to-implement solution to start their journey in terms of tackling climate change."
Already, there has been a noticeable shift among some of the largest investors in the world, especially after the success of the COP21 talks in Paris last year showed a certain political resolve across the world to tackling climate change.
Norway's sovereign wealth fund - the largest in the world at US$890 billion - in April pulled money out of 52 companies that it deemed too reliant on coal. Sweden's AP4, which has 312 billion kronor (S$48.9 billion) of assets under management, has invested nearly a quarter of its US$15 billion placed in equity in low-carbon strategies.
In the US, the California State Teachers' Retirement System (Calstrs) - the second largest pension plan in the country - last month committed to invest US$2.5 billion to a low-carbon index strategy (MSCI ACWI Low Carbon Target index), with plans to invest larger amounts in future if the strategy works. Its chief investment officer said this was in response to an expected impact that climate change will make on the market.
All in, some 120 investors with US$10 trillion in assets have committed to the Montreal Pledge - which requires signatories to measure and publicly disclose the carbon footprint of their investment portfolios every year - in the past two years, according to environmental consultancy Trucost. Among them, 25 investors have committed to significantly reducing carbon emissions associated with US$600 billion of assets under the Portfolio Decarbonisation Coalition.
Said Mr Samama: "That's the wake-up call we are observing among asset owners." Amundi is also now in talks with certain investors in Asia, he told BT.
Adding to the pressure for investors to de-carbonise their portfolios is the growing likelihood that governments will adopt policies to encourage greener practices. He pointed to France, which has made it mandatory for asset owners such as pension funds and insurance companies to disclose their carbon footprint.
This will spark off similar actions by other governments around the world, helping to generate a greater amount of carbon-related disclosures which in turn produces data necessary for low-carbon indices to grow even further.
Concurring, EY Asia Pacific oil and gas leader Sanjeev Gupta sees the Paris agreement providing some clarity for businesses about the direction governments are likely to move in.
"It will likely accelerate the transition to a lower carbon future," he said. "The dilemma is how to balance this with the desire for cheaper and more secure energy. Much will depend on the policy options governments adopt to meet their national commitments under COP21."
For Mr Samama, low-carbon investing is also distinct from ESG (environmental, social and governance) investing, a metric frequently used to measure the sustainability and ethical impact of a business.
"It's not so clear if (ESG investing) is about doing good or if it's about returns," he said, adding that ESG factors such as having female representation on a board can differ based on geographical and cultural context. Climate change, in comparison, "is all about risk management".
Agreeing with the need to distinguish low-carbon investing from ESG, Jean-Pierre Clamadieu, CEO of French chemicals multinational firm Solvay, said that sustainability itself has very broad parameters.
The concept of low-carbon investing helps to simplify some of the metrics, which will be welcomed by companies like Solvay and also by investors, he told BT. "It makes the discussion easier."