De-carbonise your investment

In the 1980s, environmental concerns gained more attention as global warming became a greater focus. This was amplified by environmental concerns such as the deterioration of the ozone layer and disasters such as the Exxon Valdez oil spill in Alaska which was, at the time, the worst human-caused environmental disaster on record.

In response many companies started to promote their commitment to the environment. Oil company Chevron, for example, launched its award winning “People Do” advertising campaign which showcased Chevron protecting wildlife. Unknown to the public, many of the environmental programs that Chevron promoted in its campaign were mandated by law. While running the ads, Chevron was found guilty of spilling oil into wildlife refuges.

At the same time, DuPont which was the world’s largest producer of o-zone destroying chlorofluorocarbons, or CFCs, ran ads in which marine life applauded to the sound of Beethoven’s Ode to Joy.

Greenwashing was the phrase environmentalists used to describe these ads. The phrase encapsulated the environmental corporate messaging which promoted one thing, while the company did another.

The term greenwashing is coming to the fore again. Now it’s being applied in the world of investing. There are many funds which claim to be environmentally conscious, but the label doesn’t match the reality.

Since the 1980s, environmental standards and investors’ expectations have changed.

Consideration of the kinds of risks associated with a company’s business activities, including environmental considerations, have become part of both the quantitative and the qualitative investment processes of professional fund managers. This has been led by clients and institutions.

In the early part of this century Norway Government Pension and the US’s largest pension fund CalPERS committed to 100% integration of sustainability.

In 2006 the United Nations launched the Principles for Responsible Investment (PRI) initiative. The Principles were developed by investors, for investors, to contribute to developing a more sustainable global financial system. The PRI now has more than 3,000 signatories, including VanEck, from over 50 countries, representing approximately US$100 trillion, a majority of the world’s professionally managed investments.¹

Sustainable investing has evolved as an approach to investing that seeks to identify and remove risks inherent in poor environmental, social and governance (ESG) practices, and that drives positive social and/or environmental impacts alongside long-term financial results. It has also been aided by government and financial reporting standards initiatives.

In some jurisdictions it is the local exchange that makes it compulsory for publically traded companies to report on their carbon emissions. ASIC has recently provided guidance that highlights climate change as a systemic risk that could impact an entity’s financial prospects for future years and that may need to be disclosed in financial reports.²

It is just a matter of time before financial reporting incorporating the impact of climate change risk on balance sheet items such as asset valuation, impairments and provisions is mandated globally.

One way companies report their environmental impact is their carbon dioxide emissions, usually reported in tons of CO₂. With this, investors now have a metric with which to calculate carbon intensity (tons of CO₂/ million $ of sales).

Other ways investors can assess a portfolio is to measure the amount of ‘green’ revenue generated by an alternate energy (such as solar) versus ‘brown’ revenue which is derived from activities related to assets such as thermal coal which in addition to generating revenue, also generate harmful carbon emissions.

But how environmental concerns are considered presents a challenge for your fund manager. And how successful a fund manager is at considering those challenges is something you should assess. There is a solution.

How fund managers incorporate environmental factors in portfolios

There are two ways to incorporate environmental factors in portfolios. The first involves ‘negative screens’ by excluding those investments in companies involved in such business activities as fossil fuels or nuclear energy.

These screens are quantitative. It is relatively easy to identify whether a company is involved in these activities from publically available data such as annual reports. Companies owning or deriving income from these sources can be excluded from a portfolio. There are many portfolios that only exclude companies because of such activities.

ESG investing has to go further than just negative screens. A second approach considering environmental factors as a part of a thorough ESG evaluation, which goes beyond quantitative data and includes qualitative analysis.

Many active fund managers incorporate this type of ESG scrutiny into their risk analysis. However, the challenge for many investors has been combining the inclusion of environmental leaders in their portfolio by identifying those companies that demonstrate a commitment to the environment. This can be done by targeting the ESG leaders in each industry.

It is also possible to target climate change leaders by identifying those companies that are the lowest carbon emitters.  

Many managed investments do only one or two of these. It has been particularly hard for passive managers, who track indices, to include effective qualitative environmental research.

How investors can identify funds that are ‘greenwashing’

Investors are now able to assess the environmental, social and governance metrics for all funds. MSCI recently launched a fund comparison tool which can be found here - ESG fund ratings

MSCI’s tool aggregates all of the holdings in a fund to give the fund an overall ESG rating. It also includes data on the weighted average carbon sales and ‘green’ vs ‘brown’ revenue. Now investors can verify for themselves if their fund manager is truly green or if they are just ‘greenwashing.’

Additionally your ESG fund should be transparent and report the CO₂ emissions of its portfolio.

• For ESGI, it is available here - ESGI ESG and Carbon metrics
• For GRNV, it is available here - GRNV ESG and Carbon metrics

If your ESG manager is not providing this, you need to ask why.