How Investors Can Profit and Reduce Climate Risk

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We’ve really asked the question, you know, “What should investors do if they want to reduce their exposure to climate risk and carbon pricing risk?”

There are now relatively good measures of the carbon footprint of the companies that are in the S&P 500. So, you can apply a carbon footprint filter to those companies, and filter out the companies that are the worst performers in terms of carbon footprint. Let’s say that 10 or 20 percent worst performers. You take those out of the index, ok, and now you have a low-carbon index if you want, that has much less carbon exposure.

Now it’s not quite a simple divestment strategy, because first of all you filter out these companies while maintaining sector balance of the index, and second, you rebalance the portfolio of the remaining stocks with the goal of minimizing tracking error of the low-carbon index relative to the benchmark index. In other words, you can reproduce the same financial returns, you’ve designed the index so as to replicate the same financial returns as the benchmark index but with much less carbon exposure.