Up in Smoke

As countries around the world roll out climate change mitigation policies, carbon divestment moves from moral high ground to financial imperative.

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Based on research by Mats Andersson, Patrick Bolton, and Frederic Samama
James Steinberg

Carbon emissions, long seen as a risk to the global ecosystem, may be a ticking time bomb for another group entirely: passive index investors, including pension funds, major institutions, and even individuals saving for retirement.

For these investors, index funds’ long reliance on the steady growth and high returns of carbon-intensive energy companies could soon become a financial liability as new emissions taxes and trading schemes eat away at fossil fuel companies’ bottom lines. A new investment strategy outlined by Patrick Bolton, however, offers investors an opportunity to hedge this risk, lowering their exposure to carbon by more than 50 percent while earning the same returns.

The carbon divestment movement, as the global effort to induce investors to wind down their stakes in fossil fuels has become known, has, until recently, largely been confined to college campuses where it has been driven by a strong moral agenda. “Up to this point,” Bolton says, “the divestment movement has been motivated by a desire to be a good citizen.”

While this strategy has had some initial success—Arabella Advisors, a philanthropic giving advisory, estimated in September that nearly $50 billion in assets had been divested from fossil fuels through commitments by individuals, governments, and institutions—many investors have been loath to wade into such a politically charged debate. “The pushback you hear from investors is ‘we have fiduciary responsibilities to our own clients and we can’t impose financial losses on them in order to be socially responsible,’” Bolton says. “But climate change isn’t just risky for society; it’s bad for investors, too.”

As governments around the world move towards climate change mitigation policies, large holdings in fossil fuel companies begin to look like liabilities. Recognizing this mounting threat to investors, Bolton and co-researchers Mats Andersson of the Swedish pension fund AP4, and Frédéric Samama of Amundi, the largest European asset management firm, approached index provider MSCI to develop a family of new indices composed of fewer carbon-intensive stocks. Launched this past September, the MSCI Global Low Carbon Leaders offer passive investors a substantial reduction in their carbon exposure while replicating the returns of their reference indices, hedging the risk of future regulation at no cost while setting the stage for higher future returns.

Globally, the threat of carbon taxation and emissions trading schemes (ets), like cap-and-trade, isn’t as far off as it might seem in the United States. The World Bank reported this summer that some 40 countries and more than 20 cities, states, and provinces accounting for 22 percent of global greenhouse gas emissions have already either implemented carbon pricing mechanisms or are planning to. This includes the world’s largest emitter of greenhouse gases, China, which is presently piloting a regional ets in preparation for a nation-wide rollout in 2018. In January, Ontario’s liberal government announced plans to implement a climate change mitigation policy, which would bring 80 percent of the Canadian economy under some form of carbon tax despite the central government’s refusal to pursue either a carbon tax or an ets.

Fossil fuel companies and other carbon-intensive industries, from air travel to IT, are taking note. ExxonMobil, which has long used shadow carbon pricing in its long-term financial planning, estimated this year that carbon taxes in the Organization for Economic Cooperation and Development (oecd) would reach $60 per metric ton by 2030 and $80 by 2040. These taxes could leave substantial proven reserves, like the Alberta Tar Sands, stranded—the cost of bringing them to market outstripping the price they could fetch there.

Numbers like these could mean a dramatic turnaround as fossil fuel companies cease to look like such attractive investments and low-carbon funds like those developed by Bolton’s team start to outstrip their benchmarks. While uniform carbon pricing is likely still years in the offing, Bolton urges investors to move towards lower carbon investments today. “We now know enough to act. We have the market testing, we have scalable solutions, and we have the investment capabilities. Delaying portfolio decarbonization would be costly for investors and society.”

About the researcher

Patrick Bolton

Patrick Bolton is the David Zalaznick Professor of Business. He joined Columbia Business School in July 2005. He received his PhD from the London School...

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