Head of ESG Research, AMP Capital
The Paris Climate Change Agreement reached in December 2015 was a significant global step towards addressing climate change. The agreement reinforced the commitment by countries to limit global warming to less than 2 degrees Celsius and confirmed that global warming needs to halt at 1.5 degrees Celsius if the world is to significantly reduce the impact of climate change.
A global commitment to manage climate change also means a great deal of change for investors who must quickly get to grips with assessing, communicating and managing climate change risk in their equity portfolios in a meaningful way.
There are three main climate change risks that manifest themselves in equity and corporate bond portfolios:
- The impact on company valuations as a result of policies to reduce the greenhouse gas emissions of companies and their value chains.
- The impact on company valuations of fossil-fuel producers and distributors as a result of policies to reduce greenhouse gas emissions.
- The impact on company valuations from the physical impacts of climate change.
In addition, investors need to understand the macro-economic impacts of an economy in transition to a lower carbon regime.
AMP Capital’s risk assessment
AMP Capital has undertaken an analysis of the potential exposure to greenhouse gas emissions by investing in some of the commonly used equity markets. We believe it makes sense to consider emissions in the context of a company’s market capitalisation rather than a company’s revenue and, as a result, we express a company’s emissions intensity as tonnes of CO2-e per year per $1 million (CO2-e/$m) of company market capitalisation.
AMP Capital has undertaken an analysis of the potential exposure to greenhouse gas emissions by investing in some of the commonly used equity markets.
In March 2016, the exposure for investors in the MSCI World index was 134 tonnes CO2-e/$m capitalisation, as measured on an equity share of emissions basis, with four sectors – materials, utilities, energy and transport -- accounting for the vast bulk of the index’s exposure.
At the same time the exposure for investors in ASX200 index was 130 tonnes CO2-e/$m capitalisation by the same measure, again with most of the exposure the result of four sectors – materials, utilities, energy and transport.
A recent analysis of the MSCI Emerging markets index estimated the exposure to this index to be much higher at 373 tonnes CO2-e/$m capitalisation.
At the same time the exposure for investors in ASX200 index was 130 tonnes CO2-e/$m capitalisation by the same measure, again with most of the exposure the result of four sectors.
Where to next?
When it comes to investment risk, the assessment of the greenhouse gas exposure is one useful way of communicating climate change exposure to members. However, it does not address the following two questions:
- What is the investment risk?
- What, if anything, should investors do about the risk?
To understand the investment risk, investors need to understand the impact these emissions may have on company value. One approach is to put a monetary value on each tonne of CO2-e, akin to assuming emissions are taxed, or assigned a value via an emissions trading scheme. An investor also needs to assess the profile of greenhouse gas emissions in the future, which is implied by the company valuation.
Interestingly, just five companies comprise more than 50 per cent of the greenhouse gas exposure in the ASX200 on an equity share of emissions basis; so the divestment of only a few companies would reduce the greenhouse gas exposure of a diversified portfolio significantly. This divestment approach has been advocated by some investors such as Portfolio Decarbonisation Coalition (www.unepfi.org/pdc).
Other investors have taken a different approach and recognised that investing in ASX200 companies necessarily sees that investment exposed to the Australian economy so the risk needs to be managed by the decarbonisation of the national economy. These investors engage in policy debates with the companies they invest in to support the significant reduction of carbon emissions in the Australian economy.
These two approaches are not mutually exclusive and many institutional investors, such as AMP Capital, undertake both approaches to manage this aspect of climate change risk. Many institutional investors also offer funds that have divested from some greenhouse gas-emitting companies or fossil fuel companies to reflect the desires of their members.
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Dr Ian Woods is the Head of ESG Research. He joined AMP Capital in December 2000, and since that time has focussed on how the issues of sustainability and ESG relate to financial investment and the investment risks.
Important note: While every care has been taken in the preparation of this article, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) makes no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This article has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this article, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This article is solely for the use of the party to whom it is provided.