By Daniel Kern
“There’s one issue that will define the contours of this century more dramatically than any other, and that is the urgent and growing threat of a changing climate.”
— U.S. President Barack Obama, U.N. Climate Change Summit, September 23, 2014
Last December, 195 countries met in Paris to discuss climate change at the 21st Conference of the Parties of the United Nations Framework Convention on Climate Change (UNFCCC). The Paris Agreement commits to limiting global temperature rise to a maximum of 2 degrees Celsius above pre-industrial levels, while setting an aspirational goal of 1.5 degrees Celsius. Under the agreement, governments targeted replacing fossil fuels almost entirely with clean energy in the second half of this century.
Thirty-four countries representing 49 percent of greenhouse gas emissions formally joined the agreement, or committed to joining the agreement as early as possible, at a high-profile April signing ceremony at the United Nations. The climate agreement becomes “operational” when formal approval is received from at least 55 countries accounting for 55 percent of global emissions. The White House said countries accounting for about half of the world’s greenhouse gas emissions would join the Paris climate agreement this year, bringing the agreement close to the finish line.
Low-carbon investment strategies attempt to minimize the overall carbon footprint of the companies owned in the portfolio. Several first-generation low carbon products are diversified portfolios that attempt to track a broad-based index, while minimizing aggregate carbon emissions and fossil fuel reserves. A “low-carbon” ETF offered by a major ETF provider reports a 77 percent reduction in current carbon emissions and a 97 percent reduction in future carbon emissions relative to a broad-based index; a “sustainability” mutual fund offered by a major mutual fund company reports a 73.6 percent reduction in emissions and a 99.7 percent reduction in potential emissions.
Low-carbon investors evaluate the carbon footprint of both fossil producers and consumers of fossil fuels. A low-carbon portfolio may avoid or underweight significant fossil fuel consumers such as airlines; they include energy services companies that provide fossil fuel production, transportation and storage services but often have low emissions and reserves. Some low-carbon products include major energy companies such as ExxonMobil, but at lower position weights than in a broad-based index.
Fossil fuel free investment strategies approach climate change differently. Fossil fuel free products typically exclude companies that explore for, process, refine or distribute coal, oil or gas. Fossil fuel free products also typically avoid utilities companies that produce or transmit electricity derived from fossil fuels or transmit natural gas. Fossil fuel free products will completely avoid energy companies such as Exxon Mobil and Chevron, while also avoiding energy services “enablers” such as Schlumberger and Kinder Morgan. Fossil fuel free products focus on production rather than consumption, so airlines and other consumers of fossil fuels are included as potential investments.
Investors who have social preferences beyond climate change may consider other exclusionary factors. Some of today’s fossil fuel free strategies were originally socially responsible products that excluded investments in companies in the alcohol, tobacco, gambling, firearms, and nuclear power industries. Some first-generation low carbon products, which may not carry a socially responsible investment (SRI) heritage, include alcohol, tobacco and other companies typically excluded by SRI strategies.
Progress in the adoption and cost competitiveness of renewable power such as wind and solar has made clean energy a popular focus for climate-sensitive impact investors, and we’re also seeing growing interest in water-related investments. We recommend that impact investments supplement a well-diversified core investment portfolio, as investments in clean energy or water are often more volatile, less liquid, and reliant on technology innovation and a favorable policy environment.
Actively managed values-driven funds have had the same difficulty in beating passive benchmarks that their non-responsible investing peers have had. The high cost of many strategies may have some impact, serving to erode returns and reinforcing the frequently heard refrain that low cost, low turnover, disciplined strategies “win” in many asset classes.
Investors who have both climate change and financial objectives should:
Daniel Kern joined TFC Financial Management in 2015 and is responsible for overseeing TFC’s investment process, research activities and portfolio strategy. Prior to joining TFC, Dan was the president and chief investment officer at Advisor Partners, a boutique asset manager in the San Francisco area that manages equities and asset allocation products for advisors, financial institutions and family offices. Dan’s previous experience included a managing director/portfolio manager role at Charles Schwab Investment Management where he was head of asset allocation. Prior to Charles Schwab, Dan held a managing director/principal role at Montgomery Asset Management where he managed global and international equity portfolios. A CFA charterholder, Dan is a member of the CFA Institute and a Trustee for Green Century Funds. Dan is a graduate of Brandeis University with a Bachelor of Arts in Economics degree. He also holds a Master of Business Administration degree from the University of California, Berkeley - Haas School of Business.
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