How can we reduce the carbon footprint of portfolios? Over the last year, this issue has been gaining momentum in the international financial community, particularly through initiatives such as the Montréal Carbon Pledge, which BNP Paribas Asset Management signed in May 2015.
In France, institutional investors are particularly focused on this subject, notably due to article 173 of France’s law for energy transition and green growth (passed in July 2015), which requires French institutional investors to measure their carbon footprint and report on their integration of environmental and social criteria.
With the COP21 just around the corner – the 2015 Paris Climate Conference to be held in Paris this December, French finance houses are currently competing to position themselves ahead of the pack on this topic. THEAM has been interested in the subject since 2008 when we launched a ‘low carbon’ European equity ETF (replicating the index Euronext Low Carbon 100 Europe). How does it work? Starting with Europe’s biggest 600 companies by capitalisation, a classic filtering is applied, based on market criteria, to eliminate companies whose free float is insufficient to meet liquidity constraints. The companies retained within each sector are those whose carbon emissions are the lowest according to the data published by specialised agencies. The index is constructed to keep a sectoral distribution similar to that of the reference universe. The idea is to retain only a hundred equities in the portfolio, which are subject to an annual review under the responsibility of an independent, multi-scientific committee of NGOs, academics, environmental experts, chaired by Pascal Canfin.
The value of this solution for institutional investors is twofold. Firstly, it is a simple tool to set up and use. Secondly, the strategy will allow a substantial reduction of the portfolio’s carbon footprint while maintaining a sectorial diversification that is similar to that of the major European indices. This is an important point because this approach avoids replacing carbon risk with another type of risk that could occur via too large a tracking error.
At a time when the need for a structural change in energy systems is increasingly apparent, investors are quickly realising that too much of a carbon footprint carries regulatory or legal risk that may affect the most carbon-intensive companies. While most of the risk has not yet materialised, THEAM’s ‘low carbon’ strategy already shows a cumulative outperformance of 13.08% for the period from 05/10/2010 until 05/10/2015, versus the Stoxx 600 distribution.