What led to the emergence of low carbon and fossil-free indices? While climate change has long been on the world’s radar from an environmental point of view, now investors must consider its impact on their portfolios as well.
What led to the emergence of low carbon and fossil-free indices? While climate change has long been on the world’s radar from an environmental point of view, now investors must consider its impact on their portfolios. Some of the key financial risks associated with climate change are rising carbon prices and the potential for “stranded assets;” that is, the possibility that a proportion of existing fossil fuel reserves will never be utilized due to changes in regulation, demand, and technology. In response, investors are increasingly considering how to hedge their portfolios against the risks posed by climate change, as well as seeking positive investment opportunities aligned with anticipated shifts in energy use and technology.
Mercer’s recent study Investing in a Time of Climate Change highlighted that investors should consider the risks posed by climate change — in particular, policy risks. Following the positive outcomes of the recent meeting of global leaders in Paris, where a new global agreement to manage carbon emissions and tackle climate change was reached, we anticipate that the policy response to managing climate change will become more urgent in the coming years.
In a world where the cost of carbon is likely to rise, managing exposure to high-carbon companies is an intuitive step to take.
One approach investors can take is to reduce the carbon intensity of their portfolios over time, also known as “portfolio decarbonization.” The benefits of this approach include:
- Creates a portfolio that is less susceptible to increasing carbon pricing, stranded assets, and/ or related regulation.
- Supports the flow of capital to a resilient low-carbon economy and may help address the market mispricing of carbon.
- Produces a market signal that incentivizes companies to develop and invest in low-carbon and clean technologies, influences policymakers, and also helps to catalyze a new standard for other institutional investors.
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