Investors are increasing allocations to public equity markets dominated by resource and carbon-intensive companies in developing countries, many of which plan to limit rising greenhouse gas (GHG) emissions. Emerging market countries including Brazil, South Africa, India and China, have set targets to reduce GHG emissions by 2020 under the Copenhagen Accord. A legally binding climate change agreement, to be discussed at the UN climate change conference in Cancun this month, could cover more than 80% of global GHG emissions.
The study shows that almost 80% of GHGs from companies in emerging market benchmark portfolios are emitted through their operations, which are likely to be subject to policy measures such as performance standards and carbon taxes. Abatement costs to reduce just 4% of projected emissions could equate to more than 5% of earnings for 24 emerging market companies in the Utilities, Resource, Oil & Gas, Construction and Travel sectors in 2013. Investors overweight in heavily carbon-intensive companies could see their returns fall relative to benchmarks.
Working with the International Finance Corporation, Trucost and Standard and Poor's (S&P) developed a carbon efficient index to provide emerging markets investors with a benchmark to reduce this risk. Findings show that equity funds that overweight carbon-efficient companies using an S&P/IFCI Carbon Efficient Index as a benchmark could reduce exposure to carbon emissions in emerging markets by 22%. The Index closely matches the financial performance of the underlying S&P/IFCI LargeMidCap Index, with an annualised tracking error on the upside of 1.41%. Large institutional investors can therefore reduce exposure to carbon costs in emerging markets while replicating the return profile of the underlying index.