Key Findings

• Companies in the S&P/IFCI LargeMidCap Index emit 563 metric tonnes of GHGs, measured in carbon dioxide equivalent (CO2e), per US$ million of revenue on average. Emerging-market equity funds could be more exposed to rising carbon costs than portfolios benchmarked against developed market indices such as the S&P 500 and MSCI Europe. However, the S&P/IFCI Carbon Efficient Index, which contains the same constituents as the S&P/IFCI LargeMidCap, but with index weight adjustments to reduce exposure to carbon emissions, has a smaller carbon footprint at 440 tCO2e/US$ mn.

• Based on wide variations in the carbon intensity of companies in sectors in the S&P/IFCI LargeMidCap Index, the S&P/IFCI Carbon Efficient Index overweights carbon-efficient companies and underweights those with relatively high carbon intensities. Investors that use the S&P/IFCI Carbon Efficient Index as a benchmark could reduce the carbon footprints of typical equity portfolios invested in emerging markets by 22%. This would reduce portfolio exposure to carbon costs while maintaining sector and market weights.

• Carbon costs associated with companies in the S&P/IFCI LargeMidCap Index could equate to up to 3% of revenue if emerging market companies had to pay US$22 per tonne for 4% of their projected direct emissions in 2013. Carbon exposure would vary significantly at a company level. The firm with the greatest profit risk from carbon costs could see earnings fall by more than 97%. At US$108 per tonne of CO2e in 2030, carbon costs could equate to 20% of revenue for one company, and more than 100% of EBITDA for 16 firms.

• Carbon costs could equate to more than 5% of earnings for 24 companies in the Utilities, Basic Resources, Oil & Gas, Construction & Materials and Travel & Leisure sectors in 2013, and for 84 companies in 2030. Carbon-intensive companies could find it difficult to pass on carbon costs without losing market share.

• If companies in the five carbon-intensive sectors had to pay for all of their current emissions, portfolios could be exposed to US$7,964 in carbon costs for every US$ million invested. However, reweighting holdings based on carbon efficiency in line with the S&P/IFCI Carbon Efficient Index could reduce exposure to carbon costs by 20%, to US$6,402/US$ mn.

• A back-test showed that the S&P/IFCI Carbon Efficient Index matches the financial performance of the S&P/IFCI LargeMidCap Index, with an annualised tracking error 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.

Why did Trucost carry out the research?

The study examines opportunities for fund managers to manage financial risk from rising carbon costs by tilting their portfolios toward more carbon-efficient companies in emerging markets, whilst maintaining financial performance consistent with the market benchmark. Trucost analysed the carbon footprint of the S&P/IFCI Carbon Efficient Index, which enables investors using the index as a benchmark to shift assets towards carbon-efficient companies. This could help encourage listed companies in emerging markets to compete for capital on carbon efficiency and make the transition towards low-carbon fuels, technologies and processes.

Report image: Reducing portfolio exposure

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