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Carbon risks in UK equity funds
06 July 2009
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Key Findings
- Trucost's analysis of the combined portfolios shows that the 2,380 companies invested in emit over 10 billion tonnes of greenhouse gases globally each year, measured as their carbon dioxide-equivalent (CO2-e) emissions.
- Since the aggregated 118 funds own approximately 1.4% of the total market capitalisation of these companies, they "own" 1.4% of greenhouse gases emitted by them annually, or 134 million tonnes of CO2-e. This equates to 22% of total UK GHG emissions.
- Trucost applied two potential carbon prices to the 134 million tonnes of CO2-e emissions attributed to the 118 portfolios. Trucost used £12 - the three-month average market price of carbon dioxide permits under the EU Emission Trading Scheme - to identify the funds short-term global exposure to carbon costs. If the companies paid £12 per tonne for the 134.2 million tonnes of CO2-e allocated to holdings, carbon costs of £1.6 billion would equate to 0.7% of revenue from holdings.
- Trucost used the social cost of carbon outlined in the UK Government's Stern Review on the Economics of Climate Change (2006) to demonstrate financial risk from possible future carbon prices. If portfolio companies paid £57 for each tonne of CO2-e allocated to holdings, carbon costs of over £7.65 billion would equate to 3.2% of combined revenues.
- The carbon footprint of the combined portfolios analysed is 582 tCO2-e per million invested. This is 20% smaller than the carbon footprint of the MSCI World Index. The lower carbon footprint is largely driven by sector allocation decisions, because the value of portfolio investments in carbon-intensive sectors such as Utilities is underweight compared with the Index. The better carbon performance of the portfolios is also due to stock selection effects. Portfolio holdings are less carbon intensive on average than securities in the Index, notably in the Utilities sector.
Extract
Governments in OECD countries are implementing legislation and regulations to introduce or strengthen controls on greenhouse gas emissions through mechanisms such as cap-and-trade schemes. Carbon-intensive companies will incur rising carbon costs under government policies to apply carbon pricing and may lose market share to more efficient and innovative companies that emit less and seek new opportunities. As a consequence, the potential exposure of earnings to carbon costs across portfolios could have a knock-on effect on pension fund returns.
WWF commissioned Trucost and Mercer to analyse the greenhouse gas emissions and potential carbon costs associated with UK-based equity funds. Trucost analysed the greenhouse gas emissions associated with holdings, valued at over £206 billion, in 2,380 companies invested in by 118 equity portfolios. The underlying holdings data represent the holdings from UK-based institutional equity portfolios which are researched by Mercer and in which institutional investors, including pension funds, invest.
The carbon footprints of portfolios provide a comparable measure of emissions associated with holdings and an indicator for related exposure to carbon costs. The analysis includes direct operational greenhouse gas (GHG) emissions as well as those from direct (first-tier) suppliers, such as electricity and logistics providers. Emissions from products in use are excluded from this analysis to limit double-counting. However, they can be a significant source of risk for companies in sectors such as Oil & Gas.
Mercer interviewed the managers of the four investment portfolios with the smallest and largest carbon footprints to find out whether decision-making includes carbon risk factors
Why did WWF commission the report?
By commissioning this report WWF was seeking to demonstrate that there are strong financial incentives for pension funds and other institutional investors to ensure that carbon risk is actively considered as a factor by their fund managers. In addition, WWF was in favour of support measures like comprehensive, mandatory company reporting, which increase the opportunities for fund managers to manage such risks.
With this in mind, WWF-UK and The Co-operative Bank, Insurance and Investments were campaigning for the introduction of mandatory reporting of current and long-term carbon emissions and their prospective costs, for listed companies in the high-emitting sectors.
The aim was that the diclosure of carbon liabilities would play an important role in providing better information and creating market incentives for investors to support and drive a successful low-carbon economy, particularly by financing clean, sustainable and renewable energy. In addition that it would help to encourage companies to work harder to prepare for a low-carbon economy where higher emissions will mean lower profits, and the leaders will be those who grasp new opportunities for sustainable business.
Report image: Distribution of fund carbon footprints
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