The companies are inviting collaboration from stakeholders across the financial community, standards development bodies and academia to provide an actionable framework to help investors assess carbon liabilities attached to derivative investments.
“Given the size of the derivatives market and its prominence in the global financial system, it is critical that this financial instrument is not discounted from GHG inventories,” notes Dr. James Salo, senior vice president, Trucost. “Investors need a complete picture of their financed carbon emissions to make informed decisions.”
An analysis of greenhouse gas (GHG) accounting for derivatives as part of investment portfolios is uncovered in the white paper and includes the following topic points:
- Derivatives are prolific within certain types of investment strategies, and ignoring their presence may lead to incomplete or inaccurate portfolio analysis.
- Derivatives are generally more complicated than stocks and bonds, and investors may not be familiar with the details of their structure. Difficulties associated with understanding derivatives could lead to inaccurate portfolio analysis.
- The derivatives market is massive. The Bank of International Settlements estimates the size of the Over-The-Counter (OTC) derivatives market at over $20 trillion of notional value, the total value of the leveraged position’s assets, and the size of the exchange traded derivatives market at over $60 trillion notional at the end of 2014.
“One of our core investment competencies is designing and implementing strategies that can augment clients’ risk/return profile, and derivatives play an important role in many of those approaches,” says Ron Albahary, CFA, chief investment officer of Threshold Group. “While we were hosting an educational retreat with a family foundation client focused on carbon divestment-reinvestment and, more broadly, aligning the portfolio with the foundation’s mission, an investment committee member asked about the role of derivatives in the divestment question. As a result, we approached Trucost with the unique opportunity to collaborate on a thought leadership framework intended to help investors develop a multi-dimensional view of their portfolio’s carbon footprint. I feel that this collaboration is a significant step in refining how we assess and address the portfolio risks associated with companies responsible for greenhouse gas emissions.”
Tracing the carbon in derivatives
Some of the investment tools Threshold Group uses to help maximize upside risk and minimize losses contain derivatives. Threshold Group and Trucost are jointly developing a best-practice approach to measuring the greenhouse gas emissions associated with derivatives. That work is expected to expand divestment methods for clients and investment advisors alike.
“Analysis of traditional corporate securities goes a long way in evaluation of a portfolio’s carbon footprint, but by analyzing derivatives, we can go a step further and provide clients a more complete picture,” says Alex Hokanson, CFA, FRM, director of asset allocation strategies at Threshold Group in Philadelphia.
“Evaluation of derivatives and their impact on the carbon footprint presents unique opportunities, due to the complexities inherent in their structure,” adds Hokanson. Researchers from both firms are collaborating on a framework for evaluating how to weight the impact of derivative exposures on the carbon footprint of investments and have released conclusions in the white paper which can be found on each company’s web site. Both companies are seeking to hear feedback from industry specialists.
The white paper on carbon in derivatives
London-based Trucost is a global authority on the economic consequences of “natural capital” dependency, providing its clients with information to manage risk from hidden and rising environmental costs. The firm began assessing the carbon risk exposures of large institutional investment portfolios in 2002 and has since expanded its analysis to address a wide range of asset classes and environmental factors, including water-related issues and stranded assets.
“Our data driven, scientific insights expose environmental risks previously concealed within investment portfolios. To the best of our knowledge, the white paper with Threshold Group is the first of its kind in the investment portfolio domain, and represents broader vision for the divestment movement,” notes Libby Bernick, senior vice president, North America, for Trucost. “The collaboration with Threshold Group continues to expand and inspire new innovations.”
Threshold Group is a national (U.S.) wealth management firm and a Registered Investment Advisor, based in Seattle and Philadelphia. This relationship is the latest in a series of initiatives by the firm to bring its clients actionable methods and advantages for impact and mission-related investing, as well as place-based, regional investing.
Threshold Group and Trucost have served the mission-related investment needs of foundations and high-net-worth individuals as strategic partners for the past year.
Greenhouse gas emissions – a comprehensive approach
Trucost and Threshold Group recommend that as a first step in measuring the GHG emissions of their investments, investors focus on their equity and corporate debt investments. This will provide investors with an indication of their current financed emissions. Analysis of direct exposure should be the primary focus. The white paper proposes for investors who wish to have a more comprehensive understanding of their GHG investment exposure, completing an analysis of derivative investments could highlight potential GHG emission investment risks. The belief is that presenting analysis of direct holdings and derivatives separately, and with a hierarchy of significance, will allow for the greatest degree of transparency and the most rational outcomes. In summary:
- The GHG emissions associated with derivative investments should be reported separately from the emissions associated with direct investments in equity or debt
- The accounting approach used to quantify the GHG emissions associated with derivatives should align with the standard calculation methodology of the underlying assets
- When derivatives are included in a portfolio analysis, the notional value of derivative investments should be used to measure GHG emissions exposure.
Please contact Alex Hokanson at Threshold Group firstname.lastname@example.org, or Dr. James Salo at Trucost email@example.com, before November 1 if you wish to share thoughts or feedback on this topic.
Threshold Group: Elizabeth Hendrix, 206-748-3692, firstname.lastname@example.org
Trucost: James Richens, +44 (0)20 7160 9804, email@example.com
About Threshold Group
Threshold Group is a family-owned wealth management firm, dedicated exclusively to serving families, individuals and family foundations. It serves clients in more than 25 states. The company provides integrated investment guidance, financial planning, legacy planning and family office services – all aimed at helping clients achieve their missions and priorities. Threshold Group is a Registered Investment Advisor, with approximately $3 billion of assets under management (AUM) as of December 31, 2014. Approximately a third of the firm’s current assets under management is for clients who have set the objective of aligning their portfolios with their missions. Offices are in Seattle, Gig Harbor, Wash. and Philadelphia. Threshold Group may be reached at 888-252-3889. Threshold Group and Trucost are separate and unaffiliated and are not responsible for each other’s policies, products or services.
©2015, Threshold Group is a Registered Investment Advisor.
The information contained herein reflects the opinion of Threshold Group on the date of production and is subject to change at any time without notice. Where data is presented that is prepared by third parties, such information will be cited, and these sources have been deemed to be reliable. However, Threshold Group does not warrant the accuracy of this information. Threshold Group and Trucost are separate and unaffiliated, and are not responsible for each other’s products, services or policies. The information provided herein is for information purposes only and does not constitute financial, investment, tax or legal advice. Investment advice can be provided only after the delivery of Threshold Group’s Brochure and Brochure Supplement (Form ADV Part 2A & B) and once a properly executed investment advisory agreement has been entered into by the client and Threshold Group. All investments are subject to risks.