Australian investors begin to hedge carbon risk

The move towards low-carbon investment portfolios has taken a small but significant step in Australia, with Industry Funds Management launching a new low-carbon, environmental, social and governance portfolio strategy, believed to be the first of its type to factor emissions intensity into an Australian investment product.

The quant-based, sector-neutral product has already attracted a $100 million mandate from industry funds group Hesta, and will be able to deliver a portfolio with half the carbon emissions of an equivalent portfolio in the S&P/ASX 200, depending on the clients’ needs.

Other funds that focus on ESG issues, or on cleantech or energy efficiency mandates, have become part of the investment landscape in Australia, but this is believed to the first to offer a broad index portfolio that offers a hedge against carbon risk. It will certainly not be the last.

Nathan Fabian, CEO of the Investor Group on Climate Change, a group whose members manage more than $700 billion of funds, says it is a significant development.

“Just the fact that there is a new type of investment mandate for the ASX that is carbon-exposure weighted – which is a direct result of progress on the carbon price – shows that the capital reallocation process is underway,” he told RenewEconomy.

“$100 million is a reasonably strong start for a fund like this. If the carbon price goes up, this thing makes a lot of money, and it has been structured so it doesn’t lose if nothing happens on carbon. That is a compelling investment proposition and the type of investment allocation that we are going to see more of.”

Fabian says the fund will allow an investor to start to hedge the risk of a “carbon bubble,” a term that has now become commonplace in Europe, particularly since the release of a report by the Potsdam Institute last year that highlighted the risk of a “carbon bubble” if the world finally took action, rather than talking about it, on limiting global warming to 2°C.

The findings and implications of this and a subsequent study, “Unburnable Carbon – are the world’s financial markets carrying a carbon bubble?,” prepared by the Carbon Tracker Initiative has since been endorsed by the International Energy Agency, which highlighted the issue and its potential impacts on the fossil fuel industry in its World Energy Outlook.

The “Unburnable Carbon” report, which can be viewed here,  questioned why stocks and shares of carbon-intensive firms are triple-A rated at a time when they face significant legislative, reputational and environmental risks across the globe.

The Carbon Tracker Initiative warned of the potential of systemic risk from the exposure of investors to carbon-intensive listed firms. On London’s FTSE index, it noted, one third of the carbon exposure came from investments in the coal industry in Australia.

Aidan Puddy, the executive director of listed equities at IFM, said the new portfolio strategy could be tailored to the needs of clients, and their appetite for low-carbon, alternative investments. He said carbon risk presented significant challenges to investors.

So, have low-carbon stocks outperformed their sector peers in recent years? Not as yet, says Puddy, but that just underlines the potential. “We have looked at past performance and not found evidence of either performance or under performance,” Puddy said. “We see that as a positive thing.

“If that had outperformed in the past, we might have argued that we missed the boat. For those people who believe that low-carbon emitting companies will outperform, well that may well happen in the future.”

The index works roughly like this: If investors want the low-carbon option, then the system will invest more money in stocks in a certain sector with a lower emissions intensity (emissions are divided by market capitalisation). In one example provided by IFM, that means going overweight in stocks such as Orica, Newcrest Mining and Oil Search, and underweight stocks such as Rio Tinto, Woodside Petroleum and Incitec Pivot.

Puddy says the mandate represents a drop in the ocean of the $11 billion in equities that are managed by IFM, but it is early days, and the portfolio strategy was developed as a result of direct approaches from clients. “We did this because we responded to clients requests (but) we think there is something in this.”

He says it took a year and a half to develop and will use data provided through MSCI. However, now that the R&D is completed, he says it should be easy to roll out similar portfolio strategies, or even create a pooled fund if the interest is there.

(Note: This story was updated to correct authorship of the Unburnable Carbon report).