Investors may not know how to solve climate change, but low-carbon indexes are growing as a way to start managing the portfolio risks associated with a warming planet, according to Fred Samama, deputy global head of institutional clients at Amundi Asset Management, Europe’s largest asset manager overseeing about 1.4 trillion euros (US$1.7 trillion).
Amundi has been offering low-carbon indexes since 2014, based on the MSCI Low Carbon Leaders Indexes. The strategy has grown popular with institutional investors such as Sweden’s AP4 pension fund and Japan’s Government Pension Investment Fund. Last month, the New York State Common Retirement Fund said it would double its commitment to low-carbon strategies to US$4 billion. Insurer AXA SA set a target to reach US$14.7 billion in low-carbon investments by 2020 and Canada’s second-largest pension fund, CDPQ, said it would boost low-carbon investments 50 per cent, adding US$8 billion in new investment.
Samama spoke to Emily Chasan, Eric Roston and Brian Eckhouse on Feb. 1 about why low-carbon indexes are growing in popularity. Comments have been edited and condensed.
Why are low-carbon indexes seeing so much growth?
We are shifting to mainstream adoption. Very large investors from New York State Common to CalSTRS to Japan’s GPIF are using this. Investors have a carbon risk that’s mispriced in their portfolios. If you are a pension fund, insurance company or sovereign wealth fund and you’re supposed to invest for the next three, five, 10 or even 50 years, then you have to manage this risk. It’s just part of your job and fiduciary responsibility.
Bank of England Governor Mark Carney said in 2015 that if investors aren’t integrating climate risk they’re breaching their fiduciary responsibility. We’re not talking about saving the planet, we’re just assessing risk over the long run. Low carbon indexes are not moving your portfolios massively, but they have 50 to 60 basis points of tracking error and can reduce a portfolio’s carbon exposure by 50 percent. Everyone can stomach that.
Are low carbon indexes based on science?
We’re really just scratching the surface on the impact of the physical risks of climate change, the impact on health, destabilizing economies and increased immigration. That’s why it matters to start the process of learning. We don’t know exactly when these risks are coming and we can debate how big the risks of climate change are, but they cannot be zero. Low-carbon indexes help us buy time.
The point of what we’re trying to do is reduce risks and put pressure on corporates. If we ban the whole fossil-fuel industry forever, then what are their incentives to change? If you exclude 3 out of 10 companies in a sector from the index and if you let them know that if they accelerate their transition to a low-carbon economy that they will be added back, then you are creating an incentive.
Why choose a low-carbon strategy versus divesting fossil fuels?
Divestment is a complicated topic. If you divest from fossil-fuel companies, you still might have a lot of polluting companies like airlines, or banks financing polluting activities. Some fossil-fuel companies are investing in renewables. It looks good in theory, but it’s really not so simple.
If you were to divest from all the airline companies, automakers, banks, insurance companies and fossil-fuel companies, then what do you have left in your portfolio exactly if you’re managing $100 billion? Fossil-fuel companies represent a significant part of major indexes, so it’s complicated to exclude them.
Is corporate carbon reporting data reliable enough?
We recognize it’s not perfect. But we say to our clients that either they can wait three to five years until we think the data will be very good, and there will be consensus affecting market prices, or they can start now and recognize they will not be perfect and there will be some mistakes. By starting now they can manage some of the risks, and by doing that they will learn something. Our investors are comfortable with that.
Why are there different types of low-carbon indexes?
It’s about how much you want to engage with companies. Either you want to send a very clear signal to corporates or you prefer to have a product that just manages your risk. So you have two schools of thought about how to build the indexes: Either you use an optimizer to reduce the weighting of carbon-intensive companies, or you use transparent rules about who can be included in the index and who cannot.
U.S. players have been more in favor of optimizers and Europeans have been more interested in transparent rules and Japan has come out publicly saying they also want to use transparent rules. Companies pay attention to whether they’re in or out. It sends a strong signal and creates pressure on them.