Investment funds divested from fossil fuels "will perform better"

The author of the influential Stern Review on the Economics of Climate Change is also calling for Europe to decarbonise the power sector by the 2030s.

Research by leading investment and asset management firm has shown that fund managers divesting fossil fuels from their portfolios, and replacing them with an actively managed portfolio of renewable energy and energy efficiency stocks, will reduce risk and achieve positive financial benefits.

The conclusion will support a call issued last Friday by Lord Nicholas Stern for Europe to "re-ignite growth by investing in the transition to a low carbon economy".

The author of the influential Stern Review on the Economics of Climate Change, said in his statement that "low-carbon growth is the only credible medium-term growth strategy" and called for a European goal of decarbonising the power sector by the 2030s.

Pressure is building on institutional investors to assess their exposure to companies that extract fossil fuels, as concerns rise about the likely effects on the climate from greenhouse gas emissions.

In parallel, financial analysts are increasingly warning investors of the risks that tighter regulations on carbon dioxide emissions and falling demand for fossil fuels could make fossil fuel reserves substantially less valuable, or even ‘stranded’, and ultimately rendered worthless.

Impax Asset Management, which won the Sustainable Investor of the Year accolade at the FT/IFC Sustainable Finance Awards last month, has assessed the relative performance over the last seven years, in terms of returns and volatility, of four alternative portfolio structures.

Its analysis of the historical data found that, over the past seven years, eliminating the fossil fuel sector from a global benchmark index would actually have had a small positive return effect.

Furthermore, much of the economic effect of excluding fossil fuel stocks could have been replicated with ‘fossil free’ energy portfolios consisting of energy efficiency and renewable energy stocks, with limited additional tracking error and improved returns.

The four alternative scenarios were:

a completely fossil free portfolio: based on the MSCI (formerly Morgan Stanley Capital International) World Index without the fossil fuel energy sector;

fossil free plus alternative energy 'passive' portfolio: replacing the fossil fuel stocks of the MSCI World Index with a passive allocation to renewable energy and energy efficiency stocks;

fossil free plus alternative energy 'active' portfolio: as [2] but actively managing the portfolio;

fossil free plus environmental opportunities 'active' portfolio: as [2] but actively managing a portfolio of stocks selected from a wider range of resource optimisation and environmental investment opportunities.

The best performing alternative was [3]. As a result, the company believes that investors should consider reorienting their portfolios towards low carbon energy by replacing fossil fuel stocks with energy efficiency and renewable energy investments.

The announcement follows news last week of two more financial institutions, Storebrand and Rabobank, divesting from fossil fuels.

Awarding the Sustainable Investor of the Year to Impax in June, Martin Dickson, US Managing Editor of the Financial Times and co-chair of the Sustainable Finance Awards judging panel, said: “The world faces not only persistent economic uncertainty but also unparalleled resource constraints that are putting pressure on social systems across both developed and emerging markets. This situation makes sustainable investment, and these awards, even more relevant.”

Managers of college endowments and municipal and state pension funds are increasingly finding themselves the target of fossil fuel divestment campaigns from within US universities, similar to the calls for divestment of stocks of companies that supported apartheid in the 1980s.

The Fossil Free campaign maintains that it is “morally wrong to profit by investing in companies that are causing the climate crisis”.

Independently, mainstream analysts are now building on research from the Carbon Tracker Initiative, which has warned that regulations to limit carbon emissions could significantly impact the market value of fossil energy companies as it becomes uneconomic to extract their reserves.

It calculates that 80% of the world’s proven fossil fuel reserves cannot be consumed without exceeding the international target to keep global warming to within 2°C above pre-industrial levels, implying that the world’s listed fossil fuel companies, whose share prices are partly based on their proven reserves, are grossly overvalued.

These mainstream analysts include:

HSBC, whose oil and gas analysts warned that European energy companies could see their market capitalisation fall 40-60% if oil prices drop to $50/barrel, as a consequence of climate policies commensurate with the 2°C goal;

Citi, which examined the value at risk from climate policies among Australian extractive companies within the ASX200 index;

Standard & Poor’s, which predicted that smaller oil companies, especially those heavily exposed to high-cost unconventional oil production, could face credit downgrades within a few years under its ‘stressed’ carbon reduction scenario;

and Aviva Investors, Bunge, Climate Change Capital and HSBC, which are funding research at Oxford University’s Smith School of Enterprise & Environment into risks posed to investors by high-carbon stranded assets.

The Impax report concludes: "Given the growing consensus around climate change science, it is rational for investors to expect much tighter carbon regulation, with profound economic effects, in many regions of the world. These regulations ... are only moving in one direction: towards a lower carbon world."

Picture from Wikimedia
caption: The author of the influential Stern Review on the Economics of Climate Change is also calling for Europe to decarbonise the power sector by the 2030s.

We're heading for 6 degrees rise says IEA. Here's a way to stop it.

I've got good news and bad news. Which would you like first?

OK, here's the bad news, and it's really bad. According to the latest figures from the International Energy Agency, greenhouse gas emissions reached a record high last year of 31.6 gigatonnes, an increase of 1Gt, or 3.2%, on 2010.

IEA’s energy pathway, that seeks to limit the average global temperature increase to a still-risky 2°C, requires CO2 emissions to peak at 32.6 Gt no later than 2017, i.e. just 1.0 Gt above 2011 levels.

Clearly this is no longer possible.

"When I look at this data, the trend is perfectly in line with a temperature increase of 6 degrees Celsius (by 2050), which would have devastating consequences for the planet," Fatih Birol, IEA's chief economist, commented.

This constitutes nothing short of a global emergency. Panic stations. Hit the red button. Call International Rescue. Something must urgently be done, right?

Yet negotiators from over 180 nations, meeting in Bonn last week to try to get a new legally binding global climate pact signed by 2015, failed abysmally in their efforts. Tragically, reports coming out suggest that they became bogged down in procedural wrangling and got lost on the road to nowhere. Any deal reached ideally needs to be ratified at the annual climate talks in Qatar in December.

That’s all bad enough. But then there's the economic paralysis gripping Europe that is stifling both investment confidence and the setting of ambitious climate-protecting legislation.

So in the face of this perfect storm, how could there possibly be any good news?

What we need is money. Lots of it. And we need the conditions necessary for it to be invested in low carbon infrastructure. Everywhere.

We are told there isn't any. But there is.

In 2009, the most recent year for which figures are available, $16.8 trillion in total was held in pension fund assets around the world, according to the OECD.

$1.589 trillion of capital is held in UK pension funds alone (just over 10% of that total), with $9.58 million held by US pension funds.

What is more, $399.6 billion is also written in insurance premiums in the UK.

Let's confine our considerations of the potential of this pot of money to the UK, although clearly a bigger sum could be unlocked on a global level.

In 2008, the rate of return on pension fund investments in the UK was negative, by a large amount, reflecting falls in the stock market. The figure represented a drop in value of around 14%. I don't have corresponding figures for the insurance industry, but I would imagine they are not too different.

Both industries are known to be conservative with their investments. Mostly, they don't invest in low carbon and environmental infrastructure. But last week's official figures show that this is one sector of the economy that is actually defying the recession and the growing, not just in the UK, but globally.

Wouldn't it make sense for these industries to invest in this sector?

Faced with a stagnant economy, all governments seem to be able to think of doing in a vain attempt to stimulate it, is to inject more cash into it. But, according to Charles Cowling, managing director of JLT Pension Capital Strategies, this is exactly the wrong thing to do, because it forces up costs (by forcing up liability values) for the very funds that could be invested in infrastructure.

Joanne Segars, Chief Executive of the National Association of Pension Funds (NAPF), protested against the prospect of another round of quantitative easing only last week.

Furthermore, the UK's pension system is threatened with having its tax income drained by ballooning retirement costs as we all get older.

Actually, this should provide it with a further incentive to obtain a higher rate of return from its investments. But investment conditions are not yet right. And, surprisingly, nor are the attitudes of the fund managers.

According to Christopher Greenwald, head of sustainability application and operations at Swiss-based Sustainable Asset Management (SAM), which provides the data for the Dow Jones Sustainability Indexes, while companies are taking on board the sustainability agenda, investors are lagging 15 to 20 years behind.

They do not yet fully understand the impact of sustainability on their business performance and financial returns, and this is why they are experiencing losses from their investments. "Investors are about where companies were in 1995 when sustainability reporting was just getting off the ground," he says.

Clearly, they need some training in the importance of sustainability issues in evaluating company performance.

At the moment, just 1% of pension funds' assets around the world are invested in infrastructure. Regulation is one of the major drivers of pension funds investment strategies.

So what is the Treasury doing to improve the confidence of fund managers that any money they might put into investing in infrastructure in the UK will have a good ROI, and will not fall into a black hole due to the usual British disease of cost overruns and missed schedules?

Last November, the National Association of Pension Funds signed a memorandum of understanding with the Treasury to support the establishment of a new Pension Infrastructure Platform owned by pension funds, to bring as much as £2bn of investment by early 2013. Its representatives have been meeting regularly with officials in the Treasury ever since.

£2bn is not much nowadays, but it's a good start. If just 2% of that $1.5 trillion or £1 trillion in assets were invested in infrastructure, that would represent £200 billion, or the amount required for investment in low carbon infrastructure up to 2020. No one is suggesting that all of this money should be invested in low carbon infrastructure. And we haven't even considered investment companies' assets.

This gives an indication of the opportunity that the Chancellor and the Treasury has, to create the right conditions for these companies to feel confident to invest in this area.

At the moment, the cost of government debt is so low, because George Osborne wanted to lock in current low borrowing costs by issuing perpetual bonds, that there is scant reason for fund managers to be interested in the potentially much more costly mechanism to fund infrastructure projects.

But the NAPF says it is working with a core of 10-12 pension funds and the Pension Protection Fund on the details of the Pension Infrastructure Platform. “The Platform, which will be owned by pension funds for pension funds, will seek to invest in a wide range of infrastructure assets," said Joanne Segars. "It aims to raise £2 billion which could be leveraged up to £4 billion of new money for investment in infrastructure and be open for business in early 2013.”

I hope this happens. It should be just the start. There is precious little light in the gloom, but this is some of it. Let's not let this chance pass us by.

Goldman Sachs, while being investment bankers rather than pension funds, are leading the way with a $40 billion clean energy investment plan announced last week. They clearly see a good bet. Let others follow.

Oh yes, and someone should also educate pension fund managers about the advantages of looking at the sustainability performance of companies.