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President Donald Trump’s policy directives have fueled conversation across market sectors and geographies as decision makers prepare for a multitude of possible economic and geopolitical scenarios. Among these scenarios, the transition from an administration that strongly advocated for low carbon economies globally to one intent on deprioritizing such initiatives is likely to have disruptive consequences.

Trump’s promises to withdraw from the Paris Agreement, expected repeal of Obama’s Clean Power Plan in an effort to revive the coal and fossil fuel industries, and deep spending cuts to the Environmental Protection Agency (EPA) in February’s budget proposal signal a shift in attitude sparking concerns over the future of sustainability in business and the momentum of ESG investing.

Emerging Sustainability Leaders in Business and Finance

Despite shifts in U.S. policy, major companies like Apple, Unilever, Walmart, and others continue to engage in initiatives like RE100, which challenges them to increase their use of renewable energy sources. At the vanguard of the movement, pension boards around the world are increasingly adopting investment approaches centering on companies with environmental factor momentum. For example, Norway’s Government Pension Fund Global runs an environmental fund of approximately US$6 billion of investments in alternative energy and energy efficiency.

Major ETF providers such as BlackRock and State Street are among a host of asset managers that offer ETFs with climate-aware exposures. As of February 28, FactSet’s ETF classification system identified 17 such ETFs with a combined $1.6 billion in assets, which over $190 million in new investment since the start of 2017.

The largest of these, iShares MSCI ACWI Low Carbon Target ETF (CRBN-US), offers broad-based exposure to global companies that favor stocks from firms with lower greenhouse and carbon emissions (relative to firm size) while maintaining very tight tolerances to a broad and market-like index. The end result is a fund that correlates almost perfectly with the MSCI ACWI Investable Market Index, while holding only 13% (by count) of the ACWI IMI’s stocks, according to FactSet’s Elisabeth Kashner, Director of ETF Research and Analytics.

Ticker

Name

AUM 2-28-17,
in $millions

YTD flows through
2-28-17,
in $millions

CRBN

iShares MSCI ACWI Low Carbon Target ETF

348.8

14.9

URA

Global X Uranium ETF

324.5

155.3

TAN

Guggenheim Solar ETF

218.1

24.7

LOWC

SPDR MSCI ACWI Low Carbon Target ETF

134.3

0.0

PBW

PowerShares WilderHill Clean Energy Portfolio

90.9

-2.1

PZD

PowerShares Cleantech Portfolio

83.6

0.0

ICLN

iShares Global Clean Energy ETF

79.6

1.7

FAN

First Trust Global Wind Energy ETF

75.3

-2.3

GEX

VanEck Vectors Global Alternative Energy ETF

69.7

0.0

QCLN

First Trust NASDAQ Clean Edge Green Energy Index Fund

56.9

0.0

PBD

Powershares Global Clean Energy Portfolio

53.8

-2.2

NLR

VanEck Vectors Uranium+Nuclear Energy ETF

35.0

0.0

EVX

VanEck Vectors Environmental Services ETF

19.5

0.0

KWT

VanEck Vectors Solar Energy ETF

11.5

0.0

ETHO

Etho Climate Leadership U.S. ETF

10.3

1.4

YLCO

Global X YieldCo Index ETF

7.9

0.5

GRN

iPath Global Carbon ETN

0.8

-0.3

 

Cost of Inaction and Lure of Alpha

For the asset management industry, the long-term benefits of capitalizing on climate-change related opportunities are plentiful.

To help identify these opportunities, benchmarking practices like “sustainability accounting” seek to understand an organization’s environmental presence and quantify it into actionable intelligence. Such practices look at a variety of metrics, including the time value of carbon, a firm’s near-term climate forcers (NTCF), and greenhouse gas emissions (GHG) to arrive at a Global Warming Potential (GWP) value over various time horizons. This score allows for more informed decision-making for investors that place a premium on environmental stewardship.

Median multi-horizon returns across different carbon footprint quintiles of the S&P 500 in the stacked chart below tell an interesting story. Here we see the lowest carbon footprint quintile consistently outperformed competing quintiles of the S&P 500 with its one-year, three-year, and five-year total return figures.

The Economics of Energy

The momentum of climate change leadership is poised to grow, if not due to commitment from major global companies and the investing community, then due to the economics of energy.

While a significant proportion of electricity production is still derived from oil, gas, and coal sources in the United States, the contribution of renewable, hydroelectric, and nuclear sources have increased at a much faster rate than the former.  According to the Climate Change and the Environment Report published by the Grantham Institute and the Carbon Tracker Initiative, the cost of solar panels has fallen 85 % over the last seven years. The technology expected to become significantly cheaper than alternative options in less than a decade given the major current investments into solar technology.

The International Energy Agency (IEA) believes this trend is here to stay. Where electricity production is concerned, the International Energy Agency’s 2016 Medium-Term Renewable Market Report forecasts that renewable energy will remain the fastest-growing source of electricity generation, with its share growing from 23% in 2015 to 28% in 2021 .

If the production costs of renewable energy sources continue to fall, Trump’s policies will have limited influence on the push for climate change risk mitigation.

Identifying Exposure to Climate Change Risk

As explained in the Economist Intelligence Unit’s special report on Climate Change VAR (Value at Risk), “climate change is a problem of extreme risk.” This research goes on to say that the average expected losses stemming from climate change could be roughly on par with the value of Japan’s GDP.

Given that the VAR calculation includes a wide range of probabilities, it is not just the average expected losses but also the tail risks that need to be considered in portfolio or index level analysis. In assessing the impact of climate change risk to a company’s value or the contribution to climate change from a company’s operations, the nature of operations, revenue by sector or segment, and value of supply chain relationships dispersed across geographies will prove helpful.

When conducting negative screening on indices or portfolios to divest positions in companies with exposure to the coal sector, taking the revenue hierarchy a level deeper with FactSet RBICS Rev to differentiate between the revenue generated from metallurgical coal mining and thermal coal can help paint a more accurate picture of a company’s operations.

Data sets like FactSet GeoRev and Supply Chain Relationships can reveal a company’s revenue exposure and supply chain exposure to countries at particular risk from rising temperatures.

For example, severe aridity resulting from increasing global temperatures has already sent wildfires sweeping through central and southern Chile this year. The event has destroyed more than 580,000 hectares of land, deeply affected the local economy, and cost the government nearly $333 million. The resulting damage could put foreign companies and sectors with exposure to Chile at varying degrees of risk. One of Chile’s largest forestry companies, Empresas CMPC, provides raw materials to the likes of Home Depot and Walmart in the United States and has customers in China and Peru. The truly global nature of supply chains and business operations today mean that the effects of an extreme climate change scenario will permeate through the different sectors and stages of the supply chain and have an indirect impact on businesses and local economies around the world.

Responsible Investing Challenges

One of the major challenges for climate change investors and ESG investors alike is the lack of consistent, verified, and comparable data. The scoring methodology and disclosure of data currently in use is far from transparent, and as the demand for more environmental data increases, the volume and quality of data too will increase. The Task Force on Climate-Related Financial Disclosures, led by Financial Stability Board Chair Mark Carney, is one organization hoping to develop consistent climate-related financial risk disclosures to provide lenders, insurers, investors, and other stakeholders better information on the companies they hold.

According to Pamela Steer, CFO of the Workplace Safety and Insurance Board of Ontario, the industry has seen “the emergence of a lot of different methodologies for financial disclosure and sustainability accounting, but now confront serious ESG risks that will require the development of standards that can be consistently adopted across geographies and within industries.”

Steer, also a founding member of the Canadian chapter of the Prince of Wales’ Accounting for Sustainability project (A4S) CFO Leadership Network and member of the Global Advisory Committee for A4S believes there is “fragmentation” in the approaches adopted within each industry and across industries to disclosures and measurement. “We will need a set of principles that will allow for an apples to apples comparison,” she says. 

Incorporating data on geographic exposures, granular subsector revenue exposure and supply chain relationships data with environmental data series on emissions, external costs and carbon footprint among other factors can help uncover numerous linkages. With a relational database of linkages created, insightful stress tests and factor correlation matrices can be generated to analyze the impact of changes in independent variables on climate change VAR in different scenarios.

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Consultant, Canada IM Consulting
Nikita is a FactSet Consultant based out of our Toronto office. She partners with a diverse list of clients on the buy-side in Eastern Canada designing and implementing custom analytical models using FactSet software. She is a BA Economics graduate from McGill University in Montreal, Canada where she was actively involved in writing for university journals and student-run publications on economics, international business and foreign policy.

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