Practical analysis for investment professionals
05 July 2017

Carbon Free? Really?

Let me begin by saying, I was skeptical.

A client asked me how he could eliminate — or at least minimize — the carbon footprint in his investment portfolio. The ability to completely remove the carbon effect from a portfolio seemed as likely to me as switching from oxygen to argon in our choice of breathing matter.

As the United States begins to withdraw from the Paris Agreement, however, this is a timely topic. And acting independently, many companies have made significant strides in this area over the past decade.

Today, all human civilization carries some kind of carbon implication. Virtually all products, at a minimum, have some energy input to them in their production or contain some fossil fuel byproduct: think epoxies or plastics.

In my effort to comply with my client’s wishes, here are the steps I learned:

  • Reduce exposure to carbon-heavy stocks. This is clearly the lowest hanging fruit. If you don’t want carbon in your portfolio, then screen out the biggest producers of carbon emissions. There are several funds that endeavor to meet this criteria.
  • Focus on companies whose environmental strategies are producing tangible results. Look at the form of revenue growth, cost improvements, or enhanced franchise value, for example. This is a key process element in each manager I review.
  • Invest with bond managers who have expertise in green bonds. Green bonds are those issued by companies that develop products or provide services that seek to implement environmental solutions or support environmental projects. I know of several bond funds that focus in this area.

It is important to make sure you receive what was advertised.

Be mindful: Some green bonds are actually “brown” bonds in sheep’s clothing. Brown bonds are, in effect, loophole bonds that don’t do anything for the environment or further any sustainable objectives. Instead, they are issued “as if” they do to take advantage of favorable tax treatment or subsidies. A good environmental, social, and governance (ESG) bond manager can tell the difference.

What about performance?

There is no reason to expect underperformance from a green fund just because it screens out certain investments. It may also select certain investments using the same criteria — one of the key differences between a traditional socially responsible investing (SRI) portfolio and an ESG portfolio.

What is important is to analyze the investments for risk and return and to understand which managers are more skilled at applying these factors in their investment selections.

What about cost?

There are several factors to consider when comparing the cost of a green fund to other available funds.  Managers I reviewed for the carbon-free portfolio were no more expensive than those offering similar products without a green emphasis.

So in the final analysis, can we truly measure the emissions of our portfolio? Or understand what the actual “carbon footprint” is? No, not really.

But the data is improving as more companies are asked — and more are willing to report — about their environmental impact through the use of “sustainability reports.” The Global Reporting Initiative (GRI) is leading the charge on sustainability reporting and has developed guidelines and standards to help companies and organizations document these issues. According to the Governance and Accountability Institute, over 80% of S&P 500 companies released sustainability reports in 2015, up from 20% in 2011.

While we aren’t there yet, determining your investment carbon footprint is slowly becoming easier — one step at a time.

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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

About the Author(s)
Christopher K. Merker, PhD, CFA

Christopher K. Merker, PhD, CFA, is a director with Private Asset Management at Robert W. Baird & Co. He holds a PhD in investment governance and fiduciary effectiveness from Marquette University, where he has taught the course “Sustainable Finance” since 2009. Executive director of Fund Governance Analytics (FGA), an ESG research partnership with Marquette University, he is a member of the CFA Institute ESG Working Group, an international committee currently exploring ESG standards, publishes the blog, Sustainable Finance, which covers current topics around governance and sustainability in investing, and is co-author of the book, The Trustee Governance Guide: The Five Imperatives of 21st Century Investing.

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