'Smart Carbon Portfolios' capitalise on low-carbon transition, without sacrificing returns

Ridhima Sharma
clock • 2 min read

‘Smart Carbon Portfolios' enable investors to capitalise on a low-carbon transition, without sacrificing returns, according to new research from Imperial College Business School.

With global warming making the last five years the hottest on record (NASA), pressure is mounting on governments of the world's major economies to reduce greenhouse gas emissions. Carbon prices in Europe have jumped by 200% in the past 12 months and there is increasing momentum around "carbon pricing[1]" in major economies around the globe. The research developed an asset allocation model to capture the potential impact of carbon pricing on fossil fuel stocks and to create what they call Smart Carbon Portfolios.

Mark Carney, Governor of the Bank of England, has warned of the potential perils of ‘transition risk' arising "through a sudden and disorderly adjustment to a low-carbon economy." In response, financial researchers at Imperial are developing new tools that allow investors to hedge against escalating risks, while sacrificing virtually no ex-ante financial gains. The Smart Carbon Portfolio is statistically indistinguishable from relevant unhedged portfolio benchmarks.

Ian Simm, Founder and Chief Executive of Impax Asset Management Group, said: "Companies and investors are under increasing pressure to use forward-looking scenario analysis to assess their climate change risks. This research goes beyond the generic guidelines and demonstrates, in a practical way, that scenario analysis can be used not just to assess risk, but effectively manage it as well."

In further work on this topic, Imperial College Business School has produced a framework to help investors differentiate amongst oil & gas majors' preparedness for a low-carbon energy transition. The research finds that transition preparedness varies significantly across the sector. European oil & gas majors markedly outperform their North American counterparts, with European-based firms adopting early innovations and material strategic options for transformation in response to stakeholder pressures.

The framework consists of a set of 15 parameters based on key dimensions identified by the Financial Stability Board's Task-force for Climate-related Financial Disclosure (TCFD).  The new parameters go beyond existing rule-based indices, which fail to adequately consider governance, strategic planning and risk management policies within these businesses.  Most importantly, the new framework considers companies' investments in new lines of business and tangible efforts to re-shape business models in response to declining demand in the power and transport sectors.

Charles Donovan, Director of the Centre for Climate Finance and Investment at Imperial College Business School, said: "For the oil and gas sector, the heat is on. Pressure is mounting on the industry heavyweights to respond to the strategic challenges posed by an energy transition. Everywhere you look, there are signs this transition is accelerating.  Our research reveals some names are far better placed than others.  In pulling investment from a range of oil and gas producers, Norway's sovereign wealth fund sent a shot across the bow for the industry. Investors will need to place their bets, and soon."