An Investment Strategy to Save the Planet

New York’s investment in Goldman’s fund is an example of a third way.  The fund starts with the Russell 1000, excluding coal producers.  Then it groups companies by sector, such as health care or information technology, and within each sector increases the shares of companies with the lowest emissions, and reduces those of companies with higher emissions.  Goldman will periodically re-weight the fund to try to mimic the returns of the benchmark, but to do so in the lowest-carbon way possible.  Goldman says the historical performance of the basket of stocks matches the performance of the Russell 1000 while reducing carbon emissions by 70 percent.

This is called index or passive investing because there is no active money manager trying to beat the market by picking stocks.  Passive funds seek only to match the market, but they outperform active funds for investors 75 percent of the time, largely because the passive funds’ fees are much lower.
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Why do these funds matter?  First, because they could become very, very big.  Second, all companies, not just energy producers, emit carbon, and burning carbon releases far more greenhouse gas than extraction of it does.  So these funds use the market to encourage all companies to reduce their emissions.  By putting money into the most environmentally responsible companies in each sector, they help those companies grow at the expense of less responsible ones, while creating an incentive for all to bring down emissions.

Green indexes are not new.  FTSE had a version in 2001, and Standard & Poor’s started in 2009. But they are only catching on now.  One reason is that we now have more than a decade’s worth of data about companies’ carbon footprints.  The data comes largely from a nonprofit group called CDP, formerly the Carbon Disclosure Project.

Since 2003, CDP has been asking companies to provide information about their carbon emissions.  CDP’s request for information to each company goes out under the signature of 822 major institutional investors.  Requests go to every publicly traded company in the world, and many provide answers — 75 percent of the S&P 500, according to Paula DiPerna, special adviser to CDP North America, and companies that issue 55 percent of stocks traded worldwide. Although the information is self-reported, most of the responses have been audited, said DiPerna. For companies that don’t report to CDP, index providers work with environmental data analysts such as TruCost and Sustainalytics to estimate emissions.
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Carbon-efficient companies ... often outperform their less responsible counterparts; research that tracks companies over a long period found thathttp://www.msci.com/ those that had worked to improve their environmental, social or governance records did nearly 5 percent per year better than other companies.  Other researchers found that these companies were less volatile and risky.

There are other reasons for the current interest in low-carbon index funds.   Institutional investors are increasingly moving money into passive funds to reduce fees, and universities are under pressure from students to do more than divest.

In October the Obama administration made long-awaited changes in its guidance for private pension funds.  The Bush administration had changed the guidance to compel pension fund managers to consider only financial returns when choosing investments.  Now investors are free to consider a company’s environmental, social and governance records, as long as they do not compromise their fiduciary obligations.

For many pension fund managers, environmental factors are financial factors. Climate change already costs the world — and its corporations — trillions of dollars.  In the long term, there is no greater financial risk, and long-term risk is exactly what pension fund managers are paid to worry about.

Pension fund managers aren’t alone.  One in every six dollars invested in the United States is screened for environmental, social or governance factors, and the number is rising fast.

S&P, for example, is now taking climate considerations into credit ratings, the investment research firm Morningstar is calculating carbon ratings for its mutual funds, and MSCI is publishing the ratings of all 160,000 indexes it designs.

Read more at An Investment Strategy to Save the Planet