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Post COP21: Investing in a low carbon world

To understand an issue as complex and important as redirecting the global economy to avoid dangerous climate change, the numbers matter. The reports in this month’s RI Quarterly call on investors to heed the new climate change calculus of the Paris Agreement.

Six months ago, an agreement contemplating so rapid a low-carbon transition seemed out of reach to many, but the Paris Agreements will come into legal force once just 55 countries representing 55% of global emissions ratify the agreement in their national parliaments.

As a consequence of fulfilling the Paris Agreement, 80% of proven coal reserves may go unused, along with half of proven gas reserves and one third of proven oil reserves. This analysis is provided in the first report in this month’s RI Quarterly by McGlade and Ekins. Although a low-carbon transition of this speed sounds drastic and potentially volatile, it is the lesser of two evils for investors according to the team at the Cambridge Institute for Sustainability Leadership, who provide our second report. Their research shows that unless significant and rapid emissions mitigation takes place, up to half the impact of the inevitable climate change and delayed transition may be unhedgeable through asset allocation decisions alone.

Investor exposure to low-carbon infrastructure is currently less than 1% of typical portfolios says Chris Kaminker at the OECD, asking important questions about current asset allocation strategies and the sustainability of historical risk/return benchmarks in this asset class. The same insights lead Caldecott and Rook from the Smith School at Oxford to pose the risk of so-called ‘stranded advice’ from asset consultants. They outline ways for investors to interpret whether their asset consulting advisor has properly considered the implications of a low-carbon transition.

While investing in the zone between too much global warming and rapid decarbonisation may seem like residing between a rock and a hard place, according to Andersson, Bolton and Samama, the news is not all bad. Their report finds that passive equity investors can enjoy a ‘free option on carbon’ through carbon-weighted indices, and as a result hedge much of the carbon risk present in passive equity portfolios through emissions reductions of up to 50%.

As our academic and investment practitioner readers will be well aware - numbers do not lie. Following resolution of the Paris Agreement, it is time for investors to redo their sums.

Nathan Fabian
Director of Policy and Research, PRI