Portfolio climate change strategy three: avoid

Where an asset owner is exposed to companies dependent on fossil fuel reserves (conventional and unconventional oil, gas and coal), reallocation is a way to reduce this exposure, bearing in mind that fossil fuels are a key component of the world economy and that sectors such as electric utilities may remain mainstream investments.

Typically, an investor will review the possibility by first measuring their exposure to high-carbon or fossil fuel companies and then assessing the impact on investments of removing or reducing this exposure. Such a review will also require assessing implications for tracking error, volatility and returns. Things to consider include:

Excluding the most carbon intensive companies such as coal and/or oil sands, on a greenhouse gas per joule basis;
Excluding using a percentage-threshold for extraction of fossil fuels;
Beneficiary and stakeholder views, and the local policy trajectory; and
Risk of underperforming the market during commodities up-cycles.

PRI evaluation

Pros: Reallocation based on carbon,financial risk exposure or values, lowers emissions in the portfolio and send a signal to the market on investor concern about carbon risk.
Cons: Reallocation has potential short-term performance implications, and does not reduce carbon usage if ownership is simply transferred to another asset owner.
Timeframe: Reallocation has an immediate impact in lowering emissions in the portfolio, although the impact on the overall global carbon budget is unclear.
Tracking and measuring performance: A carbon footprint can assess emissions in the portfolio against a baseline (including year-on-year changes) and benchmark.

Possible actions

Asset owners can undertake reallocations reviews internally, or with consultants or providers, drawing on input from beneficiaries and other stakeholders to decide on reallocation options.
Foundations can consider joining the Divest-Invest Philanthropy Coalition.