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Low Carbon ETFs for the Socially Responsible Investor

Many investors believe we are reaching a political tipping point, when the regulatory burden on firms with a large carbon footprint must increase dramatically

Kenneth Lamont 11 April, 2016 | 5:12PM

Global temperatures for the month of February eclipsed those on record, reminding investors that there may be considerations beyond simple rate of return to consider when investing for the future.

The case for low carbon investing is difficult to make on past performance

The concept of low carbon investing (LCI) revolves around reducing financial exposure to firms with high carbon emissions, for example oil majors like BP (BP.) or mining firms like BHP Billiton. (BLT) It has been popular with institutional investors such as sovereign wealth funds and endowments globally for many years. A company’s carbon intensity is one of the environmental indicators, used to determine Morningstar’s own recently launched Sustainability Ratings.

Investment Rationale

Like other forms of socially responsible investment, the thesis grounding an investment in a low carbon portfolio is jointly financial and social.

The financial case for LCI is not an easy one to make if we rely on historical performance alone. The available academic literature on the subject suggests that ‘green funds’ have not produced superior performance.

This said, many believe we are reaching a political tipping point, when the regulatory burden on firms with a large carbon footprint must increase dramatically. As regulation tightens, we can expect rising costs and falling profits. By reducing exposure to these companies, investors may be able to achieve better returns. Simply put, companies are incentivised to reduce their carbon footprint when investment is withheld or directed to competitors with a greener business model.

Low Carbon Passive Funds

The systematic screening involved in selecting low carbon portfolios makes passive vehicles an ideal low cost way to reduce the carbon footprint of a portfolio. Leading the charge in the European low carbon passive funds space are the French providers Amundi and EasyETF.

Back in 2008, BNP Paribas launched the Easy Low Carbon 100 Europe UCITS ETF, with an annual fee of 0.6%, the first of its kind in Europe. The fund selects the 85 stocks with the lowest ‘carbon intensity’ from the 285 largest companies in Europe, before adding 15 specially selected ‘green stocks’ and weighting all holdings to comply with the sector weightings of the reference universe.  As part of the screening process the ETF also excludes all those stocks from specific industries such as defence and tobacco, and those which have experienced Environmental, Social or corporate Governance (ESG) controversies, giving it a broader socially responsible flavour.

It receives four out of five Morningstar globes indicating above average sustainability score, when ranked against its category peers.

However, newer low carbon launches from Amundi currently offer broader and cheaper exposure through its Equity Global Low Carbon and Equity Europe Low Carbon index funds, each with an on-going charge of 0.2%. The World Equity exposure is also offered in an ETF wrapper, the Amundi ETF MSCI World Low Carbon UCITS ETF, with an annual management fee of 0.25%. The European fund receives four out of five Morningstar globes indicating an above average sustainability.

Interestingly, the Global index fund only receives three, an average score when compared with category peers. This can be explained by the fact that carbon emissions form only one part of the Morningstar sustainability rating, which also considers other environmental, social and governance factors.

These funds track indices which exclude 20% of the most carbon-intensive stocks in the parent index, such as MSCI world, MSCI Europe, before re-weighting to match the characteristics including style, geography, and sector, and returns of the parent index.

Both providers have opted to offer ‘low carbon’ versions of core equity exposures, that is, funds which seek to mimic the characteristics, and in the case of Amundi the performance, of broad equity markets, while excluding firms with high carbon emissions. This makes them suitable substitutes for existing core holdings rather than as tactical holdings in a portfolio.

Taking the MSCI World Low Carbon Leaders index, used by Amundi, as a graphical example, we can clearly see that the low carbon index has successfully matched and actually marginally out-performed its parent the MSCI World since its inception in late 2010. This suggests that investors may be able to reduce their own carbon footprint by replacing core equity holdings without sacrificing performance.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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About Author

Kenneth Lamont  is a passive funds research analyst for Morningstar Europe.