An emerging risk for clients

CARBON EXPOSURE REPRESENTS an emerging risk to investment portfolios that can be ignored no longer.

With global leaders set to meet in Paris for the latest round of talks on international action to address climate change, and with a new federal government in Ottawa having put carbon reduction at the top of its agenda, the necessity of factoring these forces into investment decisions is becoming increasingly evident. According to a new report from New York-based BlackRock Inc.’s Investment Institute: “Climate change is gaining traction as a global policy initiative, a key risk factor and an emerging investment theme.”

That traction is particularly evident in Ottawa. Not only has the new prime minister explicitly attached “climate change” to the portfolio of his environment minister, Catherine McKenna, he also has directed her to meet with the provinces following the Paris summit to develop a pan-Canadian plan to combat climate change and reduce greenhouse-gas emissions. This plan will include national emissions-reduction targets, provincial carbon pricing policies and the creation of a fund to finance projects that materially reduce carbon emissions.

Whether these promises result in concrete action remains to be seen. Previous Canadian governments have pledged action on climate change and promised to introduce mechanisms, such as a cap-and-trade emissions market, to facilitate reductions in emissions, but didn’t follow through. This inherent uncertainty makes gauging the risk of regulatory action on climate change and the possible impact of that on investment portfolios tough.

Yet, the BlackRock report suggests that “a climate change risk premium” is likely to emerge for equities in the future. As countries adopt emissions-curbing policies, such as carbon taxes or cap-and-trade systems, and as the effects of these policies filter down through the economy, the report predicts that investment securities’ valuations will be affected.

Shrewd investors will want to be ahead of the curve if environmental policies will begin impacting the value of their assets. That could mean reducing exposure to carbon-heavy industries and/or stepping up investments in renewable energy.

“If climate change regulation picks up steam, [carbon-intensive] sectors may have to write down assets that have declining or no economic worth [think: coal-powered utilities],” the BlackRock report states. “Successful investment is often as much about avoiding losers as picking winners, in our view.”

Making related shifts within portfolios as disclosure improves is getting easier for investors. Earlier this year, New York-based index giant MSCI Inc. began reporting the carbon footprint of its global equities indices, and Toronto-based TMX Group Ltd. launched new indices that screen companies based on their carbon footprints or exclude firms that own fossil fuels.