Among the private clients which wealth managers work with, there is a growing desire for their portfolios to achieve net zero greenhouse gas emissions.
A rotten British summer, plus excessive heat and wildfires across the US, Canada and southern Europe offered further evidence that greenhouse gas emissions are a significant factor in global warming.
Nearly all countries have signed up to the UN Paris Agreement, a legally-binding international treaty on climate change. Investment managers are also very much alive to the environmental challenges. Upwards of 5000 investment firms, managing more than $125tn have become signatories to the UN Principles for Responsible Investing (UNPRI). The majority of the 135 data contributors to the ARC Private Client Indices are signatories to UNPRI too.
Implementation of the Paris Agreement requires economic and social transformation by countries, companies and consumers. But what of discretionary investment managers and their clients? How can they embed net zero – commitments requiring minimisation of greenhouse gas emissions – into investment outcomes?
Ostriches and meerkats
In behavioural finance, the ‘ostrich effect’ is the tendency for people to avoid or ignore negative financial information for as long as possible. A paper published by Karlsson et al noted that investors were less likely to monitor their investment portfolios, following equity market downturns.
Anecdotally, private clients often appear to be behaving rather like ostriches when it comes to incorporating environmental, social and governance (ESG) issues into investment guidelines and performance reporting. At least part of the reason appears to be that they are faced with far too much subjective information and far too little objective fact. The result is that presented with a deluge of negative data and to avoid being overwhelmed, they bury their heads in the sand.
However, a follow-up study by Gherzi et al identified that some UK online investors behaved more like ‘meerkats’. Following market downturns, these investors significantly increased their vigilance to the point where they were consuming too much information, experiencing unhelpful anxiety and making poor investment decisions. Again anecdotally, investment managers appear to be responding to ESG issues in a meerkat fashion. Information overload compounded by proprietary metrics has left investors feeling confused.
Such hypervigilance not only carries the danger that it will result in poor investment decisions. It has spilled over into client performance reporting. Information overload compounded by proprietary metrics has left investors feeling confused and suffering from emotional contagion.
What might be more effective is for investors and investment managers to find a middle ground on the ostrich-meerkat spectrum. Between the blizzard of noise and the bliss of silence, there should be a place where rational responses are possible.
Seeking the middle ground
Among the private clients we work with, we sense a growing desire for their portfolios to achieve net zero greenhouse gas emissions. By purchasing carbon offsets investors can act now to attain net zero for their investments and make a small contribution towards preventing global warming.
To start the journey towards a net zero impact portfolio, an investor can simply ask their investment manager to provide a figure for “carbon emissions per pound invested”. While managers might initially resist, the data is available for managers to calculate at least a reasonable estimate and, if the manager is a UNPRI signatory, they will find it awkward to refuse.
Consider the following worked example: the world equity index has carbon intensity measured as Scope 1 and Scope 2 emissions of around 100 tonnes per £1m ($1.3m) invested. However, most private client portfolios have a much lower carbon intensity due to being underweight in energy, mining and utilities. In our experience, the average private client equity portfolio runs at around two-thirds of that figure, or 65 tonnes per £1m invested. A lack of consistent data for non-equity investments means that the easiest route is probably to scale up the equity figure to cover the entire portfolio value.
At the low end of the scale, planting one tree will sequester one tonne of carbon over its lifetime and the cost of one tree is roughly £1 through a scheme such as One Tree Planted. If the desire was to offset the carbon footprint in one year, then other routes are available. These include the Durrell Rewild Carbon programme, where the cost is around £30 per tonne. For this example, let’s assume the cost of carbon offset is somewhere in the middle, say £8 per tonne. For a multi-asset class portfolio of say £10m, the cost of moving the portfolio to net zero would be £8 x 65 x £10 = £5200 or approximately 5 basis points.
The cost of carbon offset should be considered as negative alpha or as a hidden fee. If investors are serious about being part of the solution to reaching net zero by 2050, carbon offsets make sense not least as investors are the owners of the company.
For those investors looking to respond to the climate crisis, carbon offset offers a valuable contribution towards the planet achieving net zero. The cost is not excessive. Carbon offset is available at between 1 basis point and 20 basis points per annum.
Whether you are an ostrich or a hyper-vigilant meerkat stuck in a quagmire of confusing data, carbon intensity offers a simple actionable data point. Investment managers should be willing and able to provide their clients with the necessary data for the carbon offset cost to be calculated. Let’s embrace this opportunity; to quote Emmanuel Macron: “There is no planet B.”
Graham Harrison, chairman, Asset Risk Consultants
