Carbon Investment

Overview of investing in carbon

This theme has been included in the Worldwise list of funds because carbon emissions are a central issue to the global environmental agenda. However, from an investment fund perspective there is no consistency of approach, meaning that each investment fund within this theme in effect represents a unique investment proposition which needs to be considered individually.

How carbon funds are managed

There are two broad approaches to this theme. The first approach is to invest directly in carbon markets, with the investment funds trading in permits and thus performance will follow the movement in the market price of carbon emissions traded on international markets.

The second approach involves investing in an index of companies, filtered by some relative measure of carbon emissions. The rationale behind this second approach is that companies which have relatively lower carbon emissions should outperform the broader markets in the future as the cost to emit carbon starts to impact company operations and eats into company profits.

Investor approach to investing in carbon

Carbon credits are issued by the European Commission as EUAs (European Union Allowance) and by the United Nations as CERs (Certified Emission Reduction). The value of these carbon credits depends both on industrial activity and future negotiated government policy. This exposes this type of investment and thus the investment funds in this area to significant unknowns which have seen returns vary wildly since the carbon markets started.

Investment funds which invest in companies which have been identified as having lower exposure to carbon emissions than their competitors is an interesting way of investing in equity markets. It is highly likely that the price to industry of emitting carbon will rise and that this will impact on company profits. Thus carbon-weighted index trackers, with a lower exposure to the carbon risks could outperform normal index trackers.

However, investors should be cautious where Fund Managers are selecting stocks on a single basis such as the ratio of carbon to turnover, because it is less clear that this ratio will lead to outperformance in the future, or lower carbon costs.