Impax champions a successful switch to fossil fuel divestment

Impax Asset Management ("Impax") the specialist investment manager focused on environmental markets and related resource efficiency sectors, has published an update of its Smart Carbon model portfolios. PIF spoke to Impax about how these three portfolios will reduce exposure to fossil fuel Exploration and Production (“E&P”) companies.

A new approach to managing climate change investment risk

In 2015, Impax developed a new approach to managing climate change investment risk within equity portfolios, exploring the potential impairment to future cash flows of companies whose valuations are linked to fossil fuel assets (i.e. extractors of coal, oil and gas).

The three model portfolios are based on modifications to the MSCI World Index, which reduce exposure to fossil fuel Exploration and Production (“E&P”) companies by varying degrees. In order to preserve energy price (factor) exposure, these holdings have been replaced with Energy Efficiency stocks.

The models have been rebalanced four times over the past year in response to MSCI index
weightings and updates to proprietary fossil fuel risk analysis. The model currently indicates a larger shift into Energy Efficiency from fossil fuel (exploration and production companies) than one year ago.

How Smart Carbon B indicates further allocation to energy efficiency

The first six months of this new approach coincide with tumultuous political times. This has created significant currency movements and has also had a major impact on investors' appetite for risk, equity valuations and oil prices. However, Energy Efficiency markets have been resilient and shown sustained positive returns over this period.

Results from this period:

Since inception, the model portfolios have performed better than the market with the full
divestment option delivering a return of 45bps in excess of the “do nothing” MSCI World
index, with limited impact on tracking error.

The Smart Carbon B model portfolio (partial fossil fuel divestment and reallocation to Energy Efficiency) now indicates a further reallocation to Energy Efficiency resulting in portfolios as shown above. By making this switch from E&P stocks to Energy Efficiency companies, the portfolios have retained energy price exposure whilst reducing carbon price risk exposure and demonstrating only a very small tracking error (0.56%). The changes in allocation have been influenced by the lower profits of the E&P companies, driven in part by long-term low oil price expectations. These results are based on model performance results that have certain inherent limitations.

If you’d like to find out more about fossil fuel divestment and how this could affect cost-efficiency in power generation, contact Impax today.