In the face of a surge of interest among institutional investors in the carbon management of their portfolios, we have been exploring ways asset owners can take a top-down approach to carbon exposure to work in conjunction with more obvious bottom-up strategies.
Most asset owners now actively manage their exposure to climate change risks within their portfolios. In particular, risks associated with the transition to a low or zero carbon economy and the resultant future carbon pricing and taxation regimes are increasingly coming in to focus from a risk perspective.
In an extensive research paper released to our clients, our Alternatives and Derivatives Team has explored the carbon offset emission derivatives market and ways investors could use these instruments to reduce total portfolio exposure to higher carbon prices and mitigate against transition risks. Used at the same time as more direct approaches, such as evaluating asset holdings on specific ESG criteria, we believe investors can effectively hedge some of their climate change risk.
“Frontier has been advising clients on transitioning their portfolios to mitigate long-term climate change risks generally, for many years. However, there is now an increasing awareness of the issue of decarbonisation more specifically. Our research has explored ways investors can use carbon derivatives to complement the existing tools available to them to take a total portfolio approach to carbon exposure and manage climate change risks within their portfolio”, said James Bulfin, Senior Consultant at Frontier.
“Carbon derivatives are under-utilised in the institutional landscape today. And while there are some challenges, which we have explored in our analysis, we believe this is an area which has the potential to play an important future role in institutional investment portfolios and is worthwhile investors interested in carbon management getting their heads around”, James said.
There are a series of strategies investors could pursue to hedge carbon price risk, but we consider ongoing analysis and management of carbon exposures within portfolios should remain the bedrock of carbon exposure and transition assessment and management.