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As growth opportunities in developed markets become limited, investors are increasing allocations to emerging market strategies covering growth economies such as China, India and Brazil in order to deliver their expected returns.
However, in comparison to developed countries, public equity markets in developing countries are still dominated by resource and carbon-intensive companies, presenting additional financial risks and unique opportunities to investors as many of these countries take action to limit rising greenhouse gas (GHG) emissions.
Emerging market countries including Brazil, South Africa, India and China, have set targets to reduce emissions by 2020 under the Copenhagen Accord, which could underpin a legally binding climate change agreement covering more than 80% of global greenhouse gas emissions at the UN climate change conference that starts in Cancun next month.
The study shows that almost 80% of greenhouse gases from companies on emerging market benchmark portfolios are emitted through their own operating activities, which is likely to be subject to policy measures such as performance standards and carbon taxes proposed to achieve national emission reduction targets. Abatement costs to reduce just 4% of projected emissions could equate to more than 5% of earnings for 24 emerging market companies in the Utilities, Resource, Oil & Gas, Construction and Travel sectors in 2013. Investors finding themselves overweight in heavily carbon-intensive companies could see their returns fall relative to benchmarks.
Working with the International Finance Corporation and Trucost, the environmental research company, Standard and Poor’s (S&P) has developed a carbon efficient index to provide emerging markets investors with a benchmark to reduce this risk.
Findings show that equity funds that overweight carbon-efficient companies using the S&P/IFCI Carbon Efficient Index as a benchmark could reduce exposure to carbon emissions in emerging markets by 22%. The Index closely matches the financial performance of the S&P/IFCI LargeMidCap Index, with an annualised tracking error on the upside of 1.41%. Large institutional investors can therefore reduce exposure to carbon costs in emerging markets while replicating the return profile of the underlying index.
On a price return basis, the S&P/IFCI Carbon Efficient Index has declined 3.74% from the index launch on 11 December 2009 to 30 June 2010, but has outperformed the S&P/IFCI LargeMidCap Index by 135 bps. Likewise, during the back-test period, the S&P/IFCI Carbon Efficient Index returned a cumulative 19.17%, besting the 17.18% return of the S&P/IFCI LargeMidCap Index.
Simon Thomas, chief executive, Trucost comments, “This ground-breaking research highlights how, by using standard benchmarks, investors in emerging markets are allocating capital to more carbon intensive companies. The S&P/IFCI Carbon Efficient Index currently tracks the financial performance of the S&P/IFCI LargeMidCap Index while reducing the portfolio’s carbon footprint, presenting a significant opportunity for investors to mimimise risk from carbon regulation. As we shift to a low carbon economy and governments act to impose carbon costs on companies in these emerging economies, this Index should improve investors’ risk/return profile in emerging markets.”
