Low-carbon and factor-based investing are two key trends in the global investment management industry. This paper investigates the impact of low-carbon screening on traditional market-cap-weighted portfolios and factor portfolios (quality, value, momentum, and low volatility) across seven Asian markets: Australia, China, Hong Kong, India, Japan, South Korea, and Taiwan.
In December 2015, under the Paris Agreement, nearly 200 governments adopted a consensus to limit the increase in global average temperature to “well below 2°C above pre-industrial levels and to pursue efforts to limit the temperature increase to 1.5°C above pre-industrial levels.”2
Governments are now increasingly becoming aware of the perils of greenhouse gases (GHGs) and aiming to penalize the source of pollution while looking to incentivize low-carbon technologies. Pricing carbon emissions is one potential approach to reducing GHG emissions. As of 2017, carbon prices averaged around USD 40 per metric ton of carbon dioxide and are expected to increase in the near future, which could affect companies directly with regulatory costs imposed on their operations through energy and fuel price increases, or indirectly through costs passed on by suppliers. These costs may be borne by companies or passed on to consumers in the form of higher prices.3 Therefore, understanding carbon exposure is essential for businesses to manage risk.
It is equally important for asset owners, lenders, insurance underwriters, and portfolio managers to factor in the impact of climate risks in order to make informed decisions. They may want to consider an organization’s future financial position to discount potential write-downs of assets as well as the effect on revenues, costs, cash flows, and capital expenditure associated with adhering to policy changes to factor in climate risks. Eventually, one could expect capital flight toward investment themes that are aligned with global climate commitments.
The Japan’s Government Pension Investment Fund (GPIF), for example, decided to invest in carbon efficient passive portfolios that seek to track global and domestic carbon-efficient indices4 in September 2018, with the intention of promoting carbon efficiency and disclosure by companies. The global market for environmental, social, and governance (ESG) exchange-traded funds (ETFs) alone is expected to expand from USD 25 billion to more than USD 400 billion within a decade.5 In Japan, sustainable investments have grown fourfold between 2016 and 2018.6