By Dr. Basma Majerbi. Originally published in the fall 2019 issue of Business Class magazine.
In this Ask A Prof feature, we invite alumni to pose questions to Gustavson faculty. In this edition, Associate Professor Basma Majerbi answers: What should I as an investor know about the transition to a low-carbon economy?
Financial systems and the low-carbon economy
The effects of climate change are becoming increasingly apparent. While our financial systems are not yet buckling under the strain, they are under high pressure. Investors need to be aware of these pressures and understand that they themselves are a source of pressure, which they can alleviate by shifting investments to the low-carbon economy. Financial systems, composed of banks and other financial institutions, financial markets, and their regulatory and supervisory authorities, will need to adjust. But why and how should individuals invest in the low-carbon economy? Is it an ethical or a financial choice? Or is that a false dichotomy?
Low-carbon investments make financial sense
Whether in five years or 30 years, the world is transitioning to a low-carbon economy. Companies and investors that do not take this into account are inviting larger risks and missing opportunities. Reducing or avoiding exposure to carbon-intensive stocks is a hedge against climate change risk even if it doesn’t lead to higher returns in the short run. Oil companies may have enjoyed high profits recently, but this should not be taken as an indicator of future performance.
Considering past performance, as investors typically do, the trends are not favourable to carbon-intensive stocks. For example, look at the S&P/TSX EW Oil & Gas Index in the Canadian market: it has consistently underperformed compared to more general benchmarks such as the S&P/TSX Composite Index (CAD), with an annualized total return of -0.72% vs 7.33% respectively over the last 10 years. Using the last five-year average returns, the numbers are worse: -10.21% vs 4.1%. On the other hand, the S&P/TSX 60 Fossil Fuel Free Index delivered, over the last five years, an annualized total return of 6.77% compared to 4.97% by the S&P/TSX 60 Index (which includes fossil fuel stocks) over the same period.*
In addition to investing in low-carbon companies, many environmentally-friendly financial products such as green bonds offer financially sound alternatives to conventional portfolios focused on fixed income.
Advocating for non-conventional financial goals
Financial advisers often look at an investor’s risk tolerance and other criteria such as age. Based on this profile, they make suggestions on portfolio choices. They will rarely ask investors about their ethical, social or environmental goals. Investors need to ask the question and challenge advisers to thoroughly explore the answers. Discussing the numbers, such as historical returns for low-carbon funds or other socially responsible investment choices, will help investors make informed decisions. Fortunately, there’s increasing awareness among financial advisers about the need for more knowledge on this subject, not only to meet investors’ demands but also to prepare for new regulatory pressures to transition to a climate-smart financial system.
Individuals make a difference
Exactly as it happens in the consumer markets, the more investors demand products that align with their values, the more the financial sector will use creativity and expertise to offer climate-friendly financial instruments. Every investor counts in this debate. It’s important at the individual level that people assert their values not only in what they consume but also where they invest their money. It makes sense financially, and it’s the right thing to do for our children’s future.
*All data from https://web.tmxmoney.com/indices.php?section=tsx as of August 30, 2019.
Or go to tmxmoney.com under “Research”, select “Indices and Constituents” and see factsheets “F” for historical performance and other analytics on multiple indices for the Canadian market.
Dr. Basma Majerbi is an associate professor of finance at Gustavson. Do you have a question for a Gustavson professor that you’d like to see featured in a future issue of Business Class? Email it to bizedit@uvic.ca for consideration.
Photo: Karsten Würth on Unsplash
