The carbon pollution levels of US equity mutual funds will come under scrutiny next year when Trucost, the London-based environmental research company, launches a US version of its Carbon Counts ranking of the CO2 emissions of UK retail equity funds.
Simon Thomas, chief executive and co-founder of Trucost, said there had been significant interest from large US institutional investors, particularly pension funds, to measure the carbon footprint of equity funds: “The report will use the Russell 1000 index as its benchmark and will measure the whole US mutual fund industry. There are hundreds of mutual funds, of course, so we will have to buy a certain amount of fund data. It’s a massive exercise, but one of the things we are good at is handling large amounts of data.”
Trucost’s UK study, published in July, calculated the weightings of 185 UK retail funds in companies according to the levels of carbon dioxide and then measured them against the companies in the FTSE 350 index. It revealed that socially responsible funds managed by Standard Life, the Co-operative Insurance Society and Jupiter Asset Management invested incompanies with a larger collective carbon footprint than those in the FTSE 350 index. The report said a quarter of funds marketed as socially responsible invested in portfolios of stocks that were bigger polluters than the index.
Three quarters of socially responsible funds did, however, emit less carbon across their investments than the FTSE 350 market portfolio (ex investment trusts). Funds managed by Prudential, Axa and Sovereign Ethical were shown to be the most environmentally friendly. Interestingly, the report found that more than half of the 20 most carbon-efficient funds were run on a growth investment strategy, which typically includes pharmaceutical and recovery stocks and smaller companies. Trucost said the report was significant because figures from the UK Investment Management Association (IMA) showed the sale of ethical retail funds was growing rapidly. IMA investment fund statistics for the first quarter of 2007 showed that assets in UK ethical funds had surpassed £5bn for the first time. Net retail sales reached £400m over the first three months of the year, three times the sales level in the first quarter of
2006. Thomas says Trucost does a lot of similar research for institutional investors: “We’ve worked with pension funds across Europe looking at how their carbon profile compares and contrasts when they are tracking different indices.” In December 2006, it won the mandate to provide an environmental footprint analysis of €17bn of global equity holdings of the French State Reserve Fund (FRR). Trucost has also started marketing an index against which investment funds can be benchmarked to be more carbon friendly. The index, again based on the FTSE 350 (ex investment trusts), takes an overweight position in companies with low carbon footprints and goes underweight in those that are inefficient compared to the sector average. It maintains the index sector weightings and holds all the same stocks. Trucost said back-testing of the index from 1998 to 2005 showed it had a 25% lighter carbon footprint with performance tracking error plus or minus against the index of 0.5%. The company sells the index data for a percentage of the fund’s management fee.
“We think it’s a valuable tool because we’re basically adding a call option on the price of carbon becoming more expensive,” says Thomas.
He says London-based hedge fund GLG is already using the data for its European long only alpha fund in order to knock out environmentally unfriendly companies: “So far they have taken out half of the companies from their portfolio and done a three-year back test on it for performance, and can still generate alpha.”
The Trucost chief says the company has memorandums of understanding with a number of investment banks that are looking to use the index as a base for relatedproducts: “Some are looking at enhanced alpha strategies, others are looking at carbon optimised indexation.”
Thomas, a former banker who co-founded the Emerging Markets Investment Trust business at LCF Edmond de Rothschild, says he came out of a youthful early retirement to set up Trucost in 2000 after sensing the urgency of the climate change issue and a need for related, meaningful data.
“We think it’s a valuable tool because we’re basically adding a call option on the price of carbon becoming more expensive.”
His founding partner at Trucost, Andrew Jacobs, was a former stockbroker and executive director at Nomura International. “I had a comfortable life with money invested in self storage assets (Both Thomas and Jacobs are directors of Lok’nStore, the AIM listed self-storage company) but I became fascinated with the subject. The first thing we realised was that we had to change the perception of climate change to an economic not an ethical issue because it is possible to be objective about it. The Stern report on climate change later explicitly posited the issue of climate change in financial terms. Getting the data together was hugely important in this respect. We were out in the wilderness on this for a few years because it wasn’t an issue people were talking about when we started,” says Thomas. Jacobs and
Thomas still hold 25% each of Trucost shares, with a further 25% in the hands of various business angels who provided early seed capital, and 25% held by American Bob Monks, the founder of Institutional Shareholders Services, who bought his stake in 2004.
Thomas says Trucost sources its company information from a mixture of public data and more specialist information such as production process figures, related business activities and external factors: “Most peoplehave taken into account the more obvious polluting sectors such as cement makers where it takes a ton of CO2 to make a ton of cement. But there are companies that may not be directly involved in carbon emissions, but who may be indirectly affected by the European Greenhouse Gas Emissions Scheme because of rising electricity prices. That’s something that is not clear until you dig down, but it is very relevant information to investors.”