Imperial College’s Centre for Climate Finance and Investment has created a smart carbon portfolio model for institutional investors to assess and manage energy transition risks.

Carbon pricing is used widely in Europe and being tried in China, India and the US, with 20 per cent of global economic activity subject to some form of carbon tax, and the concept has momentum, with carbon prices in Europe jumping by 200 per cent in the past year. Overall, investors recognise that climate change poses financial risks, but institutional investors often lack quantitative models to address their exposures.

Underweighting sectors with high carbon footprints, such as airlines, energy, and industrials, is, in the eyes of the Centre, ‘naïve’ as actions misread energy transition risks and could reduce long-term portfolio returns as well.

The Centre has offered an alternative model: The Smart Carbon Portfolios are constructed by incorporating probabilistic assumptions on carbon pricing to the universe of stocks in the MSCI World Index. The results show that the financial costs of reducing carbon risk are found to be statistically negligible.

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