Investing In A Low-Carbon Economy
By seeking out more environmentally efficient operators, investors can help offset carbon risk and potentially improve risk-adjusted returns.

The Buzz Around Carbon
There is no shortage of controversy currently surrounding global warming and climate change. With the current administration rolling back or reversing previous environmental regulations and announcing the U.S. withdrawal from the 2015 Paris Agreement on climate change, there is a policy vacuum that jeopardizes the efforts to reduce global greenhouse gas emissions. Many investors are contemplating the implications climate issues could have on their personal well-being and financial stability, along with broader humanitarian consequences. While there are differing views on the severity, timing and potential effects of climate change, there is considerable discussion among both institutional and individual investors about reallocating capital away from fossil fuel-centric companies toward more sustainable operators, including those investing in clean energy technologies and infrastructure. As companies continue to disclose more reliable data pertaining to their carbon footprint and overall environmental impact, investors will gain a clearer picture of leaders and laggards and have the ability to make better-informed decisions.
Exhibit 1: Annual Global Temperature Anomalies

Source: Fortune, “Projecting the Cost of Climate Change,” April 2020.
Climate Science & Environmental Impact
There is consensus in the scientific community that rising levels of carbon in the atmosphere is one of the leading contributors to global warming. Data has shown that temperatures have risen consistently over the past few decades, the last five being the warmest on record.1 (Exhibit 1).
Climate experts seem to have identified a strong correlation between rising temperatures and an increase in carbon dioxide (CO2) concentration in the atmosphere. In the last decade, more CO2 emissions have been released into the atmosphere than any other decade in history and research shows more than 70% of global greenhouse gas emissions are tied to fossil fuels. (Exhibit 2 and 3).
Exhibit 2 - Global Greenhouse Gas Emissions Dominated By Coal, Oil, Gas, Animal Products

Sources: Our World in Data, Poore & Nemecek (2018), Science, British Broadcast Company (BBC), BofA Global Research graphic.
Exhibit 3 - Carbon Dioxide Emissions

Source: International Energy Associate; Energy related CO2 emissions as of 2019.
Past performance is no guarantee of future results.
The environmental effects of global warming include extreme weather events such as heat waves, frigid cold, droughts, wildfires, floods and hurricanes. We may already be feeling the effects of long-term global warming:
- During 2018, Europe had its second-warmest July since continental records began in 1910; record warm temperatures were observed in Scandinavia, northwestern Africa, southern Asia, and southwestern United States.2
- 2018 saw some of the most devastating fires in recent history for California and Colorado.3
Exhibit 4: California Wildfires 4-5 Times Bigger in Recent Years versus 1975-1980

Sources: Data from research paper “Observed Impacts of Anthropogenic Climate Change on Wildfire in California,” July 2019, BofA Global Research graphic, Note: data approximated from research paper.
- Record rainfall across the Midwest United States caused widespread flooding during 2019, severely hampering farmers’ ability to sow crops during the limited planting window.4
- Alaska smashed heat records in March 2019 with temperatures averaging 11 degrees Celsius above normal, causing the Bering Sea to open up three months sooner than usual.5
Exhibit 5 - Arctic Minimum Sea Levels are Down Around 40% in 2015-2018 versus 1975–1980

Sources: National Aeronautics and Space Administration (NASA) data, BofA Global Research graphic, as of January 2020. Note: Data approximated from NASA graph.
- During 2019, widespread fires in the Amazon basin, fueled by drought-stressed areas, resulted in the destruction of carbon-dioxide absorbing forests that are essential to the health of the planet.6
While these events may cause only temporary disruption, geographical changes such as melting polar ice caps, rising sea levels and warming ocean temperatures pose a permanent threat to our planet. Essentials like food, water and medicine are commodities that may be abundant today but whose supplies could be strained in the not-too-distant future due to global warming. And there are also significant economic implications as societies wrestle with relocating coastal population centers, rebuilding infrastructure, responding to negative effects on health, and securing adequate fresh water and food supplies. University of California, Berkeley scientists estimated that three degrees of global warming would cost the median American county 4% of its gross domestic product (GDP) and this figure would likely rise to a loss of 6% or more with five degrees of warming (Exhibit 6).
Exhibit 6 - Economic Impact of Climate Change on the U.S.

* Estimated. Past performance does not guarantee future results. Source: The Economist, March 2019.
Investor Risks & Opportunities
There is a compelling investment case that companies that are environmentally efficient (i.e., using fewer natural resources and generating less waste in the production process) have an economic advantage over their peers. Research suggests these leaders may enjoy a cost advantage, greater flexibility and efficiency in their supply chains, increased productivity, less regulatory risk, and fewer instances of costly fines, recalls or mitigation requirements.
A 2019 report titled Blind to Carbon Risk? An Analysis of Stock Market’s Reaction to the Paris Agreement, found that the stocks of companies with solid environmental performance historically experienced both steadier overall performance and less downside capture than the stocks of firms with poor environmental performance. This effect, not surprisingly, was more pronounced in manufacturing and resource-intensive industries.
Investors may have differing views on how to best position a portfolio for the transition to a low-carbon economy. A key decision is whether to fully divest from carbon-intensive market sectors such as energy and fossil fuel-burning utilities or to invest in companies from all market sectors, which are best positioned for this transition. Some ESG investors believe that divesting entirely from fossil fuel companies is the “right” thing to do. One can argue that starving fossil fuel development projects of capital will raise the cost of extraction and further level the playing field with renewable energy sources.
A less restrictive approach involves avoiding more carbon-intensive fuels like coal or oil from tar sands, while looking for companies with a positive trend toward reducing carbon intensity. This method allows investors to maintain energy exposure but with an environmental focus. For example, businesses providing renewable energy infrastructure, clean technology and resource efficiency tools are likely to thrive in a carbon-regulated environment especially given the improving economics of low carbon technologies like electric vehicles and renewable energy power production (Exhibit 7a and 7b). In addition to solving environmental challenges, investing in these companies may lead to better operational and resource efficiency, potentially improving the bottom line and driving long-term growth.
Exhibit 7a - Falling Lithium-ion Battery Costs Enabling Move to Electric Vehicles

e=Estimate. Sources: Bloomberg New Energy Outlook, BofA Global Research graphic as of 2018.
Exhibit 7b: Solar and Wind Costs Now Similar or Below Fossil Electricity with Further Reductions to Follow

e=Estimate. Sources: Bloomberg New Energy Outlook, BofA Global Research, April 28, 2020, Note: Graph shows U.S. data but illustrative of global trends despite differences in absolute levels of cost of energy.
Environmental Stewardship & Sustainability (E2S) & Carbon Reserve Free (CRF) Portfolios
Our Chief Investment Office (CIO) Socially Innovative Investing (S2I) platform offers two internally managed investment strategies with an environmental focus, Environmental Stewardship & Sustainability (E2S) and Carbon Reserve Free (CRF). Both strategies seek to identify companies within the S&P 1500 universe with leading environmental policies and practices compared to their industry peers. The two-part due diligence framework examines corporate disclosure of policies relating to the environment and considers a company’s track record and performance on quantifiable factors to ensure that policy decisions produce the intended outcomes. While this “scoring” process takes into account a variety of environment, social and governance (ESG) factors, environmental metrics have a more significant contribution to the overall company assessment. The E2S portfolio seeks to invest in the top-performing companies in each economic sector, even those industries with a poor reputation for environmental performance. Companies that provide “green” solutions are often looked at favorably within the context of the S2I framework; however, it is unlikely that a speculative renewable energy company will qualify for inclusion, due to size, maturity or other fundamental factors.
For investors who choose to divest from fossil fuels, the CRF portfolio uses the same rigorous stock selection methodology while removing energy and fossil fuel-burning utility companies. In order to avoid adding unintended risk, the resulting portfolio is “optimized” to reduce tracking error to the benchmark. This final step aligns the portfolio to the overall market, with the exception that its environmental performance may be considered superior, allowing the potential for more favorable risk-adjusted returns over the long term. As shown in Exhibit 8, both strategies offer substantial improvements over the carbon intensity of the market as a whole and also demonstrate greater improvements in reducing the amount of carbon emitted per unit of sales over the past three years.
Exhibit 8: Carbon Intensity

Source: Most recent available data from MSCI as of 3/31/20; This figure represents the most recently reported or estimated Scope 1 + Scope 2 greenhouse gas emissions in metric tons of carbon dioxide equivalent, normalized by sales in USD, as a weighted average of the companies held in each portfolio. Past performance is no guarantee of future results. Short-term performance shown to illustrate more recent trend.
Conclusion
Today’s investors have many choices when it comes to applying an environmental lens to their portfolio. More-sophisticated portfolio construction techniques make it possible to adhere to an “environmentally friendly” investment mandate without adding significant risk. In fact, given the recent evidence supporting the case for investing in environmental leaders, potential risk-adjusted returns may be attractive indeed. Even with the heightened scrutiny around carbon intensity and climate change, evaluating your investment portfolio for environmental and economic risk will likely be an ongoing process. There is no one “right” strategy, and your implementation strategy may evolve over time. But given the direction of the global economy and development of institutional class investment strategies, now is a great time to get started.
To learn more about investment opportunities and the Chief Investment Office Socially Innovative Investing, E2S or CRF portfolios, please contact the Socially Innovative Investing Team at dg.s2i-core@bankofamerica.com.
1 National Oceanic and Atmospheric Administration, January 2020.
2 National Centers for Environmental Information, July 2018.
3 World Resources Institute, March 7, 2019.
4 National Geographic, June 3, 2019.
5 Union of Concerned Scientists, April 12, 2019.
6 NASA, Global Climate Change, November 2019.
Index Definition
Securities indexes assume reinvestment of all distributions and interest payments. Indexes are unmanaged and do not take into account fees or expenses. It is not possible to invest directly in an index. Indexes are all based in dollars.
S&P 1500 is a stock market index of U.S. stocks made by Standard & Poor’s. It includes all stocks in the S&P 500, S&P 400 and S&P 600. This index covers 90% of the market capitalization of U.S. stocks.
Important Disclosures
The opinions are those of the author(s) and subject to change.
The Chief Investment Office (CIO) provides thought leadership on wealth management, investment strategy and global markets; portfolio management solutions; due diligence; and solutions oversight and data analytics. CIO viewpoints are developed for Bank of America Private Bank, a division of Bank of America, N.A., (“Bank of America”) and Merrill Lynch, Pierce, Fenner & Smith Incorporated (“MLPF&S” or “Merrill”), a registered broker-dealer, registered investment adviser and a wholly owned subsidiary of BofA Corp. This information should not be construed as investment advice and is subject to change. It is provided for informational purposes only and is not intended to be either a specific offer by Bank of America, Merrill or any affiliate to sell or provide, or a specific invitation for a consumer to apply for, any particular retail financial product or service that may be available.
All recommendations must be considered in the context of an individual investor’s goals, time horizon, liquidity needs and risk tolerance. Not all recommendations will be in the best interest of all investors.
Impact investing and/or Environmental, Social and Governance (ESG) managers may take into consideration factors beyond traditional financial information to select securities, which could result in relative investment performance deviating from other strategies or broad market benchmarks, depending on whether such sectors or investments are in or out of favor in the market. Further, ESG strategies may rely on certain values based criteria to eliminate exposures found in similar strategies or broad market benchmarks, which could also result in relative investment performance deviating.
Investments have varying degrees of risk. Some of the risks involved with equity securities include the possibility that the value of the stocks may fluctuate in response to events specific to the companies or markets, as well as economic, political or social events in the U.S. or abroad. Investments in foreign securities involve special risks, including foreign currency risk and the possibility of substantial volatility due to adverse political, economic or other developments. These risks are magnified for investments made in emerging markets. Investments in a certain industry or sector may pose additional risk due to lack of diversification and sector concentration.