​How to carbon-neutralize your stock portfolio

Climate change is on everyone's mind. This year is on pace to be the hottest since record-keeping began in 1880, and extreme weather is adding to risks and costs for businesses, governments and citizens. That's raising the question among many investors about how they might "carbon-neutralize" their portfolios.

The issue is coming up increasingly often, said State Street Global Advisors managing director Chris McKnett, who's in charge of the firm's global environmental, social and governance investments business. While some institutions have looked at the question from a divestment perspective, others are now seeking out strategies for investing in companies with low-carbon emissions, as well.

"If they have a portfolio where they are exposed to climate risk and carbon emissions, more and more investors are starting to recognize that that represents a genuine economic risk," said McKnett. "They want to take steps to mitigate or reduce that risk."

That's something of a switch from the earliest investors who sought to invest in environmentally friendly companies. Those investors wanted to align their beliefs with their money, which led to a trickle of "socially responsible" mutual funds that invest based on yardsticks such as whether companies promote animal welfare or sustainable fishing.

But with climate change now a growing topic of concern, investors are considering other issues besides ethics, including whether companies with high levels of carbon emissions or if that produce fossil fuels might be subject to financial risks, ranging from higher taxes to lower growth rates as societies search for alternative fuel sources.

"The focus by investors, whether institutional or retail, on carbon in the climate is remaining very acute and frankly will become more acute going forward," McKnett said. "The interest in these strategies is not a temporary fad. It's borne out of the growing recognition that business as usual, from a carbon standpoint and climate change standpoint, is really not sustainable in and of itself."

With investors considering more strategies for carbon-proofing their portfolios, State Street has created two exchange-traded funds geared toward helping investors mitigate climate change risk. The first is the SPDR MSCI ACWI Low Carbon Target ETF (LOWC), and the second is the SPDR S&P 500 Fossil Fuel Free ETF (SPYX).

The Low Carbon ETF overweights companies with ... low carbon emissions, and its top holdings are well-known names such as Apple (APPL) and Microsoft (MSFT). The Fossil Fuel Free ETF invests in companies that don't hold fossil fuel reserves.

The Low Carbon ETF "provides a tool for investors who really are concerned about carbon exposure in their portfolios either from the economic dimension or the environmental dimension, and those aren't mutually exclusive," McKnett noted.

Still, it remains debatable whether investing in a fund that avoids companies with high carbon emissions or fossil fuel holdings can shield an investor, given that the full risks and impact of climate change aren't entirely known. Without action, climate change costs could lower GDP by -1.5 percent per year, leaving global investment portfolios at risk for losing 45 percent of their value, according to Bank of America Merrill Lynch Global Research.

With more countries looking for alternatives to fossil fuels, demand for low-carbon infrastructure might climb, which could lead to new bonds being issued to finance those efforts, according to the bank, which estimates an annual need for $6.2 trillion to meet that demand.

"Green bonds, fixed-income instruments where proceeds are earmarked for environmental solutions, are key to mobilizing private capital for environmental needs," the report noted.

Of course, buying bonds can be tricky for individual investors, but funds are already available that invest in bonds, such as the Calvert Green Bond Fund (CGAFX), which invests in debt used to advance environmental sustainability and human rights.

It's an issue that might only grow over the next several years, said State Street's McKnett, who added: "Investors are really just starting to get focused on this now."