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How Carbon Offsetting Works, and What Investors Should Know

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How Carbon Offsetting Works, and What Investors Should Know

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Carbon Offsetting: What Investors Should Know

In 2016, an international treaty known as the Paris Agreement was negotiated by member nations of the UN Framework Convention on Climate Change.

The long-term goal of this agreement is to limit the increase in global temperature to below 3.6°F (2°C) over the next century. Achieving this target will require the world to develop cleaner solutions across all areas of the economy, from energy to transportation.

In this infographic from New York Life Investments, we introduce carbon offsetting, an activity used by both businesses and investment funds that has the potential to accelerate the development of a more climate-friendly economy.

What are GHG Emissions, and Where do They Come From?

Greenhouse gases (GHGs) are a family of gases known to trap heat in the Earth’s atmosphere. The most prevalent among them is carbon dioxide (CO₂), which accounts for 80% of America’s GHG emissions. Common sources of CO₂ include fossil fuel consumption and deforestation.

Businesses are often significant emitters of CO₂, but due to the complexity of their production chains, emissions can be difficult to track. To combat this, a company’s carbon footprint is measured across three scopes:

  • Scope 1: These are direct emissions from a company’s operations. An example would be the CO₂ emitted by company-owned factories.
  • Scope 2: These are indirect emissions from a company’s operations, such as the pollution generated from purchased electricity.
  • Scope 3: These are indirect emissions from the company’s supply chains. Common sources include the extraction of raw materials and business travel.

Although we understand that GHGs are harmful to the planet, our ability to eliminate them is limited by technology and costs. Fortunately, this is where offsetting can help.

How Does Carbon Offsetting Work?

Carbon offsetting is a method of neutralizing one’s emissions by investing in GHG-reducing projects. The benefits of these projects are measured by the amount of CO₂ equivalent (CO₂e) that they avoid or absorb. Then, the company or fund that is engaging in the carbon offsetting project will then receive one carbon credit for every tonne of CO₂e negated.

Below are the three common types of GHG reduction programs.

1. Energy efficiency projects

These projects reduce energy consumption. One example is the distribution of energy-efficient cookstoves in Rwanda, a country where many people rely on firewood and charcoal. By distributing 10,800 cookstoves throughout the country, nearly 60,000 tonnes of CO₂e can be avoided each year.

2. Forestry projects

These projects nurture and protect our CO₂-absorbing forests. One notable example is the Garcia River forest protection program, which ensures the longevity of California’s redwood forests. The program oversees over 9,600 hectares which has been estimated to store almost 80,000 tonnes of CO₂e annually.

3. Renewable energy projects

These projects reduce our dependency on fossil fuels. They are especially effective in economies such as Taiwan, where 75% of electricity capacity relies on fossil fuels. Thanks to its strong coastal winds, Taiwan is able to remove 328,000 tonnes of CO₂e per year with just 62 wind turbines.

How is Offsetting Regulated?

Carbon offsetting in America is primarily a voluntary activity, but some state governments have made it mandatory for significant polluters. Here’s how both markets are regulated.

The Voluntary Market

The voluntary market is regulated by a variety of third-party organizations such as Verra, Gold Standard, and American Carbon.

They conduct audits on GHG reduction projects to ensure each one meets four broad criteria:

  • Measurability: The GHG savings of the project must be measurable
  • Verifiability: The results of the project must be verified on an annual basis
  • Sustainability: Each project should have a minimum lifespan of seven years
  • Additionality: GHG reductions of project must be considered in reference to a baseline scenario

Carbon credits are only issued after a project has passed this verification process.

The Mandatory Market

Some U.S. states have introduced carbon offsetting schemes to meet their climate goals. One of the largest is California’s Cap and Trade program which was introduced in 2013.

The program is targeted at businesses that emit over 25,000 tonnes of CO₂e annually, and works by setting a “cap” on total annual emissions. This cap is reduced each year, and overpolluting businesses must acquire carbon credits to offset their excess pollution. These can be purchased from state-administered auctions or from other firms.

Revenues generated from California’s carbon credit auctions are used to fund various GHG reduction projects, including:

  • 690,000 acres of land preserved or restored
  • 287,000 rebates issued for zero-emission and plug-in hybrid cars
  • 108,000 urban tree plantings
  • 150,000 energy efficiency projects installed in homes

By 2030, California’s emissions cap is intended to reach 200.5 million tonnes of CO₂e, marking a near 50% reduction from its 2015 level.

What Role can Investors Play?

A majority of U.S. investors consider themselves to be values-based, meaning they care about the societal and environmental impacts of their investments. This mentality is increasing the demand for ESG investing and placing pressure on corporations to become more sustainable.

For example, the percentage of S&P 500 firms that publish sustainability reports has risen from just 20% in 2011 to 90% in 2019. More importantly, a growing number of U.S. firms are cooperating with the CDP (formerly the Carbon Disclosure Project) to report their emissions and set formal reduction targets.

YearCompanies with active emissions reduction targetsAll other companies reporting to the CDPTotal
2013322166488
2014335164499
2015365143508
2016378124502
2017385123508
2018389117506
2019419138557

Source: CDP 2020

Some of the world’s largest oil producers are also taking action—a testament to the significance of these shareholder concerns. Royal Dutch Shell announced earlier in 2020 that it intends to fully offset its Scope 1 and 2 emissions.

Does Offsetting Really Help?

Carbon offsetting programs such as the one implemented by California have the potential to generate revenues and encourage innovation. Critics, however, have suggested it has a number of design issues.

One such issue is the fact that California’s carbon credits do not expire. This could allow companies to stockpile credits and ignore future cuts to the emissions cap. Another concern is that the companies covered by California’s cap and trade will simply pass their higher costs to the consumer, although this claim didn’t seem to hold up in a 2016 study conducted by UCLA.

Other inefficiencies within the program may exist, but its benefits are hard to ignore. By the end of 2019, the revenue generated from California’s carbon credit auctions totaled $12.5 billion. Of this amount, over $5 billion has been invested in GHG reduction projects to date.

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Infographics

Five Trends for Investors to Watch Amid a COVID-19 Recovery

As economies face structural shifts, this infographic covers five trends that have the potential to alter financial markets amid a COVID-19 recovery.

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5 Trends for Investors to Watch Amid a COVID-19 Recovery

If history tells us anything, crisis forges change.

Like other pandemics throughout history, COVID-19 led to tectonic shifts in society, markets, and government policy. People and businesses are rethinking traditional work structures, while inflation concerns are rising amid trillions in stimulus injections. But what impact does this have on investors?

To answer this question, this infographic from New York Life Investments pinpoints five trends to watch amid a COVID-19 recovery.

1. Inflation

Today, investors are closely watching inflation. Core factors that influence inflation include:

  • Increasing money supply
  • Rising raw materials costs

Between 2020 and 2021, the money supply in the U.S. rose over 28%. Meanwhile, building materials and supplies, as shown through the producer price index, have jumped 44% between May 2020 and May 2021.

In fact, as of May 2021, inflation has seen its greatest rise in over a decade, with year-over-year figures increasing 5%.

The Opportunity

To hedge against potential inflation risk, investors can consider the following asset classes:

  • Infrastructure
  • Bank loans
  • Gold
  • Commodities
  • Real estate
  • Treasury inflation-protected securities (TIPS)

2. Innovation

How companies navigate digital disruption will likely affect their revenues and future operations. Notably, during COVID-19, companies that adopted new technologies saw higher revenues than their peers, according to one survey.

Companies that reported over 25% revenue growth  
First to experiment with new technologies during the crisis72%
Not the first to experiment with new technologies during the crisis33%
Invested more in digital-related expenditures67%
Did not invest more in digital-related expenditures31%

*Responses from 899 C-level executives and senior managers representing the full range of regions, industries, company sizes, and functional specialties. Compared to industry peers, time period is over three years.
Source: McKinsey, 10/05/20

The Opportunity

Frontier technologies have the potential to reshape markets and productivity both during and after a COVID-19 recovery. Here are among a few examples:

  • Artificial intelligence (AI)
  • Big data
  • Internet of things (IoT)
  • Robotics
  • Solar photovoltaic (PV)

3. ESG

Environmental, social, and governance (ESG) investing continues to break records, attracting nearly $2 trillion in assets as of Q1 2021.

 Global ESG assetsGlobal ESG fund flowsGlobal ESG funds
Q1 2020$841.5B$45.7B3,297
Q1 2021$1.9T$185.3B4,524

Sources: Morningstar 04/30/21, Reuters 01/28/21

The Opportunity

Within the sustainable investment landscape, three particular segments may be poised for potential growth: green bonds, solar PV, and transition finance.

Green Bonds: In the last year, green bond issuance has quadrupled to $131 billion globally.

YearGlobal sustainable bond growthNumber of issues
Q1 2015$6B22
Q1 2016$14B30
Q1 2017$26B58
Q1 2018$28B84
Q1 2019$39B123
Q1 2020$35B123
Q1 2021$131B314

Source: Refinitiv 04/23/21

Solar photovoltaic (PV) installations: Global solar PV installations are set to rise roughly 28% over two years.

YearPV installations (conservative)PV installations (optimistic)
2020e129145
2021p151194
2022p165205

Source: Bloomberg NEF 03/01/21

Transitional finance: These are financing tools designed for big carbon polluters to adopt greener alternatives. In the future, these types of vehicles could accelerate. For instance, bonds whose interest rates would likely increase if sustainability targets aren’t met.

4. Future of Work

Since COVID-19, job markets have faced a historic change. One study shows that 22% of the U.S. workforce are projected to be working remotely by 2025, equal to roughly 36 million Americans.

 Percentage of respondents
Employees who would prefer to work from home42%
Percent of the workforce projected to work from home by 202522%
Would maintain traditional working-at-the-office schedules10%

Sources: Center for the Digital Future 08/26/20, Upwork 12/15/20

The Opportunity

As traditional work models shift, key industries could be impacted, for instance:

Video conferencing: Global market size is projected to jump from $9.2 billion in 2021 to $22.5 billion in 2025.

Office space: Future office space preferences are changing. According to one study, here is how CEOs view their office space needs going forward.

  • 76% less office space is needed
  • 18% no change
  • 6% more office space needed

Interestingly, it is estimated that one-third of power, utilities, and renewables companies are looking to add more office space going forward.

5. Healthcare

Health costs related to the pandemic are set to reach a staggering $2.6 trillion.

At the same time, digital healthcare investment hit record levels last year:

    • 2020: $21.6 billion
    • 2019: $13.9 billion

The Opportunity

Especially as behavior shifts to digital platforms, the demand for healthcare innovation is likely to expand. Here are three segments of health expenditures, and their potential to be virtualized:

      • Urgent care visits: 34%
      • Office visits: 24%
      • Home health visits: 20%

One estimate suggests that 20% of all healthcare spending in the U.S. could be conducted virtually, worth $250 billion.

COVID-19 Recovery: The Next Stage

New and powerful trends—from AI to ESG investing—have the potential to structurally change systems and industries.

At the same time, many of these trends aim to solve complex problems. How investors adapt could have lasting effects on their portfolios. Thanks to these underlying shifts, new opportunities for investors are underway amid a COVID-19 recovery.

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Infographics

A Visual Guide to Planning for Retirement

Did you know the average American will outlive their savings by nearly 10 years? In this infographic, we cover the basics of retirement planning.

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How Retirement Planning Today, Can Ensure Freedom and Stability Tomorrow

When it comes to retirement planning, millions of Americans across different generations are finding it difficult to feel secure.

This is evidenced by the fact that only 54% of Baby Boomers have a retirement strategy in place. For younger generations such as Millennials, this falls to as low as 31%.

Thankfully, it’s never too late to start thinking about retirement. In this infographic from New York Life Investments, we’ve put together a straightforward overview that covers the various aspects of the retirement planning process.

How Much Should You Save?

Although this is one of the most frequently asked questions, it doesn’t come with an easy answer. That’s because retirement planning isn’t just about dollars saved, it’s also about income.

The following table lists a number of factors that could affect the level of retirement income you might need:

FactorDescription
LifestyleYour desired lifestyle will have a large impact on your required level of income.
Hobbies, vacations, and other pursuits can be a significant expense.
Housing needsRetirees often find themselves needing less space.
Selling your home and downsizing is a common method for increasing cash flows.
Medical needsMedical expenses can arise unexpectedly and be a large drain on savings.
The average American aged 65+ spends roughly $11,000 a year on medical needs.*
InflationInflation can erode the purchasing power of your retirement income, and highlights
the importance of picking the right investments to counter this effect.

*Source: U.S. Department of Health

After estimating your retirement income, the next step is figuring out how to achieve it. Here’s how a savings plan might look, based on two assumptions: (i) your retirement income is equal to 70% of your current annual income, and (ii) you are able to generate an annual return of 7%.

Annual salaryAnnual retirement incomeRequired savingsMonthly contributions
(20 years until retirement)
Monthly contributions
(25 years until retirement)
Monthly contributions
(30 years until retirement)
$50,000$35,000$777,778$1,480$955$635
$75,000$52,500$1,166,667$2,230$1,435$955
$100,000$77,000$1,711,111$3,270$2,100$1,395

The key takeaway from this table is that the earlier you start saving for retirement, the lower your monthly burden will be.

It’s also important to remember that the 70% retirement income goal was simply used as a benchmark—your own retirement strategy will ultimately be guided by your unique needs.

The Importance of Financial Assets

In the previous example, our second assumption was that you were able to earn an annual return of 7%. Achieving this typically requires the use of financial assets like stocks and bonds, which have the potential to grow your wealth much faster than a typical savings account.

For example, as at March 15, 2021, the national average interest rate offered by a savings account was 0.04%. Compare this to the S&P 500, which has generated an average annualized return of 13.9% between 2011 and 2020. The S&P 500 is a stock market index that consists of the 500 largest publicly-traded U.S. corporations.

Issues become apparent when we take a closer look at who actually owns stocks.

U.S. Families by WealthPercentage of Families with Equity Exposure
Top 10%90%
Middle 50-90%70%
Bottom 50%31%

Source: Federal Reserve

With only 31% of families in the bottom 50% having exposure to stocks, many Americans are missing out on a powerful tool for growing their wealth. This highlights the importance of investor education, particularly when thinking about retirement.

Retirement Planning Accounts

Retirement accounts are another important tool that many Americans are not using to their advantage. For example, just 50.5% of Americans own a retirement account, while 98.2% own transaction accounts (checking or savings).

Here’s a simple overview of two retirement accounts that most Americans have access to.

Traditional IRA

A traditional IRA (Individual Retirement Account) provides tax benefits to help you prepare for retirement. It can be opened online or in-person through various banks, brokerage firms, wealth managers, or trading platforms.

Contributions to this account may reduce your taxable income for that given year, but these assets will be locked until retirement. Once retired, any untaxed income would be taxed upon withdrawal, ideally when you are in a lower marginal tax bracket.

Traditional 401(k)

A traditional 401(k) is typically offered through your employer and offers similar tax benefits as an IRA. Contributions into a traditional 401(k) reduce your taxable income, but in this case, they are automatically taken from your payroll.

An added benefit of the 401(k) is that your employer will usually match some or all of the contributions you make.

Roth IRA and Roth 401(k)

The Roth variants of these accounts follow a similar concept as their “traditional” counterparts, but flipped around. This means that contributions are taxed, while withdrawals are tax-free.

Ultimately, the decision to use either a Roth or traditional account will depend on your financial position, and can be a great topic to discuss with a professional advisor.

Feeling Secure

While everyone has different goals for retirement, the need for financial security is shared by all.

It’s been estimated, however, that the average American has a retirement savings shortfall of nearly 10 years. Also known as longevity risk, this dilemma refers to the scenario where retirement savings and income are unable to support you for the rest of your life.

With this in mind, it’s never too late to take control of your future and put a plan into place.

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