by   |   May 15, 2014   |   on ,

Is Stanford’s sale of coal stocks just the tip of the iceberg?

Much is being made of Stanford University’s decision to dump coal stocks, citing the effects of climate change and the risk of holding such assets.

At the New York Society of Security Analysts Sustainable Investing Conference, Bob Litterman of Kepos Capital said he thinks Stanford’s move could be just the tip of the iceberg.

Climate change has long been debated, but the investment risks of the issue are starting to become realities.

To the extent other money managers follow Stanford’s lead, the losses could be substantial. You certainly don’t want to be the last one to this party.

Currently, energy stocks like coal are valued based on reserves or resources in the ground available to bring to market.

In some scenarios it is entirely plausible that these companies will be unable to tap reserves because of the prohibitive cost of doing so.

At the moment there is no social cost to pumping carbon into the atmosphere, but at some point there is a very good chance there will be.

It really is a matter of risk.

If you believe that ultimately there will be a prohibitive cost for bringing fossil fuels,  an adjustment to future value in the space must take place.

The easiest play is to avoid stocks that are vulnerable to such a scenario,  and coal stocks are a good place to start.

Peabody Energy (NYSE: BTU) has rallied significantly since March. Shares are up over 20%, but are still well off their two-year highs.

It might make sense to lock in some of those profits now.

To the extent the coal industry loses more support after Stanford’s decision, these stocks could take a 50% hit or more.

Once selling accelerates, it will be hard to stop.

The high-level play here would be to liquidate coal stocks. In its place, the growth potential in the alternative energy or clean-burning fuel space remains attractive.

Solar stocks, for example, have been big winners in 2014 and that trend should continue. First Solar (NASDAQ: FSLR) shares are up approximately 70% since September.

Clearly there is a rotation taking place, and there is more to come.

The hedge fund industry is full of managers who have the inclination to follow a global warming risk-adjusted strategy — in other words, using their massive purses to promote a political cause.

Right or wrong, it is happening, and to ignore it would be a mistake.

Litterman of Kepos Capital is also on the board of the World Wildlife Fund. There they are swapping investments in tar sands and coal for the S&P 500 index.

Hedge fund manager Chris Hohn of The Children’s Investment Fund Management believes a carbon tax of some kind is definitely coming.

Hohn, plus Jeremy Grantham of $117 billion money manager GMO and Steven Mandel of $27 billion Lone Pine, have teamed up together in support of a global warming series on Showtime called “Years of Living Dangerously.”

That should tell you all you need to know about the future of carbon-based investments. It may not happen overnight, but there are some powerful forces here lining up on the sell side of these stocks.

The downside risk is not worth the potential reward.