02 Feb 2021
02 Feb 2021
For Marketing Purposes - FOR QUALIFIED INVESTORS ONLY– This document is reserved and must be given in Switzerland exclusively to Qualified Investors as defined by the Swiss Collective Investment Scheme Act of 23 June 2006 (as amended from time to time, CISA).
Last month we launched our new COtool, which allows you to see how more than 150 Lyxor ETFs align with the temperature goals of the Paris Agreement.
We’ve been delighted with all the positive feedback as we encourage the industry towards total transparency and honesty. We hope you continue using the tool to analyse the implied temperature rise of your investments. And remember: we show you Lyxor ETF temperatures, but they are based on underlying indices which are also being tracked by several other ETF issuers.
In any case, the COtool has been live for a little over a week – and today we are going to share some of the most interesting things we’ve learned so far.
Many European utilities are 1.5°C aligned
Utilities companies provide electricity, natural gas and water, among other amenity services. This sector is excluded from many ESG indices due its high carbon impact. Yet, in the COtool, the European utilities sector (as represented by the STOXX Europe 600 Utilities Index) is 1.5° aligned, with 65% of its AuM under the 1.5° threshold.
Even the MSCI World Utilities index, comprised of over 50% US companies, has an implied temperature of 1.8°C – under the Paris Agreement’s 2° central scenario. Why?
Utilities are aligned because the sector is “under budget”. Our methodology assigns a carbon budget to utilities using the sectoral decarbonisation approach (SDA). SDA factors in the decarbonisation opportunities of a given sector – and while high carbon budgets are allocated to utility companies because they tend to be carbon-intensive, those budgets are decreasing year on year.
In fact, most utility companies are aligned because the sector is more advanced than other industries in terms of its transition to a low-carbon economy. Even though much more needs to be done to decarbonise the sector, a significant number of emission-reducing projects have been launched over the last decade. Many utilities have also made firm commitments to a well below 2° scenario with the Science Based Targets initiative.
Most indices are above 3°
Depending on your knowledge of the financial industry, this might not be a big surprise. But it’s worth highlighting that most indices are aligned with a ‘business as usual’ temperature outcome, above 3°.
One option to reduce the temperature impact of a core portfolio building block, such as the S&P 500, would be to consider the S&P Paris-Aligned benchmark variant. The Lyxor S&P 500 Paris-Aligned Climate (EU PAB) (DR) ETF is compatible with the Paris Agreement’s most ambitious 1.5° warming scenario.
ESG indices can be ‘hot’
We’ve received several questions on why an ESG ETF can have a high temperature, or be ‘hotter’ than its parent index or comparable non-ESG ETF.
Taking the DAX 30 as an example: this index reflects a part of the German economy with high carbon intensity, due to the large share of coal in the German power sector and the high representation of power companies in this index.
However, the COtool shows that the DAX 30 is compatible with a 1.5°C temperature scenario, whereas the DAX 50 ESG benchmark is >3°C.
The answer to this is that an index may have a very high carbon footprint today, and still be aligned with the Paris Agreement. The temperature reflects the fact that the index is on a pathway aligned with the Paris Agreement, not if it is carbon-intensive today.
In our example, the DAX 30 contains several big companies in the power sector. These companies are well known for having a lot of coal in their power mix. They are accountable for very high volumes of emissions, and therefore are excluded from ESG indices. But because they have taken strong commitments to reduce their emissions – even more ambitious than their expected SDA decarbonisation trajectory requires – they are 1.5°-aligned.
Ultimately, the best way to understand this is by recognising that an ESG measure is fundamentally different from a temperature measure.
An ESG score evaluates an issuer on Environmental, Social and Governance aspects, while a temperature measure has a narrower focus on alignment against the goals of the Paris Agreement. A carbon-intensive company can still have a high rating on social and governance topics, which might compensate a low score on environmental side to give a strong ESG score.
If an ESG index methodology overweights issuers with high ESG scores, and if these are also unaligned with the Paris Agreement goals, it can lead to a high temperature, or a higher temperature than its parent index.
This is very much a moment-in-time snapshot. Temperatures can and will change in the coming months. There are a few reasons why that might be:
• Changes in the fund composition and weightings in the fund
• Variations of enterprise value among issuers in the fund (fluctuations of their market capitalisations, increase or decrease of their debt, available cash, etc.)
• Effective reduction of emissions of issuers in the fund
• Change in theoretical carbon budgets from updated climate scenarios
• Expansion of Trucost database with new data for issuers that were not covered until now
Note that a decrease of a fund temperature is not necessarily due to a real reduction of emissions of issuers in a fund. An increase is not necessarily due to higher emissions.
The COtool does not yet consider what are known as ’scope 3 emissions’. Scope 3 refers to indirect GHG emissions that are a consequence of the company’s activities, but which come from sources not owned or controlled by the company.
For some sectors such as automotive and oil & gas, scope 3 emissions represent a major part of the sector’s emissions and taking them into account to evaluate alignment in these sectors is necessary to get a true picture of their carbon intensity.
Unfortunately, there is incomplete reporting of scope 3 emissions by companies, it’s hard to model these emissions, and climate scenarios used for target-setting do not yet integrate scope 3 emissions in transition pathway forecasts.
To fulfil the COtool’s potential, we are working to integrate scope 3 emissions in our methodology in 2021 for automotive and oil & gas.
That’s all for this update. Send us any questions or comments you have on the tool and we’ll try to answer them in a future blog.
This document has been provided by Lyxor International Asset Management that is solely responsible for its content.
This document is not to be deemed distribution of funds in Switzerland according to the Swiss collective investment schemes act of 23 June 2006 (as amended from time to time, CISA) or any other applicable Swiss laws or regulations.
The shares are not registered under the U.S Securities Act of 1933 and may not be directly or indirectly offered or sold in the United States (including its territories or possessions) or to or for the benefit of a U.S Person (being a “United State Person” within the meaning of Regulation S under the Securities Act of 1933 of the United States, as amended, and/or any person not included in the definition of “Non-United States Person” within the meaning of Section 4.7 (a) (1) (iv) of the rules of the U.S. Commodity Futures Trading Commission.). No U.S federal or state securities commission has reviewed or approved this document and more generally any documents with respect to or in connection with the fund. Any representation to the contrary is a criminal offence.
Past performance is no indication of current or future performance. The performance data do not take into account of the commissions and costs incurred on the issue and redemption of units.
Financial intermediaries (including particularly, representatives of private banks or independent asset managers, Intermediaries) are hereby reminded on the strict regulatory requirements applicable under the CISA to any distribution of foreign collective investment schemes in Switzerland. It is each Intermediary’s sole responsibility to ensure that (i) all these requirements are put in place prior to any Intermediary distributing any of the Funds presented in this document and (ii) that otherwise, it does not take any action that could constitute distribution of collective investment schemes in Switzerland as defined in article 3 CISA and related regulation.
Any information in this document is given only as of the date of this document and is not updated as of any date thereafter.
This document is for information purposes only and does not constitute an offer, an invitation to make an offer, a solicitation or recommendation to invest in collective investment schemes. This document is not a prospectus as per article 652a or 1156 of the Swiss Code of Obligations, a listing prospectus according to the listing rules of the SIX Swiss Exchange or any other trading venue as defined by the Swiss Financial Market Infrastructure Act of 19 June 2015 (as amended from time to time, FMIA), a simplified prospectus, a key investor information document or a prospectus as defined in the CISA.
An investment in collective investment schemes involves significant risks that are described in each prospectus or offering memorandum. Each potential investor should read the entire prospectus or offering memorandum and should carefully consider the risk warnings and disclosures before making an investment decision.
Any benchmarks/indices cited in this document are provided for information purposes only.
This document is not the result of a financial analysis and therefore is not subject to the “Directive on the Independence of Financial Research” of the Swiss Bankers Association.
This document does not contain personalized recommendations or advice and is not intended to substitute any professional advice on investments in financial products.
Lyxor International Asset Management (“LIAM”) or its employees may have or maintain business relationships with companies covered in its research reports. As a result, investors should be aware that LIAM and its employees may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. Please see appendix at the end of this report for the analyst(s) certification(s), important disclosures and disclaimers. Alternatively, visit our global research disclosure website www.lyxoretf.com/compliance.
Conflicts of interest
This research contains the views, opinions and recommendations of Lyxor International Asset Management (“LIAM”) Cross Asset and ETF research analysts and/or strategists. To the extent that this research contains trade ideas based on macro views of economic market conditions or relative value, it may differ from the fundamental Cross Asset and ETF Research opinions and recommendations contained in Cross Asset and ETF Research sector or company research reports and from the views and opinions of other departments of LIAM and its affiliates. Lyxor Cross Asset and ETF research analysts and/or strategists routinely consult with LIAM sales and portfolio management personnel regarding market information including, but not limited to, pricing, spread levels and trading activity of ETFs tracking equity, fixed income and commodity indices. Trading desks may trade, or have traded, as principal on the basis of the research analyst(s) views and reports. Lyxor has mandatory research policies and procedures that are reasonably designed to (i) ensure that purported facts in research reports are based on reliable information and (ii) to prevent improper selective or tiered dissemination of research reports. In addition, research analysts receive compensation based, in part, on the quality and accuracy of their analysis, client feedback, competitive factors and LIAM’s total revenues including revenues from management fees and investment advisory fees and distribution fees.
© 2021 LYXOR INTERNATIONAL ASSET MANAGEMENT ALL RIGHT