09 Feb 2021
09 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).
We have a guest blog to share with you this week. You’ve heard all about our climate ETFs, which can help you align your portfolio with the goals of the Paris Agreement. Today, we are delighted to share some insights from S&P Dow Jones Indices (S&P DJI), index provider for our climate ETF range designed to align with EU Paris-Aligned Benchmark (PAB) standards.
In this blog, Ben Leale-Green, ESG Index Analyst, explains how stocks are selected and reweighted in their Paris-Aligned & Climate Transition (PACT) indices.
Ben Leale-Green, Analyst, Research & Design, ESG indices at S&P DJI
In April 2020, S&P DJI launched the S&P PACTTM Indices (S&P Paris-Aligned & Climate Transition Indices). The indices aim to align with the following: a 1.5oC climate scenario, the relevant aspects of the EU Low Carbon Benchmark regulation (BMR), and recommendations from the Task Force on Climate-related Financial Disclosures (TCFD), while maintaining a broad, diversified exposure. The S&P PACT Indices consist of the S&P Paris-Aligned (PA) Climate Indices and S&P Climate Transition (CT) Indices.
In this blog, we try to answer a simple question: what drives the S&P PACT Indices’ weights?
First, companies are excluded (‘exclusion effect’) due to business activities, public controversies,1 and a low alignment score with the principles of the UN Global Compact (UNGC) — these companies receive zero weight.
Second, companies that remain are reweighted (‘reweighting effect’) to achieve climate-related objectives.2 Companies that perform well from a climate perspective receive an overweight, while those that perform poorly receive an underweight or zero weight, as shown in Exhibit 1 below.
The S&P CT Indices, which align with the EU’s minimum standards for EU Climate Transition Benchmarks, have fewer exclusions than their PA counterparts, those that align with the EU’s minimum standards for EU Paris-Aligned Benchmarks. Fossil fuel-based exclusions are the difference.
Oil operations are particularly impactful in excluding companies. The additional exclusions are evident in the excluded columns in Exhibit 2, where the S&P PA Indices show that more of their market cap is excluded.
When reweighting eligible companies to meet the climate objectives, we observe (see Exhibit 3) company performance on four climate metrics to have the largest and most significant impact on the change of company weights, across regions:
So how can companies improve the climate metrics that have the largest influence on their S&P PACT Indices weight?
Ineligible companies can reduce undesirable exposures (e.g. public controversies and UNGC misalignment, as measured by the Arabesque GC Score). Eligible companies can gain increased weight in the S&P PACT Indices by significantly reducing carbon intensity year-on-year (to improve their 1.5oC alignment), disclosing more information regarding environmental policies and metrics (to improve their S&P DJI Environmental Score3), improving performance against environmental policies and metrics (also to improve their S&P DJI Environmental Score), divesting assets in locations highly exposed to physical risks and reduce assets’ physical risk sensitivity factors (to improve their physical risk score).
Exhibit 4 shows company level case studies, which are explained further here. For example, PPG Industries Inc gain a stronger overweight than Albemarle Corp, attributed to their 1.5°C alignment, McDonald’s Corp’s sees a stronger overweight than Starbucks Corp, due to a stronger environmental score and lower physical risk, and Exelon Corp’s strong environmental score and 1.5°C alignment don’t offset high potential physical risk, which results in underweighting.
For further detail, please see our paper on S&P PACT Indices weight attribution.
The posts on S&P DJI’s Indexology blog are opinions, not advice. Please read our Disclaimers.
Published December 10th, 2020 by S&P Dow Jones Indices on Indexology Blog.
1Public controversies are judged by the SAM, part of S&P Global, Media Stakeholder Analysis (MSA), which monitors ongoing controversies from companies.
2Climate-related objectives include the 7% year-on-year decarbonization, carbon intensity reduction, 1.5oC alignment using the Trucost, part of S&P Global, transition pathway dataset, S&P DJI Environmental Score improvement, green-to-brown share control/improvement, physical risk mitigation, high climate impact revenue constraint, carbon disclosure overweight cap, Science-Based Target overweight, and fossil fuel reserve exposure control/reduction.
3The environmental score is the environmental pillar from the S&P DJI ESG Scores.
4The table employs a color-coding system, in which green shades represent relatively positive climate metric exposure, while orange tones depict weaker values compared with the benchmark index counterparts. For instance, where a strong transition pathway factor (green) is achieved through being below the 1.5oC carbon budget on a forward-looking basis, the opposite is true for the environmental score, in which a higher value (green) denotes a better overall score. Similarly, while a lower physical risk score (green) drives stock overweight, a lower green-to-brown revenue ratio (copper) negatively impacts weighting, especially in the Utilities sector.
The view from Lyxor
We’d like to thank Ben and S&P DJI for this insight into the S&P Paris-Aligned and Climate Transition indices. At Lyxor, we think it’s very important for investors to understand the ‘how’ and ‘why’ of stock selection and weighting in their climate funds. It’s too easy to focus on the big headlines of climate investing (‘1.5°C alignment’, ‘net zero’, and so on) without fully grasping what this means in practice inside an ETF.
Lyxor is committed to providing investors with all the ETF tools needed to make a difference on the climate, as well as our other key areas of ESG, thematics and low-cost Core. We’re also trying to lead the industry towards total transparency and honesty – and that’s why we were the first ETF provider to launch a temperature tool, where you can see the implied temperatures of most ETFs in our range.
We hope you’ve enjoyed learning a bit more about the S&P methodology. If you’re still in the mood for climate investing topics, head over to our COtool and get a handle on the implied temperatures of ETFs.
And to learn more about our relevant ETFs that can help reduce your carbon footprint, have a look at our climate-focused solutions.
This article is for informative purposes only, and should not be taken as investment advice. Lyxor ETF does not in any way endorse or promote the companies mentioned in this article. The opinions expressed by Ben Leale-Green are his own, and do not necessarily reflect the views of Lyxor International Asset Management or Societe Generale. Capital at risk. Please read our Risk Warning below.
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.