09 Feb 2021

Climate investing: how our Paris-Aligned ETFs reweight companies


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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.

What drives the S&P PACT Indices’ Weights?

Ben Leale-Green, Analyst, Research & Design, ESG indices at S&P DJI 


benleale

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.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.

exhibit 1

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.

exhibit 2

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:

  • S&P DJI Environmental Score;
  • 1.5oC alignment via the transition pathway dataset;
  • Physical risk score; and
  • High climate impact revenues.

exhibit 3

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.  

exhibit 4

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.

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