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Readying Investment Portfolios for a 2°C World

Mar. 07, 2017

Mar. 07, 2017

Climate change awareness has never been a more relevant issue for investors. According to EY1, 97 of the world’s 500 largest asset owners are taking tangible action to control their exposure to climate risks, and a further 157 are in initial steps to address climate-related factors.

This comes as nations are taking action to combat climate change. The Paris Climate Conference of 2015 set out a plan to bring down global warming to 2°C above pre-industrial levels through an ambitious scale-down of carbon emissions. There is ever more risk associated with exposure to high-carbon assets with the introduction of laws that could hamper a company’s operations.

The Task Force on Climate-related Financial Disclosures (TCFD), a Financial Stability Board workgroup, in December issued recommendations2 for companies to report climate-related financial data in the areas of governance, strategy, risk management, and metrics and targets, as part of their regular public filings.

Managing long-term climate risks

To help investors get a more accurate perspective on the climate impacts of their portfolios, STOXX launched in 2016 the Low Carbon Indices, a comprehensive range of benchmarks tracking companies that appear best placed to conquer climate-change risks.

Within them, the STOXX® Global Climate Change Leaders Index was the first equity measure to incorporate CDP’s3 climate-change research scoring methodology that evaluates a company’s climate-related governance, strategy, risk and opportunities, targets and accountability. In other words, forward-looking carbon emission indicators instead of past snapshots of carbon footprint. This assessment is crucial to gauge which companies are transitioning towards a new low-carbon economy, but also, importantly, puts the focus on companies’ management of long-term climate risks in line with the TCFD recommendations.

From disclosure to performance leadership

CDP, STOXX’s partner in low-carbon products, ranks companies worldwide according to their efforts to combat climate change. Their scoring methodology assesses companies not only based on their past track record, but also on their future commitment and roadmap towards a more sustainable world. The data comprises variables from climate-related governance, strategies, and targets to the risks and opportunities they perceive.

There are four CDP bands that classify the progress towards environmental stewardship: (A) Leadership, (B) Management, (C) Awareness and (D) Disclosure.

The STOXX Global Climate Change Leaders index uses CDP’s A list of businesses scoring highest for their carbon-reduction actions (currently 179 components).

Transition pathway towards leadership

STOXX is now expanding its low-carbon capabilities with the introduction of the Climate Impact and Climate Awareness indices. The former broaden the universe of stocks to roughly 690 by incorporating companies from CDP’s A to B bands. The STOXX Climate Awareness indices take a step further by including also companies from the C band (about 960 companies). To put that into perspective, the underlying universe (STOXX® Global 1800 Index) has 1,800 components.

A larger universe of stocks results in a more diversified portfolio with lower tracking error to broad-market benchmarks, in this case without losing the focus on climate risk. It also allows investors exposure to companies that may be set for a transition towards environmental leadership.

Both index groups exclude companies involved in the coal and controversial-weapons businesses and in activities singled out in the UN Global Compact (screened by Sustainalytics). A special version of the new indices additionally excludes tobacco companies.

The Climate Impact and Climate Awareness indices offer global, Europe, North America and Asia Pacific coverage. For more information on the index methodology, please click here.

Environmental stewardship

The latest rollout in STOXX’s low-carbon family enhances the potential for investors to measure their environmental challenges, and therefore be better equipped to mitigate risks in the future and take advantage of opportunities. This new benchmark solution makes climate-awareness principles more accessible and makes investors better equipped to bring their portfolios in line with a 2°C scenario.

 

1 Asset Owners Disclosure Project (AODP) data in “Climate Change: The Investment Perspective,” Ernst & Young, 2016

2 “Recommendations of the Task Force on Climate-related Financial Disclosures,” TCFD, December 2016.

3 Formerly ‘Carbon Disclosure Project.’

 

 

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