Net Zero and the Enhanced Approach to EM Equities The Effect of Adding a Climate Objective on Risk and Return

  • We sought to determine whether investors can address their Net Zero objectives without sacrificing the risk and return characteristics of an Enhanced, or low-risk active, approach in emerging markets equities.
  • By utilising the natural active risk within the Enhanced framework, we were able to integrate climate objectives with only a marginal change in the overall tracking error relative to the benchmark
Head of Portfolio Management
Research Analyst

As investors look to build climate-aware portfolios and consider how best to meet Net Zero1 objectives, we in State Street Global Advisors’ Active Quantitative Equity (AQE) team believe it is important that investors pay particular attention to their emerging markets equity allocation. The makeup of emerging markets equities brings key challenges and opportunities when considering a Net Zero, or climate-aware, approach.

The first consideration is the market construct of emerging versus developed countries. Carbon dioxide emissions are typically concentrated in three of the 10 sectors under the GICS classification system: Energy, Materials, and Utilities.

These three sectors currently make up 15% of the market cap of emerging markets (EM), and make up only 11% of the market cap of developed markets (DM).2 Though this difference may not seem extreme, because 81% of EM emissions come from these three sectors,3 the higher weighting is meaningful.