Investors worldwide are increasingly concerned about the impact of their decisions on the future of the planet. At the same time, of course, they want to generate returns. Are the two goals mutually exclusive?
We examined how investors can incorporate climate-aware indices into a portfolio, and assessed the differences between the S&P Carbon Control Index Series and their traditional market-value-weighted counterparts. The ultimate goal was to establish whether using these indices can deliver the twin goals of reducing carbon emissions and delivering long-term returns.
A Booming Field
Globally, assets under management in climate-aware funds grew at a CAGR of about 15% a year over the past decade, from around US$600 million to more than US$2.2 trillion.1 In Australia, the growth trajectory has been even steeper at an annual average of 34%.1
The trend is undeniable – but how do these investments perform? Historical analysis suggests there is indeed a carbon premium, and that lower-carbon-intensity stocks to lead to higher returns.
In our view, there is reason to believe this is the case, but to understand the impact of using the Carbon Control Indices in place of their market-cap-weighted benchmarks, we created a carbon-aware simulated portfolio using S&P Carbon Control developed ex-Australia and emerging markets indices and compared it against its market-cap multi-asset benchmarks (market-value-weighted multi-asset benchmark).2
The results (Figure 1) show that historically, both climate-aware portfolios outperformed the market-cap weighted multi-asset benchmark across different time periods.
Given recent market volatility, we must be cautious about extrapolating past results to predict the future. Even so, we can reasonably expect that lower-carbon-intensity stocks will continue to find medium and longer-term support as the world tilts toward renewables and low-carbon energy alternatives.
Figure 1: Hypothetical Model Portfolio Using Carbon Control Benchmarks
Both climate-aware portfolios demonstrated not just financial outperformance but also a material reduction in their carbon-emissions intensity after replacing their market-cap weighted benchmarks with Carbon Control Indices. For the S&P Developed ex-Australia Carbon Control Index, we saw a reduction of nearly 70% in emissions intensity compared with the Developed ex-Australia broad benchmark. For the S&P Emerging Markets Carbon Control Index, there was an even stronger reduction in carbon emissions (more than 80% on average3) compared with the broad benchmark.
For investors, the results of this study suggest that reducing carbon intensity by following these indices does not materially impact portfolios. Not only that, it represents a sensible investment strategy for long-term returns, and a responsible one for the future of the planet.
To downloaded a copy of the full research report, How to Mitigate Climate Risk with International Equities, click here.
1 Source: State Street Global Advisors, Morningstar. Data from February 2012 to January 2022.
2 Portfolios were simulated on the basis of returns between 2014 and 2021 and were rebalanced on a monthly basis.
3 Over the study period between April 2014 and December 2021.
This material is general information only and does not take into account your individual objectives, financial situation or needs and you should consider whether it is appropriate for you. Investing involves risk including the risk of loss of principal.
The views expressed in this material are the views of ETF Model Portfolio Team through the period ended 31 May 2022 and are subject to change based on market and other conditions. This document contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.
Past performance is not a reliable indicator of future performance.
Diversification does not ensure a profit or guarantee against loss.
Equity securities may fluctuate in value and can decline significantly in response to the activities of individual companies and general market and economic conditions.
Investing in foreign domiciled securities may involve risk of capital loss from unfavorable fluctuation in currency values, withholding taxes, from differences in generally accepted accounting principles or from economic or political instability in other nations.
Investments in emerging or developing markets may be more volatile and less liquid than investing in developed markets and may involve exposure to economic structures that are generally less diverse and mature and to political systems which have less stability than those of more developed countries.
Investments in mid-sized companies may involve greater risks than in those of larger, better known companies, but may be less volatile than investments in smaller companies.
Companies with large market capitalizations go in and out of favor based on market and economic conditions. Larger companies tend to be less volatile than companies with smaller market capitalizations. In exchange for this potentially lower risk, the value of the security may not rise as much as companies with smaller market capitalizations.
Currency Risk is a form of risk that arises from the change in price of one currency against another. Whenever investors or companies have assets or business operations across national borders, they face currency risk if their positions are not hedged. Currency Hedging involves taking offsetting positions to reduce exposure to different currencies. These currency exchange contracts may reduce or eliminate some or all of the benefit that an investment may experience from favorable currency fluctuations.
The returns on a portfolio of securities which exclude companies that do not meet the portfolio's specified ESG criteria may trail the returns on a portfolio of securities which include such companies. A portfolio's ESG criteria may result in the portfolio investing in industry sectors or securities which underperform the market as a whole.
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