ETFdb Logo
ETFdb Logo
  • ETF Database
  • Channels
    • Active ETF
    • Alternatives
    • Beyond Basic Beta
    • China Insights
    • Climate Insights
    • Commodities
    • Core Strategies
    • Crypto
    • Disruptive Technology
    • Dividend
    • Dual Impact
    • Emerging Markets
    • Energy Infrastructure
    • ESG
    • ETF Building Blocks
    • ETF Education
    • ETF Strategist
    • Fixed Income
    • Free Cash Flow
    • Future ETFs
    • Global Diversification
    • Gold/Silver/Critical Minerals
    • Innovative ETFs
    • Institutional Income Strategies
    • Leveraged & Inverse
    • Managed Futures
    • Market Insights
    • Megatrends
    • Modern Alpha
    • Multi-Asset
    • Night Effect
    • Portfolio Strategies
    • Retirement Income
    • Richard Bernstein Advisors
    • Tax Efficient Income
    • Thematic Investing
    • Volatility Resource
  • Tools
    • ETF Screener
    • ETF Country Exposure Tool
    • ETF Sector Tracker Tool
    • ETF Database Categories
    • Head-To-Head ETF Comparison Tool
    • ETF Stock Exposure Tool
    • ETF Issuer Fund Flows
    • Indexes
    • Mutual Fund To ETF Converter
    • ETF Data for Journalists
    • ETF Nerds
  • Research
    • First Bitcoin ETF
    • ETF Education
    • Equity Investing
    • Dividend ETFs
    • Leveraged ETFs
    • Inverse ETFs
    • Index Education
    • Index Insights
    • Top ETF Sectors
    • Top ETF Issuers
    • Top ETF Industries
  • Webcasts
  • Themes
    • AI ETFs
    • Blockchain ETFs
    • See all Thematic Investing ETF themes
    • ESG Investing
    • Marijuana ETFs
  • Multimedia
    • ETF 360 Video Series
    • ETF Trends on Videos
    • ETF Trends on Podcasts
    • ETF Prime Podcast
  • Company
    • About Us
    • Swag Store
  • PRO
    • Pro Content
    • Pro Tools
    • Advanced
    • FAQ
    • Pricing
    • Free Sign Up
    • Login
  1. ESG Channel
  2. Using Optimization For Reduced-Carbon Portfolios
ESG Channel
Share

Using Optimization For Reduced-Carbon Portfolios

James ComtoisMar 14, 2022
2022-03-14

More investors are constructing portfolios with environmental, social, and governance principles in mind. This includes explicit carbon-reduction targets, temperature alignment goals, and climate objectives such as mitigation and adaption.

So, State Street Global Advisors constructed and back-tested five equity portfolios targeting carbon reduction, varying across risk and return dimensions. Of the five portfolios that SSGA constructed, two used a screening approach, two used a tilting approach, and one used an optimization approach.

  • Divest 10 (screened): The 10% highest carbon emitters in the MSCI World Index universe are removed (i.e., 10% of market cap is removed).
  • Divest 20 (screened): The 20% highest carbon emitters in the MSCI World Index universe are removed (i.e., 20% of market cap is removed).
  • Pure Tilting: A simple tilt is applied on carbon intensity with no constraints applied.
  • Iterative Tilting: A cumulative normal distribution is applied to carbon emissions, and weights are assigned to securities based on their transformed carbon scores.
  • Additional security, sector, and country constraints are applied.
  • SSGA Low-Carbon Framework (optimized): A mean-variance optimization is employed to either minimize tracking error at a target carbon-reduction level or to minimize carbon emissions at a target tracking error. SSGA opts for the latter, specifically minimizing carbon emissions at a tracking error of 75 basis points.

After testing these different portfolio types, SSGA recommends that investors use optimization when constructing a reduced-carbon portfolio, since “it best balances the multiple objectives investors have beyond just reducing carbon.” Tracking “error to the benchmark, which measures the amount of active risk investors” must “take on to reduce carbon, appears to be best managed using optimization.”

The money manager also found that over time, the optimized Low-Carbon Framework approach produced the greatest amount of carbon reduction. Plus, this same approach appears to produce the most stable level of carbon reduction per unit of tracking error. For investors who are concerned about risk, this indicates the best potential outcome.

SSGA also reviewed the active country exposures of the different strategies and found “that Iterative Tilting stood out with much more controlled active exposures. Sector exposures across the five portfolios were found to be” like “those of the country exposures.” However, the ETF issuer also noted that if investors just rotate “out of carbon-intensive sectors and overweighting low-carbon sectors,” that could lead to “significant tracking error.” So, SSGA suggests that deriving most “of the carbon reduction from security selection within sectors” could be a better approach for index investors.

Ultimately, SSGA “suggests that the tradeoff between carbon reduction and tracking error could be best managed using optimization,” since “investors can meet their carbon-reduction targets while also minimizing the amount of risk they (must) assume in deviating from their policy benchmarks.” Optimization is also more risk-efficient when contrasted with rules-based approaches.

State Street Global Advisors offers a series of ESG-focused ETFs, including the SPDR Kensho Clean Power ETF (CNRG A-), the SPDR MSCI Emerging Markets Fossil Fuel Reserves Free ETF (EEMX B+), the SPDR MSCI ACWI Low Carbon Target ETF (LOWC A-) (which is changing its name and ticker to the SPDR MSCI ACWI Climate Paris Aligned ETF (NZAC) effective Friday, April 22), and the SPDR MSCI EAFE Fossil Fuel Free ETF (EFAX B+).

For more news, information, and strategy, visit the ESG Channel.

Loading Articles...
Help & Info
  • Contact Us
Tools
  • ETF Screener
  • ETF Analyzer
  • Mutual Fund to ETF Converter
  • Head-To-Head ETF Comparison
  • ETF Country Exposure Tool
  • ETF Stock Exposure Tool
  • ETF Performance Visualizer
  • ETF Database Model Portfolios
  • ETF Database Realtime Ratings
  • ETF Database Pro
More Tools
  • ETF Launch Center
  • Financial Advisor & RIA Center
  • ETF Database RSS Feed
Explore ETFs
  • ETF News
  • ETF Picks of the Month
  • ETF Category Reports
  • Premium Articles
  • Alphabetical Listing of ETFs
  • Best ETFs
  • Browse ETFs by ETF Database Category
  • Browse ETFs by Index
  • Browse ETFs by Issuer
  • Compare ETFs
Legal
  • Terms of Use and Privacy Policy
  • © 2023 VettaFi LLC. All rights reserved.
Follow ETF Database
Follow ETF Database

Advertisement

Is Your Portfolio Positioned With Enough Global Exposure?

ETF Education Channel

How to Allocate Commodities in Portfolios

Tom LydonApr 26, 2022
2022-04-26

A long-running debate in asset allocation circles is how much of a portfolio an investor should...

Core Strategies Channel

Why ETFs Experience Limit Up/Down Protections

Karrie GordonMay 13, 2022
2022-05-13

In a digital age where information moves in milliseconds and millions of participants can transact...

}
X