Institutional Investors Discuss Decarbonization

The report found that 64% of respondents attempting to invest with ESG priorities listed the fact that there is insufficient ESG data quality that could allow for accurate target-setting and reporting as the biggest concern about orienting their portfolios around decarbonization goals. A smaller percentage (43%) reported that the lack of any type of regulation and framework within the space was a barrier to committing to decarbonization within their portfolios.

Image source: State Street Global Advisors’ The World Targets Change Report

The lack of standardizations is one that the industry is working to overcome on its own, with a majority flocking to the Institutional Investors Group on Climate Change (IIGCC) as the framework they adopted for their funds. Around 58% reported that this is what they currently use or intend to use as they shift to net-zero carbon emission goals; State Street Global Advisors utilizes this framework for its funds.

Another chief concern of institutional investors was that pivoting their portfolios to an ESG focus would negatively affect their returns, but many who have already made the transition reported that this wasn’t the case for their funds.

“We constructed a low-carbon index for our passive equity portfolio to remove some of the biggest emitters. We could do that without materially impacting the diversification or the strategy of the fund. To date, it’s proven that it hasn’t impacted returns in a negative way. We’ve actually generated a small amount of alpha from that,” reports the head of external investments for APAC Super Fund.

Looking forward, the majority of the industry plans to switch from standard index benchmarks to ESG and climate-focused benchmarks for their passive and fixed income portfolios. It’s a generalized recognition that the existing benchmarks will not work in net-zero portfolios, and as there is an increasing push from clients for ESG-prioritized portfolios, it’s a move that over half of investors in North American would prefer to make.

“By moving to a new benchmark, we put the risk in the right bucket. It’s a strategic risk, arguably, to move towards net zero relative to your market cap weighting, and it just highlights what is true alpha and what is basis risk vis-a-vis the benchmark. If those stocks have a good or bad time, they can’t be owned anyway, so it’s not alpha. I call it secular alpha, but it’s not manager alpha. They are excluded for a reason; they’re not excluded because they’re not deemed to be profitable stocks,” reports the CIO of the European Public Pension Scheme.

For investors looking to invest in reduced emissions, the SPDR MSCI ACWI Low Carbon Target ETF (LOWC A-) offers investors exposure to companies with low carbon emissions and fossil fuel reserves.

The fund tracks the MSCI ACWI Low Carbon Index. This index reweights securities in the MSCI All-Country World Index (ACWI) to favor lower carbon emissions and lower fossil fuel reserves.

The benchmark overweights companies with low carbon emissions relative to sales and companies with low potential carbon emissions, offering lower carbon exposure when compared to the broad market.

LOWC’s top five sector allocations include information technology at 23.42%, financials at 14.91%, consumer discretionary at 12.54%, healthcare at 11.45%, and industrials at 10.14%.

The ETF carries an expense ratio of 0.20%.

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