Climate investing: how our Paris-Aligned ETFs reweight companies

We have a guest blog to share with you this week. You’ve heard all about our climate ETFs, which can help you align your portfolio with the goals of the Paris Agreement. Today, we are delighted to share some insights from S&P Dow Jones Indices (S&P DJI), index provider for our climate ETF range designed to align with EU Paris-Aligned Benchmark (PAB) standards.

In this blog, Ben Leale-Green, ESG Index Analyst, explains how stocks are selected and reweighted in their Paris-Aligned & Climate Transition (PACT) indices. 

The S&P CT Indices, which align with the EU’s minimum standards for EU Climate Transition Benchmarks, have fewer exclusions than their PA counterparts, those that align with the EU’s minimum standards for EU Paris-Aligned Benchmarks. Fossil fuel-based exclusions are the difference.

Oil operations are particularly impactful in excluding companies. The additional exclusions are evident in the excluded columns in Exhibit 2, where the S&P PA Indices show that more of their market cap is excluded.

When reweighting eligible companies to meet the climate objectives, we observe (see Exhibit 3) company performance on four climate metrics to have the largest and most significant impact on the change of company weights, across regions:

• S&P DJI Environmental Score;
• 1.5^oC alignment via the transition pathway dataset;
• Physical risk score; and
• High climate impact revenues.

So how can companies improve the climate metrics that have the largest influence on their S&P PACT Indices weight? 

Ineligible companies can reduce undesirable exposures (e.g. public controversies and UNGC misalignment, as measured by the Arabesque GC Score). Eligible companies can gain increased weight in the S&P PACT Indices by significantly reducing carbon intensity year-on-year (to improve their 1.5^oC alignment), disclosing more information regarding environmental policies and metrics (to improve their S&P DJI Environmental Score3), improving performance against environmental policies and metrics (also to improve their S&P DJI Environmental Score), divesting assets in locations highly exposed to physical risks and reduce assets’ physical risk sensitivity factors (to improve their physical risk score).

Exhibit 4 shows company level case studies, which are explained further here. For example, PPG Industries Inc gain a stronger overweight than Albemarle Corp, attributed to their 1.5°C alignment, McDonald’s Corp’s sees a stronger overweight than Starbucks Corp, due to a stronger environmental score and lower physical risk, and Exelon Corp’s strong environmental score and 1.5°C alignment don’t offset high potential physical risk, which results in underweighting. 

For further detail, please see our paper on S&P PACT Indices weight attribution.

The posts on S&P DJI’s Indexology blog are opinions, not advice. Please read our Disclaimers.

Published December 10th, 2020 by S&P Dow Jones Indices on Indexology Blog.

1Public controversies are judged by the SAM, part of S&P Global, Media Stakeholder Analysis (MSA), which monitors ongoing controversies from companies.

2Climate-related objectives include the 7% year-on-year decarbonization, carbon intensity reduction, 1.5^oC alignment using the Trucost, part of S&P Global, transition pathway dataset, S&P DJI Environmental Score improvement, green-to-brown share control/improvement, physical risk mitigation, high climate impact revenue constraint, carbon disclosure overweight cap, Science-Based Target overweight, and fossil fuel reserve exposure control/reduction.

3The environmental score is the environmental pillar from the S&P DJI ESG Scores.

4The table employs a color-coding system, in which green shades represent relatively positive climate metric exposure, while orange tones depict weaker values compared with the benchmark index counterparts.  For instance, where a strong transition pathway factor (green) is achieved through being below the 1.5^oC carbon budget on a forward-looking basis, the opposite is true for the environmental score, in which a higher value (green) denotes a better overall score.  Similarly, while a lower physical risk score (green) drives stock overweight, a lower green-to-brown revenue ratio (copper) negatively impacts weighting, especially in the Utilities sector. ​

The view from Lyxor

We’d like to thank Ben and S&P DJI for this insight into the S&P Paris-Aligned and Climate Transition indices. At Lyxor, we think it’s very important for investors to understand the ‘how’ and ‘why’ of stock selection and weighting in their climate funds. It’s too easy to focus on the big headlines of climate investing (‘1.5°C alignment’, ‘net zero’, and so on) without fully grasping what this means in practice inside an ETF.

Lyxor is committed to providing investors with all the ETF tools needed to make a difference on the climate, as well as our other key areas of ESG, thematics and low-cost Core. We’re also trying to lead the industry towards total transparency and honesty – and that’s why we were the first ETF provider to launch a temperature tool, where you can see the implied temperatures of most ETFs in our range.  

We hope you’ve enjoyed learning a bit more about the S&P Dow Jones Indices methodology. If you’re still in the mood for climate investing topics, head over to our COtool and get a handle on the implied temperatures of ETFs.

And to learn more about our relevant ETFs that can help reduce your carbon footprint, have a look at our climate-focused solutions.

This article is for informative purposes only, and should not be taken as investment advice. Lyxor ETF does not in any way endorse or promote the companies mentioned in this article. The opinions expressed by Ben Leale-Green are his own, and do not necessarily reflect the views of Lyxor International Asset Management or Societe Generale. Capital at risk. Please read our Risk Warning below.

Risk Warning

This document is for the exclusive use of investors acting on their own account and categorised either as “Eligible Counterparties” or “Professional Clients” within the meaning of Markets in Financial Instruments Directive 2014/65/EU. These products comply with the UCITS Directive (2009/65/EC). Société Générale and Lyxor International Asset Management (LIAM) recommend that investors read carefully the “investment risks” section of the product’s documentation (prospectus and KIID). The prospectus and KIID are available free of charge on www.lyxoretf.com, and upon request to client-services-etf@lyxor.com.

Except for the United-Kingdom, where this communication is issued in the UK by Lyxor Asset Management UK LLP, which is authorized and regulated by the Financial Conduct Authority in the UK under Registration Number 435658, this communication is issued by Lyxor International Asset Management (LIAM), a French management company authorized by the Autorité des marchés financiers and placed under the regulations of the UCITS (2014/91/EU) and AIFM (2011/61/EU) Directives. Société Générale is a French credit institution (bank) authorised by the Autorité de contrôle prudentiel et de résolution (the French Prudential Control Authority).

The products mentioned are the object of market-making contracts, the purpose of which is to ensure the liquidity of the products on the London Stock Exchange, assuming normal market conditions and normally functioning computer systems. Units of a specific UCITS ETF managed by an asset manager and purchased on the secondary market cannot usually be sold directly back to the asset manager itself. Investors must buy and sell units on a secondary market with the assistance of an intermediary (e.g. a stockbroker) and may incur fees for doing so. In addition, investors may pay more than the current net asset value when buying units and may receive less than the current net asset value when selling them. Updated composition of the product’s investment portfolio is available on www.lyxoretf.com. In addition, the indicative net asset value is published on the Reuters and Bloomberg pages of the product, and might also be mentioned on the websites of the stock exchanges where the product is listed.

Prior to investing in the product, investors should seek independent financial, tax, accounting and legal advice. It is each investor’s responsibility to ascertain that it is authorised to subscribe, or invest into this product. This document is of a commercial nature and not of a regulatory nature. This material is of a commercial nature and not a regulatory nature. This document does not constitute an offer, or an invitation to make an offer, from Société Générale, Lyxor Asset Management (together with its affiliates, Lyxor AM) or any of their respective subsidiaries to purchase or sell the product referred to herein.

Research disclaimer

Lyxor International Asset Management (“LIAM”) or its employees may have or maintain business relationships with companies covered in its research reports. As a result, investors should be aware that LIAM and its employees may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. Please see appendix at the end of this report for the analyst(s) certification(s), important disclosures and disclaimers. Alternatively, visit our global research disclosure website www.lyxoretf.com/compliance.

Conflicts of interest

This research contains the views, opinions and recommendations of Lyxor International Asset Management (“LIAM”) Cross Asset and ETF research analysts and/or strategists. To the extent that this research contains trade ideas based on macro views of economic market conditions or relative value, it may differ from the fundamental Cross Asset and ETF Research opinions and recommendations contained in Cross Asset and ETF Research sector or company research reports and from the views and opinions of other departments of LIAM and its affiliates. Lyxor Cross Asset and ETF research analysts and/or strategists routinely consult with LIAM sales and portfolio management personnel regarding market information including, but not limited to, pricing, spread levels and trading activity of ETFs tracking equity, fixed income and commodity indices. Trading desks may trade, or have traded, as principal on the basis of the research analyst(s) views and reports. Lyxor has mandatory research policies and procedures that are reasonably designed to (i) ensure that purported facts in research reports are based on reliable information and (ii) to prevent improper selective or tiered dissemination of research reports. In addition, research analysts receive compensation based, in part, on the quality and accuracy of their analysis, client feedback, competitive factors and LIAM’s total revenues including revenues from management fees and investment advisory fees and distribution fees.