Investing in the climate change through ETFs

We wanted to look at some options to invest in the climate change and have asked some asset managers to send us some commentaries of their ETF's and some thoughts.

Investor Relations Specialist

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Investing in the climate change through ETFs is a fantastic option for investors looking at aligning their own interests with the interests of the planet. We wanted to look at some options to invest in the climate change and have asked some asset managers to send us some commentaries of their ETF’s and some thoughts on why it is so important to prioritise the climate change while thinking about good investment opportunities.

Amundi MSCI Wld Climt Trnstn CTB ETF

Matthieu Guignard, Global head of product development and capital markets – Amundi ETF, Indexing & Smart Beta.

The critical role of passive management in combating climate change

Climate change poses the greatest real threat to our planet and is not a distant but an imminent danger. This was confirmed by the alarming Intergovernmental Panel on Climate Change (IPCC) report published this summer ahead of COP 26, which will help further accelerate action on climate change in the global financial ecosystem.

What is clear is that investors can make a difference.

The European Union climate benchmarks (Climate Transition benchmarks or CTB / Paris Aligned Benchmarks or PAB) designed to align investors’ portfolios with the Paris Agreement – a framework to limit global warming to below 2°– set the stage for climate-positive investing. Both benchmarks require specific levels of “self-decarbonisation” of the index year-on-year as well as ambitious carbon intensity reductions versus the parent index. PAB indices also require specific activity exclusions. Together, the benchmarks offer a clear and transparent structure to facilitate widespread climate investing and accelerate the transition toward a low carbon economy.

Their introduction in 2020 underscores the critical role of passively managed assets in combatting climate change which has been in motion for some time.

And Amundi was a pioneer in this field as illustrated by the co-design of the MSCI Low Carbon Leaders index series in 2014. These were the first generation of climate indices, covering at the time scope 1 emissions. A few years later, with more data available covering indirect emissions and forward-looking climate commitments alongside historical data, Amundi became one of the first asset managers to launch a full suite of climate ETFs based on the new EU CTB and PAB benchmarks. 

As climate change consciousness has become more widespread, interest in climate-related investments has correspondingly soared. Assets under management in climate ETFs have doubled since the beginning of the year, reaching €9.4 billion at the end of August.

We believe this trend is likely to continue owing to a number of factors, namely: 

  • The pandemic crisis has accelerated a pre-existing shift towards more ESG and climate friendly solutions. 
  • The election of Joe Biden has brought new hope for the global fight against climate change and for climate advocacy.
  • The EU Sustainable Finance Disclosure Regulation (SFDR), which entered into application in March 2021, provides greater transparency on the degree of sustainability of financial products. This will raise the bar and require companies to act.

The IPPC climate report has highlighted the gravity of the climate emergency faced by us all, and the need for immediate action. And passive management solutions, such as ETFs aligned to EU climate benchmarks, offer the opportunity for all investors to play a role in fighting this existential crisis and reducing carbon emissions.

Product focus: Amundi MSCI Europe Climate Transition CTB UCITS ETF DR

The Amundi MSCI Europe Climate Transition CTB UCITS ETF DR ETF incorporates a 30% carbon intensity reduction along with a year-on-year self-decarbonisation target of 7% and is designed for those investors wishing to transition to a low carbon economy while maintaining broad market exposure.

Franklin S&P 500 Paris Aligned Clmt ETF

Caroline Baron, Head of distribution ETF EMEA, Franklin Templeton

With the EU Action Plan for Sustainable Finance, the European Commission aims to embed sustainability in the financial system. One step in the plan is the development of benchmarks for sustainability to encourage investments that are aligned with the Paris Agreement. The EU established minimum standards to ensure comparability and transparency: the Paris-aligned EU Benchmark (EU PAB).

In particular, it is designed to guarantee the transparency of investment instruments and minimize the risk of “greenwashing” through common standards, targets and quantitative metrics.

A new class of benchmarks to tackle Climate Change

The new climate benchmark quantitatively assesses how individual companies are aligned to the 1.5°C or 2°C global warming scenario. The aim is not only to identify climate-friendly companies in retrospect, but above all those that will be able to take advantage of the opportunities associated with climate change in the future – in other words, those transformative companies that have recognized not just the risks of doing too little, but also the opportunities of doing more.

Paris-Aligned indices: Flexible tools for portfolio construction to address climate change

The index providers STOXX and S&P have created new indices for different investment regions based on these benchmarks. In doing so, they are working with leading CO2 data specialists such as Trucost and ISS to meet the new EU guidelines. As a result, their Paris-aligned index versions feature ambitious CO2 reduction targets and strict rules more generally with regard to environmental, social and governance criteria.

What does it mean for investors?

Franklin Templeton’s Paris-aligned UCITS-compliant ETFs are an example of how the EU’s new climate benchmarks have driven the development of flexible portfolio allocation tools. The diversified structure of these funds shows that sustainability is no longer niche, but could become the new standard in the financial industry.

These new EU indices represent the next step in the evolution of climate investing. Below is a summary of how they differ from previous low carbon and climate indices.

They introduce forward-looking indicators rather than solely relying on backward-looking ones

They include a temperature rise goal, which will seek to limit the increase to 1.5 to 2C (current trajectory is 3.5 to 4C)

In addition to Scope 1 and 2 emissions, Scope 3 data is now used to account for a broader source of indirect emissions. Scope 3 encompasses all other emissions associated with a company’s operations that are not directly owned or controlled by the company. Therefore, scope 3 emissions include several sources of indirect emissions in the company’s supply chain (upstream) and downstream from the company’s owned or controlled operations.

The philosophy of the new EU Climate Benchmarks is therefore different and aims to not only assess a company based on its carbon footprint (backward-looking approach) but, through scenario analysis based on innovative new environmental and scientific datasets, also identify potential growth opportunities (forward-looking approach).

Investors can use these 2 ETFs in various ways:

As a core sustainable equity allocation aligned to the low carbon transition

As a low carbon allocation within a broader ESG Fund of Funds

As a satellite exposure to help reduce climate change risks and access opportunities to low carbon transition.

Lyxor Zero 2050 S&P Euroz ClmtPABDR

Antonio Celeste Head of ESG Product – ETF & Index Solutions at Lyxor Asset

According to the latest Intergovernmental Panel on Climate Change (IPCC) Report, emissions of greenhouse gases from human activities are responsible for approximately 1.1°C of warming since pre-industrial levels. We already experience the negative impact of emissions as 800,000 people die from air pollution each year in Europe and 8.8 million worldwide.

In the absence of policies, global warming is expected to reach 4.1°C – 4.8°C above pre-industrial levels by the end of the century, according to the Climate Action Tracker (CAT) initiative.

The Paris Agreement aims to limit global temperature increase to +1.5°C. 

The 1.5°C limit needs the countries of the world achieving a ‘net zero’ state by 2050, meaning that by then every unit of CO2 emitted will have to be matched by another unit of CO2 removed from the atmosphere.

There are encouraging signs: the European Commission will dedicate 30% of the EU budget towards this cause from 2021-2027 2, China, contributing to 28% of world’s GHG, recently committed to neutrality for 2060, while the US rejoined the Paris Agreement early this year. 

The challenge is therefore how to maintain significant emissions reductions over time. 

The EU created the Climate Transition Benchmark (CTB) and the Paris Aligned Benchmark (PAB), aligned with Paris Agreement goals to help investors decarbonise portfolios.

The CTB and the PAB provide a robust framework to align portfolios with the 1.5°C scenario: a 7% reduction in carbon intensities 3 is needed every year to achieve the target.

Thanks to the CTB and PAB benchmarks, investors can directly influence change by redirecting capital flows towards portfolios aligned with the 1.5°C scenario.

In 2020, Lyxor issued a suite of ETFs aligned with the CTB and PAB framework targeting different geographical exposures. 

One of these ETFs is the Lyxor Net Zero 2050 S&P Eurozone Climate PAB (DR) UCITS ETF

The Lyxor Net Zero 2050 S&P Eurozone Climate PAB (DR) UCITS ETF aims to track the S&P Eurozone Large Mid Cap Paris-Aligned Climate Index (EUR) NTR. The index is designed to measure the performance of eligible companies from the parent S&P Eurozone LargeMidCap index, selected and weighted to be compatible with a 1.5°C global warming climate scenario at the index level.

The index, designed to target the 1.5°C goal, at the same time improves the ESG score, removes companies involved in controversial weapons, small arms, military contracting, thermal coal, oil sands, shale energy, coal, oil and natural gas exploration, energy production from coal, oil and natural gas, gambling, alcohol and tobacco business activities, removes companies in breach of UN Global Compact or involved in relevant ESG controversies and finally minimises the deviations from the parent index.

In terms of performance, the Lyxor Net Zero 2050 S&P Eurozone Climate PAB (DR) UCITS ETF continued its strong run in 2021 with a solid performance of +23.57% on year-to-date and a performance of +36.60% during the last 12 months 4. The ETF, launched in July 2020, collected € 878 million.

JPM Carbon Transition Global Equity ETF

Yazann Romahi and Aijaz Hussain, Portfolio Managers JP Morgan Asset Management

Climate change is happening now Climate change impacts everyone, and its effects can already be seen today. Recent global events, such as the wildfires that ravaged Greece and parts of the United States, as well as the record-breaking snowfall in Madrid, to the extreme and devastating flooding that we saw in Germany, are making the consequences of global warming more apparent. The consequences of climate change are devastating and are galvanising public support for measures to shift to a lower carbon system.

Policy changes will affect corporate profits As countries around the globe are moving in line with the Paris Agreement and trying to keep temperatures below 2 degrees, we are going to need to shift to a lower carbon world.  That means we will need to reduce our use of fossil fuels and importantly increase our use of renewable energy sources.

For investors, the way that policymakers approach the path to net zero will have a meaningful financial impact on the companies in their portfolios, in terms of both cash flows and valuations. 

There will be both opportunities and risks across industries. Importantly, for most industries, emission reduction rather than offset will be required, and investors should view corporate commitments with this in mind.  

J.P. Morgan Carbon Transition Strategy: Positioning for the transition 

The J.P. Morgan Carbon Transition Global Equity UCITS ETF (JPCT) offers a core passive like exposure to global equities with a low tracking error, compared to the MSCI World Index, and delivers a meaningful reduction in carbon intensity.  

JPCT is designed to be in line with the European Union’s Climate Transition Benchmark, which requires at least a 30% reduction in carbon emissions, and at least a 7% year-on-year rate of self-decarbonisation.  

Based on our proprietary evaluation framework, which combines the insights of our Sustainable Investing Team with the portfolio management and research expertise of our Asset Management Solutions – Quantitative Solutions team, JPCT takes a comprehensive approach that considers both the downside and the upside potential created by the transition to a low carbon world.  

Our framework imports primary data, sourced directly from companies, as well as alternative data sources from ThemeBot, JPMAM’s proprietary natural language processing tool, which seeks to identify companies involved in providing innovative solutions to address the climate change challenge.  

We use a proprietary evaluation framework to provide a comprehensive view on how well companies are prepared for the transition to a low carbon economy.  Stocks are evaluated across three pillars:

  1. Emissions – both historical and forward-looking carbon emissions
  2. Resource Management – e.g. electricity, water, and waste
  3. Risk Management – both the physical risks of climate change and reputational risks 

By applying this framework, JPCT is able to tilt into those companies that are best prepared, and away from companies that are most exposed to carbon transition, focusing as much on the investment opportunities as the risks.  

By acting early, before climate risks and opportunities are fully priced in, investors can capture potentially significant returns as prices continue to adjust.

iClima Global Decarbonisation Enablers ETF

Gabriela Herculano, Chief Executive Officer & Co-Founder at iClima Earth and Shaila Khan Leekha, Co-Founder and COO, iClima Earth

We often say that the best way to reduce carbon in the atmosphere is by not emitting in the first place. This logic permeates our methodology and is very much our raison d’etre. iClima’s approach to climate-conscious investing is to represent the companies that prevent damaging emissions from ever being made.

Even when a company cuts its carbon footprint in half, it’s still polluting, and there might be an even better alternative. By using this idea, we bring a new approach to environmentally conscious investing. A lot of players in the ETF space are focusing on the side of the coin of the users doing less harm, cleaning their footprint. We think the most exciting story is the other side of that same coin: it is the story of the suppliers. Our hypothesis is that the suppliers of the solution can be the most relevant and exciting investments.

iClima launched its first ETF in Europe 18 months ago, and the Global Decarbonisation Enablers UCITS fund now has about $50 million in assets. It is an Article 9 fund as is our second ETF –iClima Distributed Renewable Energy UCITS launched earlier this year.  Both ETFs are now listed  in the US.

The question investors rightly ask is how to evaluate the companies that prevent or avoid emissions We have developed our unique methodology from scratch, by triangulating the framework developed by Mission Innovation, called the Potential Avoided Emissions. It provides a logic to how to estimate the total carbon emissions for a range of services and products over the course of their manufacturing and use. An easy example to understand is flying to a business meeting in person versus holding the event over Zoom: a video conference has lower carbon footprint than the other (it is also cheaper, less stressful and more efficient). The difference is the delta: the emissions that were never released in the first place. That’s exactly what iClima is looking for – the companies that move us away from “business as usual”. 

These products and services that are low or zero emission enable us to fulfil our needs as a society. Telepresence, plant-based diet, micro transportation, fuel cell makers, smart meters, smart thermostats and recycling solutions enable a transition to circular economies, and of course renewable energy and electric vehicles. We represent a comprehensive range of relevant solutions, without “contamination” from incumbent players tied to the “business as usual” industries.

What makes us particularly excited is that so many of the solutions we represent make economic sense. For example, renewable energy being produced at the point of consumption, using solar rooftops with associated battery storage allows users to save money from day one. The solutions have a plethora of positive externalities (plant-based food is better for our health than high consumption of red meat, distributed generation enhances security of supply), they are price competitive, and they decarbonise. With tail winds coming from many directions, these companies are likely to succeed in transitioning society towards a more sustainable future. 

Tabula EUR IG Bond Paris-aligned Climate UCITS ETF

Michael John Lytle, CEO, Tabula Investment Management

In January 2021, Tabula launched the Tabula EUR IG Bond Paris-aligned Climate UCITS ETF, the first Paris-aligned bond ETF. The ETF allows passive investors to align core corporate bond allocations with a 1.5C Paris scenario and addresses a significant gap in the market. There is around €40 billion invested in Euro IG corporate bond ETFs. We saw significant growth in ESG-screened products during 2020, but no core bond products focused on the overarching issue of climate. 

The ETF tracks an index developed in co-operation with Solactive and ISS-ESG. In accordance with PAB rules, the index delivers a 50% reduction in Greenhouse Gas Emissions relative to the broad Euro IG bond market at inception, and a minimum 7% annual reduction. It excludes fossil fuel companies and applies other important ESG screens (e.g. social norms, controversial weapons) that you would expect in any responsible investment. 

When developing the ETF, we focused on three aspects: 

  1. Simplicity: one key advantage of the EU Climate Benchmarks is that, amid a multitude of ESG products and indices, they are defined by the EU and provide a clear starting point for investors. While there are pros and cons to the methodology, it is simple and transparent. As the first ETF provider to apply this methodology to the bond market, we felt that retaining this simplicity was important. 
  2. High quality data: data quality is one of the most important considerations in any ESG product, but particularly for passive products where one is applying rules across a broad universe and there is no scope for manager intervention. Tabula’s ETF uses ESG and emissions data provided by ISS-ESG, which acquired the climate data division of South Pole Group in 2017 and has one of the broadest and deepest climate data sets in the market. 
  3. Stewardship: we have taken the unusual step of focusing our stewardship efforts on issuers that are excluded from the ETF. There are three reasons for this. Firstly, as a bond holder, we do not have voting rights so our ownership status is less important. Secondly, because of the limits on fossil fuel revenues in the PAB rules, the ETF is underweight in the energy sector. Many of the excluded energy companies are important EUR bond issuers. Finally, as a climate-focused ETF, it makes sense for climate to be the focus of our stewardship. We have joined the Institutional Investors Group on Climate Change and Climate Action 100+. 

Outcomes

  • A significant reduction in portfolio emissions – investors can use the ETF to reduce the emissions of their Euro IG bond allocation by over 60% versus the broad market.
  • The PAB methodology sends a strong signal on climate. The exclusion of fossil fuel companies by bond investors could also begin to impact refinancing, particularly if coinciding with action on lending by the banks.
  • Do no significant harm – the PAB rules stipulate that issuers violating global norms are excluded. 
  • A diversified ETF with a clear risk profile versus existing Euro IG benchmarks.

If you want to see more articles about investing in the climate change and other sustainable investments, check our section.

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Investing in the climate change through ETFs