The number of passive vehicles that allow investors to decarbonise continues to grow, but will future additions look at projected as well as current emissions, asks Sophie Robinson-Tillett from Environmental Finance.
Many investors could be accused of burying their heads in the sand when it comes to addressing climate risk in passive investments. This is often blamed on an absence of relevant investment instruments. But a boom in the number of low-carbon indexes is broadening the range of options available to investors.
Kickstarted in 2014 and 2015 with launches from MSCI, Standard & Poor's Dow Jones Indices (S&P DJI), FTSE, Solactive and others, there have been further new products this year from Stoxx, S&P DJI, Solactive and ERI Scientific Beta – and a slew more expected in coming months.
"An index based on carbon footprints, or even reserves, doesn't help the climate, it reduces your carbon exposure. They are two different things." -Maximilian Horster, South Pole Group
"These indexes have an important use as benchmarks against which to manage active portfolios, but the really great thing about them is that they can be tracked," says Maximillian Horster, partner financial industry at South Pole Group. "In the past, passive investors have been hiding behind the claim that they cannot invest in a 'climate friendly' way – but those days are over."
The availability of these tools has increased to coincide with incentives to decarbonise: institutional investors – including pension and sovereign wealth funds, which often have large allocations to passive strategies – are beginning to respond to the growing number of policy signals in the wake of the Paris climate agreement, which committed to restrict global warming to 2°C above pre-industrial levels.
But as the need for these indexes becomes clearer, the options available to investors become increasingly complex. Innovations in the field have come thick and fast. As well as numerous developments in the overall environmental, social and governance (ESG) and green bond index arena, the world's first index that tracks bonds from low-carbon issuers was launched in March by Solactive, which also launched six low-carbon equity indexes in January to bolster the existing low-carbon indexes it created with Corporate Knights in September 2014.
S&P returned to the low-carbon index market, in February, in partnership with JP Morgan. The US-based bank will, for an initial period, exclusively license the S&P Europe 350 Climate Change Index created by S&P Dow Jones Indices, as part of its plans to offer a new environmental, social and governance (ESG) investment platform.
S&P, which first launched low-carbon products in 2009, also in November teamed up with the Toronto stock exchange to create three Canada-focused low-carbon products, as well as in December launching the S&P Global 1200 Fossil Fuel Free Carbon Efficient Index – which divests from fossil fuel holdings and reweights the remaining constituents based on their carbon emissions.
ERI Scientific Beta – a provider set up by French academic body EDHEC – also dipped its toe in the market with the launch of a smart beta low-carbon index series earlier this year. In this case, carbon screens are overlaid on top of the provider's existing smart beta products, removing the most carbon intensive firms in each sector, alongside all coal mining companies. Following these exclusions, the worst remaining emitters, across all sectors, are also removed.
Investors' favoured option, so far, seems to be indexes with a focus on low tracking error and sector neutrality – keeping them closely in line with mainstream benchmarks, making the reallocation of capital easier.