How to incorporate climate-change awareness
We believe climate-aware investing is possible without compromising on traditional goals of maximizing investment returns, and indeed is necessary to the achievement of those goals. Our research suggests there can be little downside to gradually incorporating climate factors into the investment process—and even potential upside. Benchmarks that take climate into account have the potential to perform in line with or better than regular counterparts. The MSCI Low Carbon Target Index, for example, has modestly outperformed the MSCI ACWI since 2010, MSCI data show.
Market Realist –Benchmarks that take climate into account
Climate-aware investing means, to a certain extent, avoiding companies that are vulnerable to climate change risk. In fact, investors may want to consider investing in the benchmark indexes that take the climate factor into account. These benchmark indexes have been performing better than the traditional ones, as you can see in the above graph.
The MSCI environmental indexes, mostly the ACWI Low Carbon Target Index, the ACWI Low Carbon Leaders Index, and the ACWI ex-Fossil Fuels Index have shown better performances in the last few years.
Have benchmarks outperformed?
These indexes include large-cap and mid-cap stocks from 23 developed markets (EFA) (DBEF) and 23 emerging markets (EEM) (VWO). They act as a benchmark for investors who are interested in managing their potential climate change risks to their investments.
The MSCI ACWI Low Carbon Target Index provides more weight to companies with low carbon emissions. Since its inception in November 2010, it has outperformed the ACWI (ACWI) (IVV) index with an annualized return of 7.9%. It’s higher than ACWI’s returns of 7.6% over the same period.
The MSCI ACWI Low Carbon Leaders Index has also outperformed the ACWI Index since its inception in November 2010. It has generated annualized return of 7.9%. This index excludes companies with the highest carbon emissions intensity. By doing this, it benefits investors by limiting their exposure to carbon risk.
The MSCI ACWI ex-Fossil Fuels Index acts as a benchmark to eliminate fossil fuel reserves exposure due to concerns about the association of these reserves to climate change. This index excludes companies that own oil, gas, and coal reserves. Since its inception in 2010, the index has outperformed the ACWI Index by posting gross annualized returns of 11.5%. This is higher than ACWI’s gross annualized return of 10.5%.
The benchmarks have clearly outperformed their traditional counterparts since their inception. This gives investors an opportunity to climate-proof their portfolios and limit their exposure to climate-related risks.
In the last part of the series, we’ll see how investors can further benefit from climate-proofing their portfolios.