Case study by MSCI
We have two main approaches to developing indexes institutional investors may use as they decarbonise their portfolios (to mitigate carbon risks and support a transition to a low-carbon economy):
- reweighting high-carbon stocks (the MSCI Low Carbon Target Indexes);
- excluding the most emissions-intensive and reservesintensive companies in each sector (the MSCI Low Carbon Leaders Indexes).
| MSCI Global Low Carbon Target Indexes | MSCI Global Low Carbon Leaders Indexes | |
|---|---|---|
|
Approach used in index design |
Re-weighting |
Selection & Re-weighting |
|
Objective |
Minimise the carbon exposure (emission intensity and reserves relative to market cap) while constraining the ex-ante tracking error to the benchmark to a target (default: 30bps) |
Exclude based on carbon emission intensity and reserves relative to market cap, and then minimise tracking error while constraining the carbon reserve relative to market cap and emission intensity to a maximum value (default: 50%) |
|
Opportunity set |
Any MSCI market cap weighted index |
Any MSCI market cap weighted index |
|
Exclusion |
No exclusions |
Largest 20% emitters by number in the parent index, with a maximum of 30% by weight from any sector Largest owners of reserves (up to 50%) |
|
Optimisation/weighting |
Minimise emission intensity and minimise reserves relative to market cap, subject to the given constraints Ex-ante tracking error to benchmark: specified target (default: 30 bps) Turnover constraint: < 10% semi-annual Sector constraint: < 2% under- or over-weight, no constraint on Energy Country constraints: < 2% under- or over-weight Model: Barra GEM3 |
Exclude based on emission intensity and reserves relative to market cap Minimise ex-ante tracking error to benchmark Reduce emission intensity and reserves relative to market cap by at least 50% (default) Turnover constraint: < 10% semi-annual Sector constraint: < 2% under- or over-weight Country constraints: < 2% under- or over-weight Model: Barra GEM3 |
|
Short-term risk |
Uses optimisation to reduce tracking error to parent index |
Uses optimisation to reduce tracking error to parent index |
|
Long-term thesis |
Uses optimisation to reduce exposure to companies most vulnerable to stranded assets (i.e. exposed to current and future emissions) while retaining complete opportunity set |
Exposure reduction based on selecting companies with low current carbon emission and low fossil fuel reserves |
|
Public stance |
Allows for engagement with companies |
Can allow subscriber to signal an intent to influence corporate behaviour |
MSCI ACWI low-carbon target indexes
Our Global Low Carbon Target Indexes reweight stocks to reduce carbon exposure. The indexes are designed to achieve a target level of tracking error while minimising the carbon exposure.
The inputs include carbon emissions and carbon reserves exposures of the individual securities. The objective is to minimise carbon exposure subject to a tracking error constraint of 30 bases points relative to the parent index. The optimisation parameters include country weights, sector weights and other constraints.
Put simply, the index may include two securities from the same sector with similar risk characteristics exposures, but overweight the security with lower carbon exposure and underweight the one with higher carbon exposure. Figure 2 outlines the top and bottom 10 active weighted constituents within the MSCI ACWI Low Carbon Target Index relative to the parent index. Most of the underweight and overweight securities belong to the energy sector.
Comparison of MSCI Low Carbon Target Indexes and MSCI Low Carbon Leader Indexes
| Top active weights | Country | Sector | Weight (%) | Active weight (%) |
|---|---|---|---|---|
|
Ultrapaper Part On |
BR |
Energy |
0.2 |
0.2 |
|
Spectra Energy |
US |
Energy |
0.2 |
0.2 |
|
American Water Works Co |
US |
Utilities |
0.2 |
0.2 |
|
Formosa Petrochemical Co |
TW |
Energy |
0.2 |
0.2 |
|
Grupo Mexico B |
MX |
Materials |
0.2 |
0.2 |
|
Enbridge |
CA |
Energy |
0.2 |
0.2 |
|
PrairieSky Royalty Ltd |
CA |
Energy |
0.1 |
0.1 |
|
Inter pipeline |
CA |
Energy |
0.1 |
0.1 |
|
Fortis |
CA |
Utilities |
0.1 |
0.1 |
|
Transcanada Corp |
CA |
Energy |
0.2 |
0.1 |
| Bottom active weights | Country | Sector | Weight (%) | Active weight (%) |
|---|---|---|---|---|
|
Exxon Mobil Corp |
US |
Energy |
0.0 |
-1.0 |
|
Chevron Corp |
US |
Energy |
0.1 |
-0.4 |
|
Total |
FR |
Energy |
0.0 |
-0.3 |
|
Royal Dutch Shell B |
GB |
Energy |
0.0 |
-0.3 |
|
Royal Dutch Shell A |
GB |
Energy |
0.0 |
-0.3 |
|
BP |
GB |
Energy |
0.0 |
-0.3 |
|
Occidental Petroleum |
US |
Energy |
0.0 |
-0.2 |
|
Duke Energy |
US |
Utilities |
0.0 |
-0.2 |
|
NextEra Energy |
US |
Utilities |
0.0 |
-0.2 |
|
Southern Company |
US |
Utilities |
0.0 |
-0.1 |
