Keeping Pace with the Climate Transition
The transition to a low-carbon economy could occur faster than investors may think.
Climate change has already become one of the most prominent line items on the world’s agenda. But we believe that its impact on the global macroeconomy is just beginning and increasing in pace. In our view, investors should think of the transition to a low-carbon economy as a multi-dimensional shock event, spread out over time, that will have major regulatory and economic consequences and profound investment implications. Investors who think the pace of climate-related change in markets/economies will be slow could be in for a major surprise.
ESG, Climate Metrics and Value Investing
Value indices could present a significant negative bias with regard to ESG and carbon securities relative to their Growth counterparts. Energy and Utilities that rank poorly with respect to carbon emissions tend to be overweight in such indices and Information Technology, Consumer Discretionary and Communication Services that rank highly from an ESG perspective tend to be underweight.
Similarly, when Value and Growth indices are compared using different climate metrics, the profile of Value indices looks a lot worse than that of Growth, with higher carbon emissions and brown revenues and lower green revenues.
Nevertheless, investors could dramatically improve the ESG profile of their Value portfolios by optimizing them to align with multiple objectives, including preserving exposure to the Value factor whilst improving the ESG and climate profile of their portfolios.
Outcomes and Opportunities
- COP26 resulted in a number of developments that will impact the financial services industry.
- A new standards body was established, which will help achieve a longdesired global ESG reporting standard.
- Other major developments were made in areas of biodiversity, phasing out of coal, new restrictions on methane, carbon markets preparation and a focus on nurturing green technology innovation.
The World Targets Change
How Investors’ Global Focus on Carbon is Set to Alter the Game
Our latest ESG research reveals an industry poised for a global groundswell of decarbonization target-setting over the next three years. Asset owners say their climate strategies are about creating real change and driving the economic transition, potentially transforming the investment landscape.
COP26, the 26th annual UN conference on climate change, is here and expectations are high. In this article, our ESG team explains more about the summit, what might happen there and how this may well impact investors everywhere.
Spiralling Disruption: The Feedback Loops of the Energy Transition
We are at a tipping point. Positive feedback loops underpinned by innovation will likely lead to a mass displacement of fossil fuels by renewables. In this article, we identify seven feedback loops that are driving a rapid transformation of the global energy system.
Peak fossil fuel demand likely occurred in 2019. This marks the tipping point where positive feedback loops start to dominate the system. We identify seven virtuous and vicious feedback loops.
Journey to Net Zero
Multiple frameworks exist to help asset owners and managers reach net zero, providing guidelines on decarbonizing portfolios, increasing investments in climate solutions and green technologies, and improving reporting.
State Street Global Advisors’ thinking on this topic is organized into six areas. For example, Asset Class Alignment shifts investments to appropriate net zero pathways within each asset class. For asset owners, the most important step is likely to be portfolio construction and we offer some approaches to consider.
A Case For: An Active Fundamental Approach to Climate Transition
A determined effort by both the public and private sectors to bring about a significant reduction in greenhouse gas emissions in the decade to 2030 also offers the potential for significant capital growth in equities. This new era of climate transition, when paired with discerning and forward-looking equity investment, presents opportunities for generating significant alpha.
Net Zero and the Enhanced Approach to EM Equities
The Effect of Adding a Climate Objective on Risk and Return
- We sought to determine whether investors can address their Net Zero objectives without sacrificing the risk and return characteristics of an Enhanced, or low-risk active, approach in emerging markets equities.
- By utilising the natural active risk within the Enhanced framework, we were able to integrate climate objectives with only a marginal change in the overall tracking error relative to the benchmark
Fundamental Active Equities: New Drivers & New Approaches for Climate-Related Investing
- As COP26 approaches, a series of regulatory and economic drivers are emerging which have the potential to dramatically reshape equity investing.
- Climate transition planning and competency will become key areas of differentiation for companies.
- We see promising opportunities in both Climate Transition and Climate Opportunity Strategies.
Engage or Divest? The Question at the Heart of Climate Impact
Climate change is a systemic threat to the global economy and represents both a strategic and operational challenge for all companies. As awareness of the systemic impact of climate change has grown, there has been progress on many fronts.
Countries have committed to reducing carbon emissions in line with the 2015 Paris Agreement of limiting global warming to well under 2°C by the end of the 21st century. In addition, many countries and local jurisdictions, led by the European Union, are implementing carbon pricing and emissions trading initiatives in order to reach net zero carbon emissions by 2050.
We have seen a sustained shift in energy use, away from fossil fuels and towards renewable energy, driven by acknowledgement of the impact of fossil fuel pollution, the need to reduce carbon emissions, and the growing affordability and practicality of renewables.
Energy Transition a Major Regime Shift for Global Economy
- As the world weans itself off fossil fuels, the terms of trade will change, with profound implications for exchange rates and sovereign borrowing costs globally.
- The energy transition will likely prove to be a structural headwind to US dollar’s dominance.
- Future global imbalances will accrue to countries at the technological forefront.
Reimagining Macroeconomics to Meet Climate Challenge
- Climate change can no longer be relegated to specialty models but must be integral to the mainstream macroeconomics framework.
- This means ESG investing would now be deemed as the necessary new framework for both macroeconomics and investing.
- Similarly, macroeconomic policies should seek to address costing disparities associated with new measures of productivity growth that take into account various aspects of climate change.
Journey to Net Zero
In this article, we examine the main net zero frameworks, their common threads and what they mean in practical terms for investors. In particular, we outline the concrete steps that investors need to take to make their portfolios “net zero aligned”.
Climate Data Nuances in Equity Index Portfolios
In our recent paper, “Weathering the Storm: Exploring Climate Strategies”, we explored the main approaches to integrating climate considerations in investment portfolios. In this article, we dive deeper and look at some nuances in climate data that need to be considered prior to implementation of climate objectives in equity index portfolios.
Weathering the Storm: Exploring Climate Strategies
Climate change is here and we will experience its impacts for decades to come. How should investors react in an environment where climate risks will only heighten and regulations will only become more onerous?
ESG Data: Addressing the Challenges
Accurate and consistent data is essential to any robust investment strategy or approach and environmental, social, and governance (ESG) investing is no exception. Yet, much has been made of the challenges of ESG data, which has — according to some studies — hindered adoption of ESG and climate investing. In this piece, we outline how ESG ratings can differ between providers and why investors need to be aware of the implications of choosing a particular ESG data provider.
A Kernel of Caution in a Robust Recovery
Since we issued our last Global Market Outlook in December, vaccination rollouts and robust monetary and fiscal support have accelerated the pace of economic recovery. COVID-related challenges remain acute in many areas, but the situation is improving, even in hard-hit emerging markets. As the US economy surges, European growth is poised to accelerate; emerging markets will soon follow. It appears that US market leadership may soon give way to international markets.
A Case For: Sustainable Climate Bond Strategy
State Street Global Advisors has developed a breakthrough climate bond strategy. Our climate-aware investment process enables you to immediately improve your portfolio’s carbon profile and reduce climate risk, while maintaining target returns.
Green Bonds: Mitigate Climate Risks, Capture Investment Opportunities and Fund the Transition
Would you like to make a positive impact through your investments? We argue that investors in listed securities who want to encourage more sustainable corporate behaviour should invest in green bonds.
Have We Seen the End of Fossil Fuel Expansion?
The International Energy Agency (IEA) has just released a report on the need for radical change in the energy sector and beyond to reach net zero emissions by 2050.
In this Q&A, Carlo M. Funk, Head of EMEA ESG Investment Strategy, discusses the report’s key findings and the implications for investors.
2020 Asset Stewardship Report
Our 2020 report showcases the engagement and voting activity we undertook in our mission to build sustainable capital markets and maximize value for our clients.
ESG, Tracking Error and Long-Term Performance
The market is replete with studies that research the relationship of ESG integration and performance. Tracking error is often discussed in conjunction with performance and the issue of tracking error against a strategic benchmark arises in most client conversations around ESG integration.
In our 2021 ESG outlook, we highlighted that investors tracking an underlying benchmark often have strict limits on tracking error embedded in their investment processes.
Yet, deviations from standard benchmarks become inevitable when ESG considerations are included in index methodologies. Also, with rising ESG adoption and the notion of ESG becoming “The New Normal” it is not inconceivable that ESG considerations will make their way into standard benchmarks.
So how should investors evaluate tracking error in light of internal and external pressure for more ESG integration?
Fundamental Active Equities: Climate Debate and Carbon Pricing
COP26, scheduled to be held from 1 to 12 November 2021, is expected to set the direction on whether ‘hard’ metrics, such as carbon pricing, will dominate environmental risk measures that are adopted in portfolios over the next decade.
ESG in Index Investing: Deconstructing Five Myths
Two of the most prominent investment trends of the post-global financial crisis world have been the sustained rise of both indexing and environmental, social and governance (ESG) investing. These trends have combined with many investors now seeking ESG and climate indexing strategies to achieve long-term and cost-effective sustainable returns.
Yet, many myths have arisen over the years around what sustainability-minded investors can achieve within an index approach. This piece aims to set the facts straight and clear up some misunderstandings of ESG in index investing.
Fearless Girl 4th Anniversary
Four Years Later, Her Impact Continues
On March 8th, 2021, we installed a broken glass ceiling surrounding Fearless Girl in New York to celebrate her 4th anniversary and International Women’s Day – symbolizing the many glass ceilings that women have shattered that continue to inspire all of us.
EU Sustainable Finance Regulations: 2021 and Beyond
This piece provides an overview of key developments in the European Union’s (EU’s) Sustainable Finance Agenda that will play out in 2021 and beyond, including the implications of the European Green Deal and the Renewed Sustainable Finance Strategy for financial market participants and financial advisors. The European Central Bank’s (ECB’s) efforts on ESG will be discussed, and in particular, what Banking Union Supervised Institutions should consider in relation to the new compliance challenges. Finally, we provide details of a proposal for potential new regulatory requirements for ESG data providers.
The ESG Data Challenge
The Importance of Data Quality in ESG Investing
Data quality is crucial in the world of investment management, and especially so in the area of environmental, social and governance (ESG) investing, where lack of mandatory and consistent reporting of non-financial information by companies makes it challenging for investors to make decisions based on that information.
Most ESG data providers employ their own proprietary methodologies, and ESG scores can differ significantly across providers.
ESG data should be transparent, align with our ESG beliefs, and incorporate our stewardship insights on companies. To achieve this, we have built our own data architecture. We partner with best-in-class data sources to create ESG scores that leverage a transparent materiality map created by the Sustainability Accounting Standards Board (SASB). This platform is used for investment solutions and reporting across asset classes.
ESG and the Biden Presidency
In a dramatic change from the previous administration, we expect the administration of President Joseph Biden to implement a broad range of policy changes meant to mitigate climate risk and bring the US back into the global sustainability conversation. We will be monitoring several themes that we believe could arise under the Biden presidency:
- Rising Calls for ESG Disclosure
- Stricter Climate Regulations
- Changing Operational Backdrops in Various Industries
- Investors Increasingly Pricing ESG Criteria Into Decision-Making
- US Department of Labor (DOL) ESG Rule
Fossil Fuels: An ESG Screening Approach
There is a growing interest among global investors in divesting, or minimizing exposure to, Fossil Fuels in their portfolios. Specifically, more than 1,200 global institutional investors, with $14.6 trillion in combined assets, have committed to divesting from fossil fuels in 2020. These investors seek to position themselves in opposition to the physical effects stemming from climate change, and seek to prepare their firms for future regulation around fossil fuels.
State Street Sustainable Climate Bond Framework: Aligning With The Paris Agreement Goals
The scientific report underpinning the Paris Agreement was authored by the Intergovernmental Panel on Climate Change (IPCC) in 2014. The IPCC is an intergovernmental body mandated by the United Nations, tasked with providing an objective, scientific view of climate change and its political and economic impacts.
Evolution Rather Than Revolution - Integration of ESG into the Fundamental Value Equity Investment Process
The Fundamental Value Equity team at State Street Global Advisors has a long history of ESG investing. The team has run a number of exclusion-based mandates since the 1980s, while our long-standing fundamental investment approach and governance activities involved implicit consideration of ESG issues across our broader suite of products. This paper explores the evolution of our process in a changing environment.
The New Normal: ESG Investing in 2021
In a year dominated by the COVID-19 pandemic, there has been a renewed focus from governments and companies on the need to address climate change and other sustainability challenges. For their part, many investors are integrating ESG and climate considerations across their portfolios in response to changing attitudes and regulations. Where will all this take us?
Read on for our five ESG themes for 2021 and why we see ESG emerging as the new normal.
Momentum Will Carry ESG Investing Far Beyond the Pandemic
The ESG investing story of 2020 has centered around the COVID-19 pandemic, but we believe that 2021 could be the transition year for concerted global action to tackle climate change and other environmental and social challenges. ESG investing is gaining momentum that will likely prevail long after the pandemic subsides.
A Case For: Sustainable Climate Equity Funds
The scientific evidence for man-made climate change is incontrovertible. The last five years have been the hottest on record and there is a greater than even chance that 2020 will be the hottest.1 Last year was marked by disaster caused by more frequent and extreme weather events brought about by climate change. A notable example was the Australian wildfires, set off by a record heatwave, which destroyed 44,400 square miles of bushland and forest and led to the killing or displacement of an estimated 3 billion animals.2 Warming has also led to unprecedented melting of ice and snow at the north and south poles. Sea level rise will mean coastal communities are much more exposed to flooding and extreme storms, leading many to migrate inland, putting pressure on infrastructure and resources. And with greater carbon dioxide in the oceans comes ocean acidification, degradation of marine ecosystems and reduction in marine biodiversity. Research suggests that ‘tipping points’ such as the melting of huge ice sheets or the loss of the Amazon rainforest are much more likely to occur than previously thought.3
Carbon Pricing: Where are We Going?
The COVID-19 pandemic has shown the power of governments to address urgent challenges. Across the world, countries have implemented unprecedented fiscal measures in response to the crisis. This shows the power of governments to implement necessary change to ensure a sustainable and resilient future.
One of the key tools in governments’ armoury has been to introduce a price on carbon emissions. An increasing number of countries and jurisdictions are implementing carbon prices, impacting the operations and asset valuations of companies across regions and sectors. This piece explains why investors should evaluate the impact of such measures.
Carbon Footprinting: An Investor Toolkit
Measuring, monitoring and reporting on carbon emissions can appear very confusing.
The recommendations from the European Commission’s Technical Expert Group (TEG) on sustainable finance and the Task Force on Climate-related Financial Disclosures (TCFD) have led to several approaches which are currently used in the market place to assess carbon emissions and calculate company and portfolio-level carbon footprint.