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).
Comparison of MSCI Low Carbon Target Indexes and MSCI Low Carbon Leader Indexes
 MSCI Global Low Carbon Target IndexesMSCI 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        CountrySector 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           CountrySectorWeight (%) 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

 

 

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