Net zero alignment by means of factor investing and 130/30
Systematic securities selection and portfolio construction can be combined with a 130/30 strategy to purposefully support decarbonisation. In doing so, we take advantage of the characteristics of the MSCI World Index with long-short positions, apply our successful multi-factor strategy in a sector-neutral manner and adhere to a predefined risk budget.
Fabian Ackermann, Head Systematic Strategies
In order to reach the 2-degree target, gross emissions must be reduced by 80% by 2050 (Figure). Business as usual is not a viable path here. The commitment made by countries can only become a reality with the participation of the private sector.
On the investment side, this results in opportunities for companies that focus on decarbonisation and risks for companies with high emissions. In the investment concept presented here, we focus on emissions and thus on managing the risks they entail in equity portfolios.
Necessary reduction of CO2 emissions
2015 Paris Climate Agreement
In the 2015 Paris Climate Agreement, it was decided to limit global warming to well below two degrees compared to pre-industrial times. In addition, efforts are to be intensified to limit warming to 1.5 degrees. With net zero greenhouse gas emissions (CO2e) by 2050, the 2-degree target would be achieved (see Figure 1). This requires enormous investments in technologies for decarbonisation as well as massive reductions in gross emissions.
How much carbon intensity reduction is possible in traditional equity funds?
Knowing that emissions must be cut by around 80% by 2050, it makes sense to already align the investment portfolio accordingly today and focus on companies that generate less emissions in a peer-group comparison. This is because these companies have fewer risks with regard to increasing regulation of emissions or rising CO2 prices.
In equities, the MSCI World Index has a CO2e intensity of around 145 tonnes of CO2e per USD million in revenue (as at 31 March 2023). This weighted sum is composed in the sectors as follows:
CO2-Intensity by sector in the index Equity World
| GICS sector | Weight | CO2e intensity | CO2e contribution |
| Finance | 13.05% | 1.62 | 1.12% |
| Industrial goods | 10.67% | 11.61 | 7.98% |
| Healthcare | 13.34% | 2.36 | 1.62% |
| IT | 22.71% | 3.59 | 2.47% |
| Utilities | 2.97% | 52.54 | 36.12% |
| Consumer discretionary | 10.80% | 4.70 | 3.23% |
| Communication | 6.95% | 0.83 | 0.57% |
| Consumer staples | 7.60% | 3.36 | 2.31% |
| Materials | 4.42% | 31.01 | 21.32% |
| Real Estate | 2.50% | 1.57 | 1.08% |
| Energiy | 4.98% | 32.28 | 22.19% |
| Total | 100.00% | 145.47 | 100.00% |
Source: MSCI for Index data and ISS for CO2e data (Scope 1 + 2) |
|||
Companies with the highest emissions can therefore be found in the utilities, materials and energy sectors. A simple way would therefore be to simply exclude these sectors, as their weighting in the index is only 12%, but they are responsible for 80% of emissions.
But is this really a sensible approach? If financing is withdrawn from all companies in these sectors, who will then supply us with electricity, gas or oil for the heating systems (still) in place? Who will supply the building materials for the maintenance of infrastructure and real estate? Apart from the social aspects, this narrowing of the investment perspective is also not necessarily sensible from a return perspective. For example, the energy sector achieved a return of 78% last year, while the overall market was -18%.
A more sensible approach is therefore to avoid companies with a high CO2e intensity per sector and to weight those with a low CO2e intensity more strongly. This rewards those who improve their CO2e efficiency and are thus prepared for the future. In this way, utility companies can then be invested in, but preferably those with a higher proportion of renewables in the energy mix.
It is possible to reduce the CO2e intensity by 80% with the same sector allocation as in the index with a tracking error of 0.40%, but the investable universe would be reduced by a third. This means that the portfolio would be in line with the <2 degree target already today. However, a greater reduction in relation to the 1.5-degree target becomes difficult because the universe is too restricted – resulting in an exponentially increasing tracking error. The 130/30 fund concept can help here.
Notice
Details on the implementation of this innovative concept were published by Dr Fabian Ackermann, Head of Systematic Strategies in Asset Management at Zürcher Kantonalbank, together with Holger Krohn, Head of Institutional Sales, Germany, in the German magazine Absolut Impact, issue 2/2023 (PDF, 471 KB).
