Briefing Note
Divestment
and
Environmental Tracking
Case Study: iShares MSCI ACWI Low Carbon Target ETF
OCTO BE R 2015
Dedicated to helping investors
understand, manage and reduce carbon risk
ET Index Series
The Environmental Tracking Low-Carbon Index Series is specifically designed
to help investors reduce their exposure to carbon risk.
The ET Index Series is underpinned by the ET Carbon Rankings, which score the world’s largest
listed companies according to their carbon emissions. By linking an investable index to a
public ranking of companies, Environmental Tracking offers investors a practical mechanism
through which to incentivise and participate in global corporate carbon emission reductions.
ET Carbon Tracker Series - 25% reduction in
carbon exposure relative to the Conventional
Market Cap index.
Key Features
T Carbon Benchmark Series - 50%
E
reduction in carbon exposure relative to the
Conventional Market Cap index.
• G
HG Protocol Scope 3 (supply chain)
emissions data included for a complete
assessment of company carbon
emissions and risk exposure.
T Carbon Transition Series - 75% reduction
E
in carbon exposure relative to the Conventional
Market Cap index.
T Fossil Free Series - available in Tracker,
E
Benchmark and Transition versions for
each index. Combines divestment with
Environmental Tracking to further reduce
carbon exposure across all companies once
fossil-fuel stocks have been excluded. Fossilfuel stocks are defined as those in the Oil,
Gas and Coal sectors in the Sustainable
Industry Classification SystemTM (SICS®) from
SASB®.
T Custom Indexes - Indexes to meet clientE
specific requirements available on request.
ET Index Briefing Note 04: June 2015
• ET
Engagement with index constituents
on behalf of clients comes as standard
and can be monitored through the
ET Carbon Rankings, the only
comprehensive public carbon ranking
system to cover the world’s largest
listed companies. The rankings,
upon which the indexes are based, are
specifically designed to encourage lower
emissions and greater transparency.
• E
T Custom Index solutions might
include sector-neutral weightings or
sector specific indexes.
2
Divestment is good,
Environmental Tracking+Divestment is better.
Since March 2015 the Guardian has been running a
the fully transparent ET Carbon Rankings.
campaign calling on the Bill & Melinda Gates and the
Building on the approach of divestment, which only
Wellcome Trust foundations to divest from fossil-fuels.
This builds on a wider divestment movement that now
includes over 200 institutions globally committed to
divesting their holdings of fossil-fuel companies over
the next 5 years.
This briefing does not question the merits of divestment
from a campaigning point of view - clearly fossil-fuel
companies are a legitimate target for concerned citizens
alarmed that their business models are incompatible
with avoiding dangerous climate change. Instead this
briefing asks if it is the most effective solution, or if there
is a complementary solution that could be more effective
at both reducing carbon exposure and encouraging
corporates to lower emissions.
Environmental Tracking (ET) is a simple mechanism made
up of two key components. The first, is a set of ET Carbon
Rankings. Here, the largest companies in the world are
ranked according to their publicly-disclosed greenhouse
gas emissions data. This includes their supply chain
(Scope 3) emissions, which are often the most significant
source of emissions. In the case of companies failing to
publicly disclose data, they are benchmarked against
the company with the highest reported emissions figure
within the same sector, providing a constant incentive
for disclosure.
The second, is a series of ET low-carbon indexes.
These are stock market indexes just like, for example,
targets fossil-fuel companies, each and every company
within the stock market is penalised or rewarded based
on their carbon emissions. This is designed to push up
the cost of capital for carbon-intensive companies.
This approach is the embodiment of engagement.
Since all companies are publicly ranked it provides an
open platform for ET investors to monitor progress in
a transparent way and demand that companies lower
emissions. For companies, the only way to move up
the ranking is to lower emissions and to encourage
the companies within their supply chains to do the
same, in turn gaining a greater weighting in the index
and therefore a greater share of investment from those
tracking the index.
As any investor will know, money speaks louder than
words.
As this briefing demonstrates, investors can achieve
a greater emissions-intensity reduction through
Environmental Tracking than divestment alone, without
compromising on returns.
For investors committed to pursuing a divestment
strategy, ET Fossil Free indexes offer the ability to combine
divestment with Environmental Tracking, re-weighting
the remaining companies in the portfolio according to
their carbon emissions once fossil-fuel companies have
been excluded.
the FTSE 100 or S&P 500. They contain all of the same
companies as conventional benchmark indexes, not just
those which are ‘low-carbon’. The difference between
ET low-carbon indexes and traditional stock market
indexes is that they are designed to redirect capital from
high-carbon to low-carbon companies. They do this by
re-weighting companies according to their position in
Visit ETindex.com to view the
ET Index Briefing Note 04: June 2015
ET Carbon Rankings online
3
Divestment is good,
Environmental Tracking+Divestment is better.
Carbon Footprint Analysis of the iShares MSCI ACWI Low
Carbon Target ETF
Figure 1 Overall portfolio carbon emissions-intensity comparisons.
1200
tCO2e / $m Revenue
1000
800
600
400
200
0
MSCI ACWI Low Carbon
ET Tracker Tilt
ET Benchmark Tilt
ET Maximum Tilt
The carbon emissions intensity, also known as the carbon footprint, of the iShares MSCI ACWI Low Carbon Target
ETF was assessed using the ET Index Carbon Footprint Analysis tool. This tool is available online for investors at
www.ETIndex.com.
The carbon footprint of the original portfolio was then compared to the footprint following the application of the
Environmental Tracking approaches, as well as following divestment, and following a combination of divestment
and the Environmental Tracking approaches.
The Environmental Tracking low-carbon investing approaches that were applied were:
• ET Tracker Tilt - Reduces carbon exposure while very closely tracking the expected performance of the
original portfolio.
• ET Benchmark Tilt - Reduces carbon exposure by a large, fixed target amount while also tracking the expected
performance of the original portfolio.
• ET Maximum Tilt - Reduces carbon exposure by the largest amount judged to be possible while still tracking
the expected performance of the original portfolio.
In each of these approaches, high-carbon companies are negatively de-weighted and low-carbon companies
positively re-weighted according to their position in the public ET Carbon Rankings. The difference between these
approaches is the degree to which company weights are adjusted and the corresponding differences in carbon
emissions-intensity and tracking error relative to the non-tilted version of the index.
These approaches offer different ways for investors to lower their exposure to carbon-intensive companies. Each
approach supports the Environmental Tracking mechanism as a means to encourage each and every company on
the stock market to lower emissions and improve transparency. Different investors have different values, objectives
and risk appetites and the ET Index approaches (and the ET Index Series) are designed to accommodate their
different needs.
ET Index Briefing Note 04: June 2015
4
Divestment is good,
Environmental Tracking+Divestment is better.
Divestment and the ET Fossil Free approaches
Figure 2 Overall portfolio carbon emissions-intensity comparisons.
1200
tCO2e / $m Revenue
1000
800
600
400
200
0
MSCI ACWI Low Carbon
Divestment
ET Fossil Free Tracker Tilt
ET Fossil Free Benchmark Tilt
ET Fossil Free Maximum Tilt
As Figure 2 demonstrates, combining divestment with Environmental Tracking enables investors to further reduce
their exposure to carbon.
The reason that the combination of the Environmental Tracking mechanism and divestment produces such a large
reduction relative to simply excluding fossil-fuel companies alone is that fossil-fuel companies are not the only ones
responsible for emissions. Indeed each and every company within the economy needs to be provided with an
incentive to lower emissions if dangerous climate change is to be avoided.
How Environmental Tracking is combined with Divestment
The ET Fossil Free Tilt approaches combine divestment with Environmental Tracking such that once fossil-fuel
companies have been divested the remaining companies in the portfolio are re-weighted to minimise exposure to
carbon, and to provide an incentive for the remaining companies to lower emissions. These approaches are designed
for investors concerned that not only will low-carbon stocks outperform high-carbon stocks, but specifically that
fossil-fuel stocks will suffer a sharp price correction due to their reserves becoming stranded, in addition to other
regulation to curb their emissions.
• The ET Fossil Free Tracker Tilt approach is designed for investors who wish to closely track the non-tilted
version of the index while further lowering exposure to carbon-intensive companies once fossil-fuel companies
have been removed.
• The ET Fossil Free Benchmark Tilt approach is designed to reduce the carbon emissions-intensity of the
remaining constituent companies by 50% after fossil-fuel companies have been removed.
• The ET Fossil Free Maximum Tilt approach is designed to achieve the maximum possible carbon emissionsintensity reduction possible across the remainder of the stocks in the index after fossil-fuel companies have
been removed.
ET Index Briefing Note 04: June 2015
5
Divestment is good,
Environmental Tracking+Divestment is better.
Environmental Tracking low-carbon investing methodology
Figure 3 Environmental Tracking: Intensity reduction versus tracking error relative to the iShares
MSCI ACWI Low Carbon Target ETF.
Intensity as a % benchmark
100
80
60
40
20
0
0.0
0.5
1.0
1.5
2.0
2.5
3.0
Tracking Error
Figure 3 shows tracking error versus the emissions intensity reduction as a percentage of the portfolio given the constraints placed on the ET investing approaches. The specific ET Tracker, ET Benchmark and ET Maximum Tilts correspond to different points on this curve.
Defining ‘tracking error’ and ensuring that the ET-tilted portfolios can be expected to track the performance
of the original portfolio
Investors typically measure their performance against a selected benchmark. This is done by calculating the ‘tracking
error’ as a measure of the expected standard deviation of the difference between the index return and the benchmark
return.
For this analysis the original portfolio serves as the benchmark. The tracking error of each ET-tilted portfolio was estimated against this benchmark. Then the ET Tracker Tilt portfolio was determined as the maximum carbon emission
intensity-reduction that can be achieved with an estimated 0.30% tracking error.
The ET Fossil Free Tracker Tilt portfolio was developed with the same tracking error constraint but with the divestment
portfolio serving as the benchmark.
ET Index Briefing Note 04: June 2015
6
Divestment is good,
Environmental Tracking+Divestment is better.
Environmental Tracking low-carbon investing methodology
Figure 4 Fossil Free Environmental Tracking: Intensity reduction versus tracking error relative to the
iShares MSCI ACWI Low Carbon Target ETF.
Intensity as a % benchmark
100
80
60
40
20
0
0.5
1.0
1.5
2.0
Tracking Error
Figure 4 shows tracking error versus emissions intensity percentage reduction of the portfolio given the constraints
placed on the ET Fossil Free approaches. The specific ET Fossil Free Tracker, ET Fossil Free Benchmark and ET Fossil
Free Maximum Tilts correspond to different points on this curve.
Constraining the ET-tilted portfolios to make sure that they are realistic
Constraints were imposed on the tilting process to ensure that the ET-tilted portfolios are composed of realistic allocations to the same stocks as in the original portfolio.
These constraints were:
• That no stock may have more than 20 times its weight in the original index.
• That no stock may have less than 10% of the weight of the lowest weight stock in the original index.
• That the rankings-based weight ceilings and floors discussed in the section on the ET Carbon Rankings below.
These constraints are applied to each of the tilt approaches that were used: the ET Tracker Tilt, the ET Benchmark Tilt,
the ET Maximum Tilt, and the Fossil Free variations.
In particular the constraints mean that there is a maximum carbon emissions-intensity reduction that can be achieved
while keeping the portfolio within these realistic constraints. The portfolio that achieves this maximum feasible reduction
is the ET Maximum Tilt portfolio.
ET Index Briefing Note 04: June 2015
7
Divestment is good,
Environmental Tracking+Divestment is better.
Environmental Tracking low-carbon investing methodology
Defining the Benchmark approach
The Benchmark approach is designed to create a benchmark portfolio for investors that has a significantly reduced
carbon emissions-intensity relative to the non-titled portfolio, while maintaining a low tracking error to the non-tilted portfolio. In general, the Benchmark approach will have a more meaningful intensity reduction than the Tracker approach,
because the reduction of the Tracker approach is limited by its tracking error constraint.
In general the target reduction for the Benchmark approach is 50%. However this is portfolio dependent. When a 50%
reduction is not possible given the nature of a portfolio, e.g. a portfolio with few highly concentrated holdings, a smaller
target reduction amount is used.
How the ET Carbon Rankings are incorporated into the portfolio tilting process
In general the tilting process skews the weights in the portfolio towards low-carbon stocks. This means that companies
with better ranks in the ET Carbon Rankings will receive higher weights in the ET-tilted portfolio.
However, part of the tilting process involves choosing the tilted portfolio weights in such a way that the tilted-portfolio
has the same expected performance characteristics as the original portfolio. That is, to achieve a low tracking error
relative to the original portfolio (see the explanation of tracking error above). To ensure that this part of the process does
not interfere with Environmental Tracking principles, ceiling and floor values are imposed on the weights of each stock.
The ceiling values ensure that no high-carbon stocks receive more weight in the tilted-portfolio than their original weight
in the portfolio. The floor values ensure that no low-carbon stocks receive less weight in the tilted-portfolio than their
original weight in the portfolio. This allows for the optimisation of the weights to achieve low tracking error, satisfying the
requirements of institutional investors, while still maintaining the principle behind Environmental Tracking: that the only
way for companies to improve their weighting within the index is to reduce their carbon emission-intensity and receive
a better rank in the ET Carbon Rankings.
ET Index Briefing Note 04: June 2015
8
Divestment is good,
Environmental Tracking+Divestment is better.
Summary
Figure 5 Overall portfolio carbon emissions-intensity comparisons.
1200
tCO2e / $m Revenue
1000
800
600
400
200
0
MSCI ACWI Low Carbon
ET Tracker Tilt
ET Benchmark Tilt
ET Maximum Tilt
Divestment
ET Fossil Free Tracker Tilt ET Fossil Free Benchmark Tilt
ET Fossil Free Max Tilt
Figure 5 shows the emissions intensity reduction achievable through employing the Environmental Tracking lowcarbon investing approaches, divestment and a combination of the two. Figure 6 contains a detailed summary of
these results.
The results demonstrate that while divestment is a worthy approach, truly significant emissions intensity reductions
require re-weighting of the entire index portfolio. This is instrinsic to the Environmental Tracking approach.
Figure 6 Scope 1+2+3 portfolio emissions-intensities and reductions relative to the iShares MSCI
ACWI Low Carbon Target ETF.
Portfolio
Scope1+2
Emissionsintensity
(tCO2e/$m
Revenue)
Scope 3
Emissionsintensity
(tCO2e/$m
Revenue)
Total Scope
1+2+3
Emissionsintensity
(tCO2e/$m
Revenue)
Total Scope
1+2+3 Emissionsintensity %
reduction versus
MSCI ACWI Low
Carbon Target
iShares MSCI ACWI Low Carbon
138
996
1133
-
ET Carbon Tracker Tilt
92
621
712
-37%
ET Carbon Benchmark Tilt
81
485
567
-50%
ET Carbon Reduction Max Tilt
38
255
293
-74%
Divestment
120
874
994
-12%
ET Fossil Free Tracker Tilt
87
553
640
-44%
ET Fossil Free Benchmark Tilt
71
426
497
-56%
ET Fossil Free Reduction Max Tilt
38
252
290
-74%
ET Index Briefing Note 04: June 2015
9