Guido Giese on how the sustainable indexes and portfolios have performed during the pandemic

Ahead of the Sustainable Investment Forum Europe 2021, Guido Giese from MSCI talks to Climate Action about how sustainable indexes and portfolios have performed better than the market during the pandemic and how net zero is not a one- off portfolio exercise but rather a pathway.

Have ambitious net zero targets at national level resulted in greater transition risks for companies?  

We looked at that question in our latest research report, Foundations of Climate Investing and we saw that ambitions are different in different regions. For example The European Union has the most ambitious target. In contrast, the U.S.’s pledge corresponds to an estimated 30% to 40% reduction and in emerging markets, we observed even lower ambitions. We checked if these national targets had any effects on companies’ performance, earnings, valuation levels and other differences in the region. And we found that, in fact, there were indeed huge differences. In the European Union, where climate policies have been the strictest, we have seen a clear outperformance of greener companies over browner companies, even after controlling for all other factors like industry, equity style factors, currency, etc. The residual effect after taking out all other factors is that in Europe greener companies outperformed browner companies quite a bit in terms of stock price and in terms of earnings.

And that is a reflection of policies becoming stricter and the early movers into green having the advantage. In fact, we have seen an substantial acceleration of green outperforming brown in the last two years. In contrast, emerging markets had less-carbon-efficient companies that outperformed their “greener” sector peers during the entire study period (though improving in the past two years), which was in line with less-ambitious NDCs in emerging markets. So, it seems that in emerging markets policies and ambitions haven't been strict enough to kick off this trajectory towards green. The U.S. sat in the middle of these extremes. We note that this is not necessarily indicative of future performance in these markets.

Do you think the COVID -19 pandemic has accelerated the momentum of the sustainability agenda? 

There is a lot of research at MSCI around that topic and we found that, yes, typically, sustainable indexes and portfolios have performed better than the market during the pandemic. Even after controlling for other factors sustainability has paid off, because it has made the portfolios more crisis resilient. In fact, at MSCI we have long before the pandemic maintained that ESG is financially relevant, because it is, to some extent, marrying crisis resilience and better management. And that has also helped to accelerate fund flows, because people have seen a financial advantage.

How difficult is it to achieve a net zero portfolio?

Of course, “Net Zero” is a very hot topic at the moment. I think it's very important to understand, that net zero is not a one-off portfolio exercise, but rather a pathway. For global companies, net zero means global need to follow a trajectory pathway to net zero. That will not happen in one year. And the role of investors may be to drive that transition, meaning, to allocate capital to accelerate companies’ journey towards net zero. I would compare it to the industrial revolution. 200 years ago, capital was allocated to win the race to become as brown as possible as quickly as possible: to build the longest railway, to build the biggest factory, to build the biggest steam engine and so on. In those days you could say that capital was allocated to maximize the carbon footprint, And now we are looking to do the exact same thing, but to maximize the reduction in carbon emissions. Capital needs to drive companies’ transition to net zero. And that can’t happen through a one-off portfolio reshuffling. It means to continuously allocate capital to drive companies to maximize the reduction in emissions.

As there is no standard definition as to what constitutes a net zero portfolio what challenges does this pose for investors? 

The challenge is to understand how to allocate capital. How to incentivize companies? Some companies will need to make massive investments to change thebusiness model, change their production. To identify what is the best way to allocate capital and in which companies to invest to help fund that transition is a big challenge.

And at the same time, investors may want to understand how do we motivate companies who are not moving in the right direction. “Which companies should be engaged, because we think they are really not moving fast enough?” This is a very industry specific question as well, because they are brown and green industries already. Investors may seek to understand which are the companies that are on a good trajectory compared to their peers, which ones are not. Which ones do I reward by allocating more capital helping them transition faster, where do I engage with companies and potentially try to motivate them to start moving faster. To summarize, the challenge is to identify the opportunities, and identify the laggards and then reacting accordingly.

What solutions does MSCI offer to effectively mitigate climate risk and successfully mine yesterday data.

Going back to my previous reply… We have, for example, the data that helps investors identify which are the relatively brown and an which are the greener companies in each industry and in each region. But we also have a lot of data showing you which companies have been moving in the right direction, which companies have been improving.

We also have data showing you which companies have greenhouse reduction targets and how well they are managing those targets, I mean redact climate. Additionally, we have models helping you understand to what extend a company is aligned with certain scenarios. For example, is a company on a 1.5 degree pathway or are they more aligned with the four degree pathway. Basically, our data helps investors to understand where a company stands now and where they will be under certain scenarios. That in turn helps them to understand which companies they want to reward and which companies they will maybe have to engage to push them in the right direction.

Of course we also have investment tools like climate indexes[1], which already take into account these risks. They typically underweight the very brown components and, in case of our Climate Change Indexes, allocate more capital towards green solutions to enable that pathway. Our Climate Paris Aligned Indexes go a step further: They are designed to help investors seeking to address climate change in a holistic way by minimizing the index’s exposure to transition & physical climate risks and aim to help investors seeking to align with a net-zero world. So, if you are an investors or a portfolio manager, you can use all these tools as a starting point to build sustainable portfolio

[1] MSCI ESG ratings, research and data are produced by MSCI ESG Research LLC.  MSCI ESG Indexes and Analytics utilize information from, but are not provided by, MSCI ESG Research LLC.  MSCI Indexes and Analytics are products of MSCI Inc. MSCI Indexes are administered by MSCI Limited (UK).

---

Guido Giese will be speaking at the Sustainable Investment Forum Europe in April, bringing together asset owners and managers, ratings agencies, banks, UN and Government policymakers, investors, development banks, think tanks, and NGOs committed to driving forward the sustainable finance agenda. Register your place for free here.