singaporeen
Indices insights: Does climate beta pick up on climate risk?

Indices insights: Does climate beta pick up on climate risk?

13-09-2022 | Insight

Our climate beta measure quantifies how sensitive a stock is to the transition to a low-carbon economy. We demonstrate how this metric can clearly discern between companies that are vulnerable to transition risks and those that are likely to benefit from a shift towards net-zero emissions.

  • Joop  Huij
    Joop
    Huij
    Head of Indices
  • Thijs Markwat
    Thijs
    Markwat
    Researcher
  • Lucian Peppelenbos
    Lucian
    Peppelenbos
    Climate & Biodiversity Strategist
  • Simon Lansdorp
    Simon
    Lansdorp
    Portfolio Manager

Speed read

  • Climate beta measures how sensitive a stock is to climate risk
  • The metric distinguishes between climate leaders and laggards
  • It captures different dimensions of climate risk versus carbon footprints

In the previous ‘Indices insights’ articles,1 we first discussed how generic carbon emissions data is less effective in differentiating between climate leaders and laggards. We then focused on a long-short – polluting-minus-clean (PMC) – portfolio that tracks the difference in returns between polluting and clean companies. Moreover, we illustrated how the PMC portfolio underperforms in months with heightened climate concerns, and vice versa.

In this article, we expand on our findings by introducing our climate beta measure which indicates how sensitive individual stocks are to the PMC portfolio.2 More specifically, firms with a high climate beta tend to do well when the PMC portfolio has a positive return, while the opposite is typically true for companies with a low climate beta.

As a result, we expect stocks with high climate betas to be negatively affected by stricter climate policies, the transition to a low-carbon economy and innovations in green technologies. On the other hand, we expect stocks with low climate betas to benefit from a shift towards net-zero emissions. In general, we contend that climate beta picks up on a different dimension of climate risk compared to carbon emissions or carbon footprint data.

For instance, climate beta has a forward-looking element as it incorporates market expectations, whereas carbon emissions are based on lagged or current datapoints at best. Since climate beta is estimated using returns, it can pick up on important factors such as (changes to) a firm’s business model, its access to green technology and innovation, competition and its financial health.

While carbon emissions data can be used to filter out heavy-polluting companies, it is not useful for identifying stocks that could benefit from the transition to a low-carbon economy or those that have announced plans to reduce their emissions. Climate beta, on the other hand, can distinguish between firms that are vulnerable to the transition and those that stand to benefit from it.

Stay informed on Sustainable Investing with monthly mail updates
Stay informed on Sustainable Investing with monthly mail updates
Subscribe

Climate beta can uncover insights beyond carbon footprints

Using a hypothetical example, we can illustrate this by comparing a company that produces solar panels with one that manufactures vehicles with internal combustion engines. The production processes for both firms are responsible for relatively high levels of carbon emissions, and for the purposes of our argument, we assume that the carbon footprints are the same for both operations.

If a carbon tax is implemented, it will likely lead to increased fossil fuel prices and decreased demand for internal combustion engine vehicles, resulting in a negative return for the car manufacturer. On the flipside, the carbon tax will likely instigate higher energy prices, which in turn will probably drive a rise in solar power demand, thus benefiting the solar panel producer and its share price.

Similarly, we would anticipate a negative return from the PMC portfolio if a carbon tax is implemented as it typically underperforms in environments with heightened climate concerns. Based on these dynamics, we would expect the car manufacturer to have a relatively high climate beta and the solar panel producer to have a relatively low climate beta.

Climate beta can be used to assess transition risk

To assess whether climate beta captures a different dimension of climate risk versus carbon footprint data and whether it picks up on transition risk, we analyzed the holdings of renewable energy and oil ETFs. Specifically, we calculated the estimated climate betas and weighted-average carbon footprints of ‘clean’ energy and ‘pollutive’ oil portfolios.

Figure 1 depicts the carbon footprints (brown bars) relative to the broad market index and the climate betas (blue bars) of some of the largest renewable energy-focused ETFs.3 Interestingly, we see that all the renewable energy-themed portfolios have higher carbon footprints than the market, despite their focus on clean energy.

By contrast, their climate betas are negative; implying that they would tend to deliver positive returns when the PMC portfolio generates negative performance, and vice versa. In other words, these ETFs exhibit relatively low climate transition risk.4 Hence, a high carbon footprint does not necessarily equal high transition risk.

Figure 1 | Renewable-energy ETFs have high carbon footprints, but negative climate betas (climate leaders)

Source: Robeco, TruCost, FactSet, Morningstar. The analysis is conducted using data as of 31 July 2022.

Similarly, we observed that all the oil ETFs have significantly higher carbon footprints than the market as shown in Figure 2. However, their climate betas are positive without any exceptions. Therefore, we would expect their returns to move in the same direction as those of the PMC portfolio, meaning that they exhibit high transition risk.

Figure 2 | Oil ETFs have high carbon footprints and positive climate betas (climate laggards)

Source: Robeco, TruCost, FactSet, Morningstar. The analysis is conducted using data as of 31 July 2022.

This outcome demonstrates that climate beta captures different information on climate risk compared to carbon footprint data, i.e. transition risk. Thus, it is better suited to distinguish between climate leaders and laggards. Put differently, a generic low-carbon investment approach would shy away from investing in renewable energy firms with high carbon footprints, even though these companies are deemed important for the transition to a low-carbon economy.

Data and methodology

Our selection of renewable energy ETFs is based on a combination of ‘renewable energy’ ETFs from etf.com and ‘clean energy’ ETFs from etfdb.com. These consist of global or US-listed stocks that are linked to firms involved in clean energy production (such as biofuels, solar, wind or other renewable sources) or in related activities (such as batteries and smart grids or firms that finance green projects). Our final sample of renewable energy portfolios comprises the five largest ETFs based on assets under management for which we have data coverage for at least 60% of their holdings.

In terms of oil ETFs, our selection is based on a combination of ‘oil’ ETFs from etf.com and ‘oil & gas exploration & production’ ETFs from etfdb.com. These offer exposure to the exploration and production sub-sectors and include many of the largest oil producers. Similar to our approach with the renewable energy ETFs, our final sample of oil ETFs comprises the five largest ETFs based on assets under management for which we have data coverage for at least 60% of the ETF holdings.

The data for the ETF holdings is sourced from Morningstar as at 31 July 2022. The holdings for the broad market index are based on the MSCI World Index and are sourced from FactSet. We calculate the carbon footprints and climate betas for each of the ten ETFs and market index. We define the portfolio carbon footprint as the weighted-average carbon footprint measured by TruCost Scope 1 and 2 emissions divided by enterprise value including cash (EVIC) relative to the market index. For climate beta, we use 36-month historical betas by regressing stock returns on the Robeco Developed Climate Risk L/S Factor Index.5

Conclusion

Based on our analysis, we conclude that the climate beta measure provides additional insights on climate risk compared to carbon footprint data. For instance, we demonstrate that the carbon footprints of renewable energy and oil ETFs are both relatively high. However, their climate betas clearly differentiate between the portfolios that are vulnerable to transition risk and those that are likely to benefit from a shift towards net-zero emissions.


The Indices insights series provides new insights focused on index investing, particularly on the topics of sustainable investing, factor investing and/or thematic investing. The articles are written by the Sustainable Index Solutions team and often in close cooperation with a Robeco specialist in the field. The team has vast experience in research and portfolio management and has been designing sustainable, factor and thematic indices since 2015 for a large variety of clients: sovereign wealth funds, pension funds, insurers, global investment consultants, asset managers and private banks. The team can also tailor sustainable indices to cater to client-specific needs.

 

1 Huij, J., Lansdorp, S., Peppelenbos, L., and Markwat, T., June 2022, “Can carbon emissions data identify leaders and laggards”, Robeco article; and Huij, J., Lansdorp, S., Peppelenbos, L., and Markwat, T., August 2022, “Do investors act on shifts in climate change”, Robeco article..
2 Climate beta is in spirit similar to carbon beta which is introduced in the paper by Huij, J., Laurs, D., Stork, P. A., and Zwinkels, R. C. J., November 2021, “Carbon beta: A market-based measure of climate risk”, SSRN working paper. In this article, carbon beta is estimated based on a portfolio that is long a basket of stocks consisting of high carbon emitters and short a basket of stocks consisting of low carbon emitters. Climate beta, on the other hand, is estimated based on a portfolio that is long a basket of stocks with negative climate SDG scores and short a basket of stocks with positive climate SDG stocks.
3 Thus, a carbon footprint of 100% means the ETF has a carbon footprint that is twice as high as that of the broad market index. Please note that the climate beta of the market index is equal to zero.
4 Please note we might be oversimplifying the concept. The transition is not per se linear and markets can also (temporarily) work against renewable energy.
5 See: www.spglobal.com/spdji/en/custom-index-calculations/robeco-indices-bv/all/#overview

Indices insights
Read all articles

Important information

This information is for informational purposes only and should not be construed as an offer to sell or an invitation to buy any securities or products, nor as investment advice or recommendation.
The contents of this document have not been reviewed by the Monetary Authority of Singapore (“MAS”). Robeco Singapore Private Limited holds a capital markets services license for fund management issued by the MAS and is subject to certain clientele restrictions under such license.
An investment will involve a high degree of risk, and you should consider carefully whether an investment is suitable for you.

Logo

Important Information

Warning/Important note: This website contains information which is only available to qualified investors as defined below. If you are not a qualified investor, please click “I Disagree” to leave the website.

By clicking on "I agree", I declare that: 

  • I am a qualified investor as defined under 1
  • I have read and understood the Terms and Conditions and Disclaimers as described under 2

1 - This website may only be accessed directly or indirectly by the following persons in Singapore:

1) “institutional investor” under section 304 of the Securities and Futures Act (Cap.289)(“SFA”), which means:
(i) the Government; (ii) a statutory board as may be prescribed by regulations made under section 341 of the SFA; (iii) an entity that is wholly and beneficially owned, whether directly or indirectly, by a central government of a country and whose principal activity is (A) to manage its own funds; (B) to manage the funds of the central government of that country (which may include the reserves of that central government and any pension or provident fund of that country); or (C) to manage the funds (which may include the reserves of that central government and any pension or provident fund of that country) of another entity that is wholly and beneficially owned, whether directly or indirectly, by the central government of that country; (iv) any entity (A) that is wholly and beneficially owned, whether directly or indirectly, by the central government of a country; and (B) whose funds are managed by an entity mentioned in sub-paragraph (iii); (v) a central bank in a jurisdiction other than Singapore; (vi) a central government in a country other than Singapore; (vii) an agency (of a central government in a country other than Singapore) that is incorporated or established in a country other than Singapore; (viii) a multilateral agency, international organisation or supranational agency as may be prescribed by regulations made under section 341 of the SFA; (ix) a bank that is licensed under the Banking Act (Cap.19); (x) a merchant bank that is approved as a financial institution under section 28 of the Monetary Authority of Singapore Act (Cap.186); (xi) a finance company that is licensed under the Finance Companies Act (Cap.108); (xii) a company or co-operative society that is licensed under the Insurance Act (Cap.142) to carry on insurance business in Singapore; (xiii) a company licensed under the Trust Companies Act (Cap.336); (xiv) a holder of a capital markets services licence; (xv) an approved exchange; (xvi) a recognised market operator; (xvii) an approved clearing house; (xviii) a recognised clearing house; (xix) a licensed trade repository; (xx) a licensed foreign trade repository; (xxi) an approved holding company; (xxii) a Depository as defined in section 81SF of the SFA; (xxiii) an entity or a trust formed or incorporated in a jurisdiction other than Singapore, which is regulated for the carrying on of any financial activity in that jurisdiction by a public authority of that jurisdiction that exercises a function that corresponds to a regulatory function of the Authority under this Act, the Banking Act (Cap.19), the Finance Companies Act (Cap.108), the Monetary Authority of Singapore Act (Cap.186), the Insurance Act (Cap.142), the Trust Companies Act (Cap.336) or such other Act as may be prescribed by regulations made under section 341 of the SFA; (xxiv) a pension fund, or collective investment scheme, whether constituted in Singapore or elsewhere; (xxv) a person (other than an individual) who carries on the business of dealing in bonds with accredited investors or expert investors; (xxvi) the trustee of such trust as the Authority may prescribe, when acting in that capacity; or; (xxvii) such other person as the Authority may prescribe.

2) “relevant person” under section 305(1) of the SFA, which means:
(i) An accredited investor; (ii) a corporation the sole business of which is to hold investments and the entire share capital of which is owned by one or more individuals, each of whom is an accredited investor; (iii) a trustee of a trust the sole purpose of which is to hold investments and each beneficiary of which is an individual who is an accredited investor; (iv) an officer or equivalent person of the person making the offer (such person being an entity) or a spouse, parent, brother, sister, son or daughter of that officer or equivalent person; or (v) a spouse, parent, brother, sister, son or daughter of the person making the offer (such person being an individual).

3) any person who acquires the units [in a collective investment scheme] as principal if the offer is on terms that the units may only be required at a consideration of not less than $200,000 (or its equivalent in a foreign currency) for each transaction, whether such amount is to be paid for in cash or by exchange of units in a collective investment scheme, securities, securities-based derivatives contracts or other assets, and if the following condition is satisfied: (i) the offer is not accompanied by an advertisement making an offer or calling attention to the offer or intended offer; (ii) no selling or promotional expenses are paid or incurred in connection with the offer other than those incurred for administrative or professional services, or by way of commission or fee for services rendered by any of the persons specified in section 302B(1)(d)(i) to (vi) of the SFA; and (iii) no prospectus in respect of the offer has been registered by the Authority or, where a prospectus has been registered (A) the prospectus has eAccxpired pursuant to section 299 of the SFA; or (B) the person making the offer has before making the offer 1. informed the Authority by notice in writing of its intent to make the offer in reliance on the exemption under this subsection; and 2. taken reasonable steps to inform in writing the person to whom the offer is made that the offer is made in reliance on the exemption under this subsection.

4) Or otherwise pursuant to, and in accordance with the conditions of, any other applicable provision of the SFA.

If you are not any of the types of persons described above, you are not authorized to enter this website and you should leave this website immediately.

2 Terms and Conditions
You acknowledge that you have read these Terms and Conditions (“Terms”) prior to accessing the website located at www.robeco.com/sg (“Website”) and you agree to be bound by the Terms.  If you do not agree to all of the Terms, you are not an authorised user and you should not use the Website. The Website is owned by Robeco Singapore Private Limited (company registration number: UEN. 201541306Z), which is licensed by the Monetary Authority of Singapore (“MAS”) pursuant to the Securities and Futures Act (Cap.289) (“SFA”) of Singapore, and is managed by Robeco Singapore Private Limited and/or its affiliates (collectively, as “Robeco”). The Website is intended for and should be accessed by institutional investors or accredited investors (as defined under Section 4A of the SFA) of Singapore.  The Website is not directed to, or intended for distribution to or use by, any person or entity who is a citizen or resident of or located in any locality, state, country or other jurisdiction where such distribution, publication, availability or use would be contrary to law or regulation or which would subject the Robeco to any registration or licensing requirement within such jurisdiction.  It is your responsibility to observe all applicable laws, rules and regulations of any relevant jurisdiction. The content contained in the Website is owned by Robeco and/or its information providers and is protected by applicable copyrights, trademarks, service marks, and/or other intellectual property rights.  You may not copy, distribute, modify, post, frame or link the Website, including any text, graphics, video, audio, software code, user interface, design or logos.  You may not distribute, modify, transmit, reuse, repost, or use the content of the Website for public or commercial use, including all text, images, audio and/or video.  Robeco may terminate your access to the Website for any reason, without prior notice. Neither Robeco, nor any of its associates, nor any director, officer or employee accepts any liability whatsoever for any loss arising directly or indirectly from the access of the Website.  You agree to indemnity and hold Robeco, its associates, directors, officers or employees harmless against any and all claims, losses, liability, costs and expenses arising from your use of the Website due to violation of the Terms. Robeco reserves the right to change, modify, add or remove any parts of the Terms at any time and for any reason.  The Terms shall deemed to be effective immediately upon posting. The Terms shall be governed by, and shall be construed in accordance with, the law of Singapore.

Disclaimers
The Website has not been reviewed by the MAS. Accordingly, the Website may not be accessed directly or indirectly to persons in Singapore other than (i) to an institutional investor under Section 304 of the SFA, (ii) to a relevant person pursuant to Section 305(1), or any person pursuant to Section 305(2), and in accordance with the conditions specified in Section 305, of the SFA, or (iii) otherwise pursuant to, and in accordance with the conditions of, any other applicable provision of the SFA. 

Nothing in the Website constitutes tax, accounting, regulatory, legal or investment advice.  The Website is for informational purposes only and should not be construed as an offer to sell or an invitation to buy any securities or products, nor as investment advice or recommendation or for the purpose of soliciting any action in relation to Robeco’s businesses, or solicitation by anyone in any jurisdiction in which such an offer or solicitation is not authorised or to any person to whom it is unlawful to make such an offer and solicitation. Any reproduction or distribution of information from the Website, in whole or in part, or the disclosure of its contents, without the prior written consent of Robeco, is prohibited.  By accessing to the Website, you agree to the foregoing.  

The funds referred to in the Website are for information only.  It is not a recommendation or investment advice, nor does it mean the funds is suitable for all investors.  The contents of the website is not reviewed by the MAS.  Any decision to participate in the funds should be made only after reviewing the sections regarding investment considerations, conflicts of interest, risk factors and the relevant Singapore selling restrictions.  You should consult your professional adviser if you are in doubt about the stringent restrictions applicable to the use of the Website, regulatory status of the funds, applicable regulatory protection, associated risks and suitability of the funds to your objectives.

Any decisions made based on the information contained in the Website are the sole responsibility of yours.  Any investments made or to be made shall be with your independent analyses based on your financial situation and objectives.  The investments and strategies contained in the Website may not be suitable for all investors and are not guaranteed by Robeco.  

Investment involves risks and may lose value.  Historical returns are provided for illustrative purposes only and do not necessarily reflect Robeco’s expectations for the future.  The value of your investments may fluctuate.  Past performance is no indication of current or future performance.  The Website may contain projections or other forward looking statements regarding future events or future financial performance of countries, markets or companies and such projection or forecast is not indicative of the future.  The information contained in the Website, including any data, projections and underlying assumptions are based upon certain assumptions, management forecasts and analysis of information available on an “as is” basis and without warranties of any kind, whether express or implied, and reflects prevailing conditions and Robeco’s views as of the date published or indicated, and maybe superseded by subsequent events or for other reasons.  The information contained in the Website are accordingly subject to change at any time without notice and Robeco are under no obligation to notify you of any of these changes.  Robeco expressly disclaims all liability for errors and omissions in the information presented in the Website and for the use or interpretation by others of information contained in the Website.

Robeco Singapore Private Limited holds a capital markets services licence for fund management issued by the MAS and is subject to certain clientele restrictions under such licence.  An investment will involve a high degree of risk, and you should consider carefully whether an investment is suitable for you.

I Disagree