FTSE Russell Insights

How asset owners are adapting climate index approaches

Tony Campos

Head of Sustainable Investment, Index Investments Group

Our latest Sustainable Investment Asset Owner survey showed that climate and carbon concerns are a priority globally. For example, nearly three-quarters of institutional respondents in Europe cited this as a priority issue. 

The converging trends of passive and climate investing are now leading to more institutional investors asking for index approaches to integrate climate risks and opportunities in investment strategies. 

73% of EMEA respondents see climate/carbon as a priority in sustainable investment

Readers note: Which sustainability issues does your organisation consider as a priority focus? 

Source: FTSE Russell Sustainable Investment Asset Owner 2023 Report

Climate transition indices evolving for the low-carbon shift

Climate transition is driving most of our index design work in this area, which is a more holistic approach for existing pools of capital sitting in core passive mandates – whether that’s equity, fixed income, listed infrastructure or listed property, all of which have benchmarks that cover them. The idea is that this is a sensible place for allocation, as it follows similar risk-return characteristics to the traditional market cap benchmark and carries high beta. This is a nuanced approach, not about divestment but about underweighting and overweighting constituents in the index, supported by engagement and forward-looking data.

Getting the ‘raw material’ – as in the data that’s feeds into this kind of index analysis and subsequently passive allocations – is where industry partnership comes in, and the Transition Pathway Initiative (TPI) provides a template for how asset owners, data providers and academic researchers can work together to produce high-quality data for use in sustainable investment.

The TPI Global Climate Transition Centre is an independent, robust source of research and data on the progress of the financial and corporate world in transitioning to a low-carbon economy. Its analysis considers both corporate climate governance and carbon emissions.

TPI’s assessments of companies' climate governance activities are aligned with the recommendations of the Taskforce on Climate-related Financial Disclosures’ (TCFD) and its assessments of companies’ future carbon emissions are aligned to the global warming limits set out in the 2015 Paris Climate Agreement. Recently TPI released a new Management Quality framework which now includes a level 5 with 24 indicators. 

In Europe (including the UK), TPI is rapidly becoming the ‘go-to’ corporate climate action benchmark—a practical, easy, and powerful engagement tool for asset owners and the companies in which they are invested.

FTSE Russell has developed ‘climate transition’ equity indices based on five key climate data inputs: fossil fuel reserves, carbon emissions, green revenues, the TPI's assessment of companies’ climate governance and its ratings of their carbon performance.

The Climate Transition index approach is one of a broader range of sustainable investment indices covering the equity and fixed income markets. These index families are designed to help asset owners navigate the ongoing shift to a low-carbon economy.

Index theme: Transition to a low carbon economy

This set of indices solves for those seeking exposure in investment strategies to securities that might prevail in a low carbon economy, based on past and forward looking trends

FTSE ex Fossil Fuels Equity
FTSE EPRA Nareit Green Equity
FTSE Global Climate Equity
FTSE Smart Sustainability Equity
FTSE TPI Climate Transition Equity
FTSE Climate Risk Adjusted Government Bond Fixed Income
FTSE Fixed Income ex Fossil Fuels Enhanced Fixed Income

Source: FTSE Russell

Data inputs for TPI

FTSE Russell provides the climate change and corporate governance-related data that underpins the initiative’s management quality assessments.

FTSE Russell’s climate framework within the ESG data model, which draws on international standards to score 8,000 companies, assessing their ESG practices, forms part of the TPI’s analysis.

FTSE TPI Climate Transition Index Series data inputs

Source: FTSE Russell

In addition to providing data, FTSE Russell is also a member of TPI’s Technical Advisory Working Group, contributing to the evolution of TPI’s methodology.

While up to now, TPI has been largely a European and equity-focused project, its approach is spreading to other asset classes and markets: later in 2023, TPI is due to launch its corporate fixed income assessment framework; and the New York State Common Retirement Fund in late 2021 chose to allocate assets to an index fund based on the Russell 1000 TPI Climate Transition Index.

Addressing long-term risk

The increasing sophistication in the use of sustainability data is consistent with asset owners’ recognition that they are confronting a long-term investment risk.

Despite market-related variations in sentiment, there is little sign of a weakening in the fundamental conviction for this continually maturing investment theme and we expect to see a further evolution in data, disclosures and construction approaches.

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