A global equity fund riding a cleaner future
As global efforts to achieve net-zero emissions by 2050 intensify, seismic shifts are set to occur across the investment landscape. The contraction of oil and natural gas production will give rise to renewable energy. Old world commodities such as coal will be phased out in favour of critical minerals needed to build electric cars and green infrastructure.
Responding to these challenges from an equity investing viewpoint requires a solution that reduces exposure to the expected losers and increases exposure to the expected winners in the battle against climate change. The State Street Climate ESG International Equity Fund strives to do exactly that.
The Fund’s portfolio mix aligns itself with science on climate change and environmental, social, and corporate governance (ESG) factors by targeting companies that, for example, have on average 70% lower CO2 emissions, and by boosting exposure to low-carbon technology and clean energy production revenues by 300%.
At the same time, the Fund excludes objectionable industries such as coal, tobacco, and controversial weapons while offering investors a cost-effective management fee of just 24 basis points.
Find out more about how the State Street Climate ESG International Equity Fund can help your portfolio ride the benefits of a net-zero emissions future by watching the video or reading the transcript below.
Hi, my name's Jonathan Shead. I'm the Head of Investments, Australia for State Street Global Advisors.
I'm going to be talking today about the State Street Climate ESG International Equities Fund, but I'd like to start by talking about climate change, and some of the particular challenges, and not only for us, how we live as a community, but also, some of the financial challenges for investors.
I'm going to start with the IPC, the Intergovernmental Panel on Climate Change. That's the UN body that was set up to assess scientific research on climate change.
One of the things the IPC does is look at different possible pathways for the global climate over the rest of this century, and each of those pathways involves different assumptions.
On Chart 1, on the top left, you can see five of those pathways, in terms of the greenhouse gases emitted into the atmosphere.
In the most aggressive reduction pathway, which is the light blue pathway, you can see that net greenhouse gas emissions get close to zero by about 2050. Then there are four other pathways.
The chart on the right shows the corresponding increases in average global temperatures associated with each of those pathways. So again, in the light blue pathway, you can see an increase of somewhere between 1.5-2% in average temperatures this century.
However, it's the chart at the bottom that's actually really caught my attention because this is a cumulative problem. It shows the cumulative emissions since the 1800s into the atmosphere up until now, those are the grey bars.
You can see that even with the most aggressive reductions, the cumulative nature of this problem means that we're going to have global temperature increases, no matter what we do, over the rest of this century.
I know this particular challenge, for some of you, you're thinking ‘Yeah, this is just some progressive left-leaning fad. That'll disappear after a couple of election cycles.’
But actually, as Chart 2 shows, climate change has been on the research agenda for over 42 years. The first climate change conference was in 1979.
Even back then, they were calling on governments to respond to this as a serious challenge. I think if I was to list all the possible bodies I could call on, to get a sense of how widely accepted this challenge is, whether it's governments or corporations or asset managers, I think the body that has struck me the most is the International Energy Agency
This is the go-to OECD body for everything to do with energy markets. So, oil, coal gas, but also solar, hydroelectric, and so on.
This particular table in Table 1 comes from a report that the IEA issued in May of this year.
I like it because it shows some of the really clear, simple examples of things that will need to happen if we are going to get emissions down quickly enough.
So, some of the examples I've pulled out there, no more new oil and gas fields, or unabated coal plants or new coal mines, pretty much from now on, by about 2030, 60% of car sales to be electric.
Then by the time you get to 2040, 50% of existing buildings to be retrofitted are using things like heat pumps, for example, instead of air conditioners.
Chart 4 shows some more examples of the kind of changes we need to see this decade.
You can see there a fourfold increase in electricity generation, from things like solar, and from wind, or an 18-fold increase in sales of electric cars, instead of internal combustion engines, and much more broadly, a 4% per an improvement in the overall energy efficiency of the global economy.
Now, some of you by this stage will be sensing what some of the financial consequences here are going to be.
There are clearly companies and sectors that are going to be negatively impacted, and there are companies and sectors that are going to have significant expansion.
But there's an extra sting to some of the financial consequences for investors, and that's to do with incentives that governments are increasingly providing, to shift the global economy away from emission intensity, and that's in the form of carbon pricing.
The two main ones are carbon taxes and then emissions trading schemes. But some of you may be surprised to know that over 20% of global emissions are already covered by some form of pricing scheme, mainly in Europe, but also some states in the US, and also China. Chart 5 shows the increase in greenhouse gas emissions covered by carbon pricing initiatives.
Not only is this coverage increasing, but most of the modeling I've seen suggests that the average price attached to each tonne of carbon is also going to increase significantly over the next 10 to 20 years.
So how do you respond to that? Well, in thinking about how to respond as investors, we reflected on the fact that this really is a global problem. It's not a uniquely Australian problem, and so, a global solution that captures equity trends across the entire global economy was a good way to approach the problem.
The fund that we've designed has some really interesting features which are summarised in Chart 6.
The first is that we're trying to deal with both the good and the bad. So, we’re trying to steer away from problem industries and companies, but also trying to increase exposure to those industries or companies that are going to go through rapid expansion.
The second is that we have tried to align this fund with the scientific research, and will continue to review that, as this research evolves.
Thirdly, while the main focus of this fund is climate, we've also included some environmental, social, and governance, or ESG, our goals, and criteria, as well.
Fourthly, we don't think you should have to pay high fees to have a fund that is climate-focused and ESG aware.
We really wanted to design something that is widely diversified, suited as a low core portfolio, and that's also low cost. And that's a lot to get into a single fund.
The process we've used to build the fund has got systematic optimisation processes built in, and that's how we actually construct the portfolio. We think that leaves us with a fund that is really ready for a low carbon future, and has ESG characteristics, as well.
So, what do we actually do when we build a portfolio? What metrics do we track and measure? Well, the first thing we do is, we exclude a number of ESG-related industries outright, so, tobacco, controversial weapons, thermal coal, that's either mining or burning of thermal coal, companies who have gross violations of UN Global Compact, companies embroiled in severe ESG controversies, and so on.
Once we've excluded those companies, we then start building a portfolio with some key climate characteristics that we've outlined in Chart 7.
We look to reduce exposure to greenhouse gas emissions by 70%. We look to reduce exposure to fossil fuel reserves by 90%. If you've got some proven coal reserve on your balance sheet, well, it may not be worth quite as much as you thought it was when you first bought it.
We look to reduce broader exposure to extractive industries, so that's brown revenues, by 90%. And then, on the positive side, we've got a huge boost to what are called green revenues. That's not only wind turbines and solar, but it's things like water, waste management, rail transport, building efficiency, all those kinds of green sectors.
We think about a 300% increase is appropriate, given the research that we've seen. But there are some companies that are not obvious problems for emissions intensity, and they're not obvious green revenue opportunities, so how do you treat them?
We’ve got a much broader measure that looks at a company's climate resiliency up and down the supply chain. And we tilt towards companies that have got stronger climate resiliency. And then, finally, we favour companies that have got better than average ESG scores.
One of the results of how we build the portfolio is that its shorter-term performance tends to track standard developed market indices quite closely as you can see on Chart 8
We're not aiming for a portfolio that's got lots of large concentrated, risky positions, and you can see from the performance history that it's tracked global indices quite closely.
The particular process we're using at the moment came in May of 2020, but this fund has had a strong climate and ESG focus for two years prior to that. It’s got three and a half years of close tracking history.
The portfolio itself, you can see from this chart, looks quite a lot like a global developed market index. The chart on the right shows sector exposures, and you can see in most sectors, the exposure fund is fairly similar to what you would expect in a globally diversified portfolio.
There are lower exposures to energy and materials, that's not surprising, or consumer staples, because of tobacco, but it looks and feels a lot like a large, well-diversified global portfolio. But on the left, the biggest holdings in the fund are the sorts of large-cap names you would expect to see in the global portfolio.
It's really when you deep dig into the portfolio you see that we've achieved these climate and ESG characteristics, not by taking big positions, but by taking hundreds and hundreds of small positions in individual companies and industries. So we're left with a fund that we think is a really compelling offer.
It's got a real boost to those future opportunities, those green revenues, while at the same time, significantly cutting the exposure to greenhouse gas emissions of fossil fuel reserves to extractive industries more broadly.
It also has those attractive ESG characteristics built into how the portfolio is constructed, and all of that, with a still widely diversified portfolio, at a really attractive price point. We've summarized these key features in Chart 9.
You'll see from the bottom right-hand side of the slide, that we are very pleased to show the number of platforms that this fund is available on, but you can also access the fund directly. So that's the Street Climate ESG International Equity Fund.
Ride a cleaner future
For more information on the State Street Climate ESG International Equity Fund, please click on the fund profile below, or visit our website.
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Jonathan Shead is Head of Investments in Australia and provides an investment voice with our clients spanning the breadth of solutions that we offer. He also provides local oversight to the Australian investment team. Prior to his current role,...