Climate change continues to gain weight as a key consideration in investment portfolios. Companies not only are impacted by growing physical risk but are also faced with operational and business risks as governments and policymakers step up efforts to meet carbon-reduction goals. Climate transition will move further to the spotlight as nearly 200 countries are expected to submit new emissions targets at the upcoming 26th United Nations Climate Change Conference of the Parties (COP26) at the end of October.
In addition, investors overseeing around $43 trillion in assets have pledged under the Net Zero Asset Managers initiative to support and align investments with the goal of achieving neutral greenhouse gas emissions by 2050 or sooner.
Willis Towers Watson and Qontigo have jointly created the STOXX Willis Towers Watson Climate Transition Indices (CTI) to meet growing demand for transparent and systematic climate-oriented investment solutions. The indices employ a unique Climate Transition Value at Risk (CTVaR) methodology that quantifies the anticipated impact of an economic transition on equity valuations.
The CTI suite consists of four initial indices:
- STOXX® Willis Towers Watson World Climate Transition Index
- STOXX® Willis Towers Watson Europe 600 Climate Transition Index
- STOXX® Willis Towers Watson USA 500 Climate Transition Index
- STOXX® Willis Towers Watson World Climate Transition Monthly Hedged Index
The CTIs enable a more sophisticated way of managing climate transition risk, one that looks beyond carbon emissions and makes a forward-looking, bottom-up evaluation of asset repricing risks in a decarbonization pathway. Specifically, the indices use the proprietary CTVaR measure that analyzes the impact on projected company cashflows of moving from a ‘business-as-usual’ scenario to a world consistent with the goals of the Paris Agreement, using today’s prices. By using these CTVaR projections, the indices tilt towards companies that are expected to fare well and away from companies that are expected to experience meaningful losses in value as the economy transitions.
Overall, the CTIs are aligned with a ‘well below’ 2°C scenario, and help investors understand and address the financial risks and opportunities that loom ahead as the world moves towards net-zero targets.
“Climate change is a systemic and urgent global challenge and also one that will significantly disrupt capital allocations and returns,” Craig Baker, Willis Towers Watson’s Global Chief Investment Officer, said in a press release. “Investors need a robust framework that can quantify and incorporate the financial impact of climate risk, but this is something that just hasn’t been widely available until now.”
Assessing climate transition risk today through company-level analysis
The CTIs’ underlying methodology measures the seismic effects that fighting global warming will have on demand for products and services — commodities, mining, electricity, transport, etc. — and on industrial processes, consumer preferences, production costs and technology, among other things. As these variables change, so will the value of companies’ assets and the viability of their business models.
Accurate allocation of capital towards emerging winners
Investors can leverage the output of the CTVaR analysis to allocate capital away from sectors and companies where the most value is at risk from climate transition, and towards firms that stand to benefit, or are better managing the risks and opportunities, from a future, net-zero economy. And the CTIs use the CTVaR output to do exactly that — weighting companies based on their value at risk.
The CTI strategy can be applied for benchmarking, portfolio construction, risk management, research and analytics. These cases benefit from the simplicity, transparency and cost-efficiency of an index-based approach.
Joining capabilities
Qontigo is excited to have collaborated with Willis Towers Watson in this pioneering solution to address climate transition risk in portfolios, combining their well-known advisory and climate research expertise with our index-building capabilities. Thanks to our open architecture, we have incorporated the most cutting-edge climate-transition data available in the market into a systematic, rules-based investment strategy that meets very specific needs and ambitions.
The STOXX Willis Towers Watson Climate Transition Indices and underlying CTVaR methodology introduce a groundbreaking approach to climate investing in a world undergoing radical transformation. The indices come at a time when impact has become a key pillar of portfolio construction and investors are beginning to integrate climate considerations into the traditional risk and return framework. The CTIs provide a robust and transparent way to manage risks with the potential to generate alpha from the transition to a low-carbon economy.
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