Specialist in Asia Pacific, Japan, China, India and South East Asia and Global Emerging Market equities.
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formerly Realindex Investments
Leader in active quantitative equities across Australian equities, global equities, emerging markets and global small companies.
Backed by a unique blend of research, portfolio construction and risk management, focused on uncovering original insights and translating them into investment strategies that are active and systematic, aiming to generate alpha.
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Insights
At Stewart Investors, we believe in putting people first. Our investment world-view is of a series of partnerships – with each other, with our clients, with the companies we invest in, the people who buy their goods and services, and with the wider society in which we all live and work.
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Leveraging our recent paper, ‘Reducing carbon intensity in portfolios: Better news than you think’, which analysed the investment impact of reducing carbon exposure versus the benchmark; we turn our attention to how we can reduce carbon risk in our Value strategies. This aligns with our commitment to reducing carbon exposure across our strategies, as outlined in our Realindex Climate Statement.
How does climate risk affect a company’s fundamentals?
Climate risk is multi-faceted. This includes the risk of stranded assets, reduction in demand for a company’s product as consumers shift away from high carbon to low carbon products, as well as changing government regulations including harsher carbon pricing. Those companies generating higher carbon emissions face a greater risk of some of the issues listed above and a greater potential impact on their revenues and profitability. If we can find a measure of the portfolio’s exposure to this risk, as well as a company’s transition pathway, we can then more accurately construct our portfolios to achieve better potential long term outcomes for our clients.
Although it can be difficult to accurately price carbon risk, in part due to the limitations of data availability and the subjectivity associated with defining a company’s transition to net zero and assessing the credibility of these transition plans; one common and objective component of measuring climate risk exposure is to look at the current carbon emissions of the company.
We look at carbon intensity, defined as Scope 1 and 2 emissions (millions of tonnes of CO2 equivalent) per million dollars of revenue, as a metric to determine our exposure to carbon risk.
The impact of reducing carbon intensity in our Value portfolios
We ran a number of backtests that looked at the impact of reducing carbon intensity in our portfolios. These backtests showed that for reductions of up to 50%, the return and risk characteristics were relatively unchanged whilst still maintaining the Value characteristics of the strategy.
Why do we get these results? Carbon emissions are concentrated not only in a small number of industries but also around a small number of stocks within those industries. Carbon reduction can be achieved through stock selection within sectors, rather than changing sector allocations. By rotating to another stock with a similar alpha and risk profile but with a lower carbon exposure, a similar overall portfolio risk and return could be achieved whilst reducing the carbon exposure. Hence, we can achieve carbon intensity reductions through portfolio construction, rather than a targeted removal or exclusion of stocks resulting in active weights to industries remaining relatively constant.
The table below shows the simulated risk, return and value characteristics of our Value portfolios.
| Simulations Jan 2012 to June 2022 | ||||||||
|---|---|---|---|---|---|---|---|---|
| Australian Shares | Australian Small Companies | Global Shares | Emerging Markets Shares | |||||
| No carbon reduction | 30% carbon reduction | No carbon reduction | 30% carbon reduction | No carbon reduction | 30% carbon reduction | No carbon reduction | 30% carbon reduction | |
| Total Return (% p.a.) | 10.89 | 11.00 | 12.75 | 12.64 | 13.81 | 13.81 | 8.46 | 8.47 |
| Total Risk (%) | 13.97 | 13.99 | 16.08 | 16.20 | 11.17 | 11.16 | 11.91 | 11.91 |
| Book Yield | 0.55 | 0.55 | 0.76 | 0.77 | 0.65 | 0.65 | 0.92 | 0.92 |
| Dividend Yield | 0.04 | 0.04 | 0.04 | 0.04 | 0.03 | 0.03 | 0.04 | 0.04 |
| Cash Flow Yield | 0.10 | 0.10 | 0.12 | 0.12 | 0.16 | 0.16 | 0.22 | 0.22 |
*Note the carbon reduction for these simulations are versus our theoretical core portfolio to provide a context of any potential risk, return and portfolio characteristic impacts. The implementation is versus the live portfolio’s carbon intensity as at 30 June 2020. Source: Realindex, MSCI. Data as at 31 December 2022
In practice: applying and implementing carbon reduction in Realindex Value portfolios
Having found that we could achieve the carbon reduction in our portfolios whilst still maintaining our Value characteristics and with very little impact on risk and return, we have set a 2025 target with a goal to reduce carbon intensity in our portfolios by 30%, relative to the carbon intensity of the portfolio as at 30 June 20201. We will be gradually implementing this reduction over the next 2.5 years to 31 December 2025. Pleasingly, a number of our portfolios are already below these levels given market movements and the impact of our signals2.
| Portfolio | Benchmark | |||||
|---|---|---|---|---|---|---|
| Carbon Intensity (tonnes/sales in AUD/USD) | Jun-20 | Dec-23 | %Change | Jun-20 | Dec-23 | %Change |
| Australian Shares (AUD) | 194.6 | 139.1 | -28.5% | 158.7 | 114.7 | -27.7% |
| Australian Small Companies (AUD) | 101.0 | 95.1 | -5.9% | 105.3 | 122.8 | 16.6% |
| Global (USD) | 255.2 | 140.0 | -45.1% | 165.1 | 131.3 | -20.5% |
| Emerging Markets (USD) | 487.6 | 275.3 | -43.5% | 275.6 | 314.8 | 14.2% |
Source: Realindex, MSCI. Data as at 1 December 2023
1 The date of 30 June 2020 denotes the end of the previous financial year when we initially started looking at the carbon reduction in our portfolio and our potential net zero commitments.
2 The levels of carbon reduction currently achieved are not static and are subject to change between now and Dec 2025.
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Important Information
This material has been prepared and issued by First Sentier Investors (Australia) IM Ltd (ABN 89 114 194 311, AFSL 289017) (FSI AIM, Realindex), which forms part of First Sentier Investors, a global asset management business. First Sentier Investors is ultimately owned by Mitsubishi UFJ Financial Group, Inc (MUFG), a global financial group. A copy of the Financial Services Guide for FSI AIM is available from First Sentier Investors on its website.
This material is directed at persons who are ‘wholesale clients’ (as defined under the Corporations Act 2001 (Cth) (Corporations Act)) and has not been prepared for and is not intended for persons who are ‘retail clients’ (as defined under the Corporations Act). This material contains general information only. It is not intended to provide you with financial product advice and does not take into account your objectives, financial situation or needs. Before making an investment decision you should consider, with a financial advisor, whether this information is appropriate in light of your investment needs, objectives and financial situation.
The product disclosure statement (PDS) or Information Memorandum (IM) (as applicable) for the Realindex funds are issued by Colonial First State Investments Limited ("CFSIL") ABN 98 002 348 352 AFS Licence 232468 under the following names: Realindex Australian Share Value – Class A (ARSN 132 950 433); Realindex Australian Small Companies Value – Class A (ARSN 132 950 175); Realindex Global Share Value – Class A (ARSN 132 951 083); Realindex Global Share Value Hedged – Class A (ARSN 132 951 467); Realindex Emerging Markets Value – Class A (ARSN 140 973 075)("Realindex Funds") issued by Colonial First State Investments Limited ("CFSIL") ABN 98 002 348 352 AFS Licence 232468, should be considered before deciding whether to acquire or hold units in the Fund(s). The PDS or IM are available from First Sentier Investors. The target market determination (TMD) for the Fund is available from First Sentier Investors on its website and should be considered by prospective investors before any investment decision to ensure that investors form part of the target market.
MUFG, Realindex, their respective affiliates and any service provider to the Fund do not guarantee the performance of the Fund or the repayment of capital by the Fund. Investments in the Fund are not deposits or other liabilities of MUFG, Realindex, their respective affiliates or any service providers to the Fund and investment-type products are subject to investment risk including loss of income and capital invested.
Any opinions expressed in this material are the opinions of the individual author at the time of publication only and are subject to change without notice. Such opinions: (i) are not a recommendation to hold, purchase or sell a particular financial product; (ii) may not include all of the information needed to make an investment decision in relation to such a financial product; and (iii) may substantially differ from other individual authors within First Sentier Investors.
To the extent this material contains any environmental, social and governance (ESG) related commitments or targets, such commitments or targets are current as at the date of publication and have been formulated by Realindex based on the Institutional Investors Group on Climate Change (IIGCC) Paris Aligned Investment Initiative framework. The commitments and targets are based on information and representations made to Realindex by portfolio companies (which may ultimately prove not be accurate), together with assumptions made by the relevant investment team in relation to future matters such as government policy implementation in ESG and other climate-related areas, enhanced future technology and the actions of portfolio companies (all of which are subject to change over time). As such, achievement of these commitments and targets depend on the ongoing accuracy of such information and representations as well as the realisation of such future matters. Any commitments and targets set out in this material are continuously reviewed by Realindex and subject to change without notice.
We have taken reasonable care to ensure that this material is accurate, current, and complete and fit for its intended purpose and audience as at the date of publication. To the extent this material contains any measurements or data related to ESG factors, these measurements or data are estimates based on information sourced by the relevant investment team from third parties including portfolio companies and such information may ultimately prove to be inaccurate. No assurance is given or liability accepted regarding the accuracy, validity or completeness of this material and we do not undertake to update it in future if circumstances change. No part of this material may be reproduced or transmitted in any form or by any means without the prior written consent of Realindex.
Any performance information has been calculated using exit prices after taking into account all ongoing fees and assuming reinvestment of distributions. No allowance has been made for taxation. Past performance is not indicative of future performance.
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