Climate Indexes Brought Short-Term Gloom with Blooming Offshoots

Blog post
5 min read
Saurabh Katiyar
July 19, 2022
  • MSCI ACWI climate indexes underperformed the MSCI ACWI Index in the first half of 2022, but historically outperformed from Nov. 29, 2013, to Dec. 31, 2021.
  • This year's underperformance has primarily been driven by the outperformance of the energy sector as well as the rally in value stocks, although the contribution from green-revenue companies was helpful.
  • MSCI climate indexes, which incorporate objectives aligned with climate change and the Paris Agreement, continued to have a robust climate profile and meet their climate objectives.
The MSCI ACWI Low Carbon Leaders and MSCI ACWI Low Carbon Target Indexes performed in-line with the MSCI ACWI Index from Nov. 29, 2013, to Dec. 31, 2021, while both the MSCI ACWI Climate Change and MSCI ACWI Climate Paris Aligned Index outperformed the MSCI ACWI Index by 125 basis points (bps) on an annualized basis (as shown below). While both these indexes incorporate climate objectives, they do so differently. This led to varying levels of active share and tracking error, which may be important as institutional investors select indexes to create investment products based on their objectives.1
Historical risk and return characteristics

None

MSCI ACWI Index

MSCI ACWI Low Carbon Leaders Index

MSCI ACWI Low Carbon Target Index

MSCI ACWI Climate Change Index

MSCI ACWI Climate Paris Aligned Index

Total return (%)

10.7

10.8

10.8

12.0

12.0

Total risk (%)

13.5

13.5

13.6

13.5

13.5

Return / Risk (%)

0.79

0.80

0.80

0.89

0.89

Sharpe ratio

0.74

0.74

0.74

0.84

0.84

Active return (%)

0.0

0.1

0.1

1.3

1.2

Tracking error (%)

0.0

0.4

0.4

1.2

1.0

Information ratio

None

0.20

0.25

1.06

1.26

Gross returns annualized in USD. Nov. 29, 2013, to Dec. 31, 2021.
Tough sledding in first half of 2022
The performance of MSCI climate indexes has been negatively impacted this year by higher oil prices and the associated outperformance of the energy sector (climate indexes generally have lower relative allocations to the energy sector). Other macroeconomic impacts included high inflation, higher commodity prices and rising interest rates. In a previous blog post, we highlighted how this macroeconomic environment could be favorable for value stocks, and there has, indeed, been a rally in value stocks, along with headwinds for climate indexes. However, these headwinds were counterbalanced with long-term commitments to addressing climate goals helped by companies with green revenues outperforming in the first half of the year.2 The MSCI ACWI Low Carbon Leaders and MSCI ACWI Low Carbon Target Indexes both have low tracking error as part of their construction rules. While both these indexes have underperformed the MSCI ACWI Index this year, their underperformance has been less significant than that of the MSCI ACWI Climate Change and MSCI ACWI Climate Paris Aligned Indexes. For this reason, we focus on the latter two indexes.
Climate indexes relative performance in first half of 2022
Performance of MSCI climate indexes relative to MSCI ACWI Index from Dec. 31, 2021, to Jun. 30, 2022.
Robust climate profile
The MSCI Climate Change and MSCI Climate Paris Aligned Indexes have net-zero-aligned climate objectives, which has led to both having a lower carbon footprint and higher green-revenue exposure as compared to MSCI ACWI Index, as of June 1. In order to meet these objectives, however, the indexes generally deviated from the MSCI ACWI Index. In the chart below, we can see that both climate indexes have historically been underweight value stocks. Similarly, if we review sector allocations, these indexes have historically been underweight energy, while information technology (with a lower carbon footprint) has generally been an overweight.
Active factor and sector allocations
MSCI ACWI Climate Change Index

None

Average

Current

Value

-0.03

-0.12

Size

0.01

0.02

Momentum

0.03

-0.12

Volatility

0.00

0.10

Quality

0.00

0.00

Yield

-0.05

-0.11

Growth

0.03

0.09

Liquidity

0.00

0.03

MSCI ACWI Climate Paris Aligned Index

None

Average

Current

Value

-0.05

-0.11

Size

-0.13

-0.09

Momentum

0.00

-0.10

Volatility

-0.05

-0.02

Quality

-0.02

-0.03

Yield

-0.07

-0.09

Growth

0.00

0.01

Liquidity

0.02

-0.02

MSCI ACWI Climate Change Index (%)

None

Average

Current

Energy

-4.8

-4.2

Materials

-1.7

-1.8

Industrials

0.06

-0.2

Consumer discretionary

0.1

2.3

Consumer staples

-0.3

-1.1

Health care

1.0

1.1

Financials

2.0

-1.3

Information technology

3.8

5.9

Communication services

0.4

-0.3

Utilities

-1.3

-0.9

Real estate

0.2

0.6

MSCI ACWI Climate Paris Aligned Index (%)

None

Average

Current

Energy

-5.5

-4.9

Materials

-1.7

-1.8

Industrials

4.4

3.5

Consumer discretionary

-0.9

-0.7

Consumer staples

-1.3

-3.4

Health care

0.5

0.9

Financials

2.5

1.7

Information technology

1.6

4.2

Communication services

-0.3

-1.4

Utilities

-0.6

-0.1

Real estate

1.4

1.8

Active allocations of the MSCI ACWI Climate Change and MSCI ACWI Climate Paris Aligned Indexes relative to MSCI ACWI for MSCI Global Equity Model (GEMLT) style factors and the Global Industry Classification Standard (GICS®), the global industry classification standard jointly developed by MSCI and S&P Global Market Intelligence.
Historically, these factor and sector allocations contributed to outperformance for these indexes over the longer-term (as shown below). Performance was consistent for both indexes, as the contribution from industry exposures was significant while the contribution from risk indexes was smaller (but still positive). Specific contribution was also positive for both indexes.
Long-term performance in detail

None

ACWI Climate Change Index

ACWI Climate Paris Aligned Index

Risk indexes

0.16

0.12

(FaCS value factor)

-0.05

-0.07

Industry

0.64

0.44

Country

0.05

0.00

Currency

0.02

-0.11

Specific

0.38

0.81

None

None

None

Total active return

1.25

1.26

Table shows the performance contribution from common factors based on performance attribution using MSCI Global Equity Model (GEMLT). Monthly data from Nov. 29, 2013, to Dec. 31, 2021.
First-half drags on performance
As previously mentioned, underweights to value stocks and the energy sector resulted in negative contribution to this year's index performance through June 30 (as shown below). There were also industries in the information technology sector, such as semiconductors as well as software and services, that the MSCI ACWI Climate Change Index was positively exposed to and detracted from performance.
Short-term performance in detail

None

ACWI Climate Change Index

ACWI Climate Paris Aligned Index

Risk indexes

-1.48

-0.59

(FaCS value factor)

-0.62

-0.47

Industry

-1.61

-1.65

(Oil-related industries)*

-0.95

-1.11

Country

0.12

-0.02

Currency

0.17

0.01

Specific

0.61

0.59

None

None

None

Total active return

-2.19

-1.66

The table shows the performance contribution from common factors based on performance attribution using MSCI Global Equity Model (GEMLT). Monthly data from Dec. 31, 2021, to June 30, 2022
*Includes contributions from integrated oil and gas, oil and gas and consumable fuels & oil and gas exploration and production industry factors.
One important thing to note about the table above, is that the "specific" return contribution continued to be positive this year. We previously mentioned that both climate indexes had higher aggregate allocations to companies with green revenues, so we analyzed whether the companies with green revenues had a role to play in the positive specific-return contribution. Interestingly, if we aggregate the specific-return contribution for all companies with green revenues higher than 5% (similar threshold to the aggregate green revenues exposure for the MSCI ACWI Index), we can see a cumulative-return contribution of 64 bps for the MSCI ACWI Climate Change Index and 38 bps for the MSCI ACWI Climate Paris Aligned Index. While other factors played a role in the specific-return contribution, greater exposure to green revenues may have contributed to performance.
Climate indexes in motion
As investors seek to build climate solutions, there is a continued emphasis on meeting specific climate objectives. And with different climate objectives comes varied levels of risk, return, active share and tracking error. Since the climate investment ecosystem is constantly in motion and evolving, investors may want to focus on key attributes and metrics that are of particular interest and manage portfolios accordingly.
Further Reading
Carbon Markets: An Emerging Derivatives Class Are Emissions Rising or Falling in Equity Indexes? Introducing the Carbon Market Age
Saurabh Katiyar
Saurabh Katiyar
Executive Director, MSCI Research

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1The analysis and observations in this report are limited solely to the period of the relevant historical data, backtest or simulation. Past performance — whether actual, backtested or simulated — is no indication or guarantee of future performance. None of the information or analysis herein is intended to constitute investment advice or a recommendation to make (or refrain from making) any kind of investment decision or asset allocation and should not be relied on as such.2Green revenue is calculated as the cumulative revenue (%) from the six clean-tech themes that include alternative energy, energy efficiency, sustainable water, green building, pollution prevention and sustainable agriculture. Performance based on the MSCI ACWI IMI Efficient Energy Index, MSCI Global Alternative Energy Index and MSCI Global Pollution Prevention Index.

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