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It is generally accepted that the world's climate is changing due to rising man made emissions of greenhouse gases (GHGs), particularly carbon dioxide (CO2). The largest single source of CO2 emissions is the combustion of fossil fuels – coal, oil and gas.
We appreciate that many schemes are looking to mitigate the risk of climate change, including the transition to a low-carbon economy, to their portfolios, but do not have access to an appropriate, cost-effective solution.
A new, forward thinking solution
Many existing solutions take the straight-forward approach of offering strategies that overweight the stocks of companies that are less dependent on fossil fuels relative to higher carbon-emitting peers. We believe this approach has two important limitations. It only incorporates past or very recent information about the carbon footprint of each company. This approach does not take into account a company's forward looking commitment to carbon reduction. A second problem with this backward-looking approach is that carbon emission data is subject to estimation errors, as a component of carbon emission data per company is estimated by data providers.
The new UBS Life Climate Aware World Equity Fund
Our new, low cost solution aims at providing investors with an innovative, rules-based equity fund, designed to capitalise on the long-term transition to a low GHG emissions economy and invest more in companies at the heart of this transition, as well as those adapting their operating models to help model the future we all want to live in.
Key features of the Fund
The Fund aims to deliver returns broadly in line with the FTSE Developed Index with a maximum tacking error of +/-0.50%. Our approach allows an increase or decrease exposures to constituents of the index based on their expected contributions towards climate change.
A ‘negative’ tilt is used to reduce the size of the investment in companies that have worse than average greenhouse gas emissions when converted to tonnes of CO2 equivalent, companies producing energy from coal, and companies with reserves of coal, oil, and gas.
A ‘positive’ tilt is used to increase the size of the investment in companies providing renewable energy or supporting technology, and companies performing in line with 2oC globally agreed climate change goals. This positive tilt also constitutes a differentiator with respect to products that rely only on reducing the portfolio's carbon emission.
Our Climate Aware model – Four key building blocks
Our model is constructed based on four core elements, or building blocks. By combining this multi-dimensional group of metrics, we guide portfolio construction towards a set of exposures aiming at reflecting the low GHG emission economy and the 2oC scenario. Our approach is innovative - it is both forward-looking and uses a probabilistic framework to capture the inherent uncertainty surrounding carbon data. The four building blocks are:
Glide path probability: We build a quantitative model that compares the company's carbon footprint trend with the required emission reduction implied by the 2oC scenario. This approach allow us to estimate the probability a company will achieve those glide path targets.
Qualitative overlay: We improve the estimates of our quantitative model with a qualitative framework that incorporates information about the company:
- Whether carbon emission is reported under the Carbon Disclosure Program (CDP)
- The company's disclosure related to implementation of policies, objectives and/or initiatives related to carbon efficiency.
This qualitative data allows us to make a more robust estimate of a company's commitment to carbon reduction. Such a step is designed to mitigate carbon data quality and reporting issues by introducing related supplemental information on a firm's stated policy.
Current Carbon intensity and Renewable Energy: The third building block relates to current information about direct and indirect carbon footprint (measured as intensity levels). Furthermore, in order to partially capture the substitution of energy sources under 2oC scenario towards clean energy, we incorporate information related to both production of renewable energy and companies proving technology to that sector.
Fossil Fuel Reserves and Energy produced: This elements allows the underweighting of companies generating electricity from coal power stations. We also allow the portfolio to reduce exposure on companies that currently hold proven reserves in coal, oil and gas.
These four elements combine to form multidimensional set of metrics that guide portfolio construction towards a set of exposures that aim at reflecting the low greenhouse gas emission economy and the 2oC scenario (The exhibit below illustrates our core climate factors).
UBS climate aware rules-based portfolio: quantitative and qualitative factors
A new, forward thinking, climate aware solution
Watch this short video of Mark Fawcett, CIO of NEST, Ian Ashment, Head of Systematic & Index Investments and Malcolm Gordon, Head of UK Institutional discuss UBS Asset Management's new Climate Aware solution.