- During the first quarter of 2023, most of the MSCI ACWI Climate and MSCI ACWI ESG Indexes outperformed their benchmarks.
- The main drivers behind the outperformance were positive returns of securities in information technology and consumer discretionary and negative returns in the energy sector.
- The carbon-efficiency factor may have helped climate-aware investors work to maintain sector diversification while seeking stocks with lower carbon intensity within sectors.
During the first quarter of 2023, the MSCI ACWI Climate Change, MSCI ACWI Climate Action and MSCI ACWI Climate Paris Aligned Indexes outperformed their parent, the MSCI ACWI Index, whereas the MSCI ACWI Low Carbon Leaders and Low Carbon Target Indexes experienced small but negative cumulative active performance. On the other hand, four out of the five flagship MSCI ESG Indexes outperformed the MSCI ACWI Index.
MSCI ACWI Climate and MSCI ACWI ESG Indexes’ performance
Cumulative performance of MSCI climate and ESG indexes relative to MSCI ACWI Index rebased at 100 on Nov. 30, 2018. Data from Nov. 30, 2018, (the earliest available data for common history) to March 31, 2023.
While all of the flagship MSCI climate and ESG indexes benefited this quarter from higher allocations to information technology, the MSCI ACWI Low Carbon Target, Climate Action, Climate Change, ESG Screened, ESG Leaders and SRI Indexes also enjoyed positive active-return contribution from consumer-discretionary stocks. Conversely, a low allocation to energy stocks resulted in positive active return for the MSCI ACWI Climate Change and Climate Paris Aligned Indexes and all of the MSCI ACWI ESG Indexes except the MSCI ACWI ESG Focus Index.
Active-sector-return contribution
The chart shows active Global Industry Classification Standard (GICS®) sector-return contribution for the MSCI ACWI Climate and MSCI ACWI ESG Indexes vs. the MSCI ACWI Index from Dec. 31, 2022, to March 31, 2023. GICS is the industry-classification standard jointly developed by MSCI and S&P Global Market Intelligence.
Average active sector weights of flagship MSCI ACWI Climate Indexes
The chart shows average active GICS-sector weights of the MSCI ACWI Climate Indexes vs. the MSCI ACWI Index from Dec. 31, 2022, to March 31, 2023.
Average active sector weights of flagship MSCI ACWI ESG Indexes
The chart shows average active GICS sectors weights of the MSCI ACWI ESG Indexes vs. the MSCI ACWI Index from Dec. 31, 2022, to March 31, 2023.
The power of small active sector weights
We have shown in previous research that small active sector weights might lead to substantial active return contributions if a sector’s performance magnitude has been large. While active sector allocations this quarter were in line with historical levels, the stocks of companies in information technology, consumer discretionary and energy exhibited a sharp reversal in performance compared to 2022. Their returns reverted to long-term performance trends resulting in a positive contribution to active returns for most of the MSCI ACWI Climate and ESG Indexes.
Average active performance of selected MSCI ACWI sector indexes
The chart shows annualized active performance of the MSCI ACWI Information Technology, Consumer Discretionary and Energy Indexes vs. the MSCI ACWI Index from Dec. 31, 2022, to Mach. 31, 2023.
While energy prices had a substantial negative impact on the global economy last year, not all companies were affected the same way. For example, high energy consumer companies may have faced higher energy bills, though energy-efficient companies exhibited a quick recovery. In the next section, we take a closer look at the carbon efficiency factor and the insights it can provide on portfolios and indexes.
What can the carbon-efficiency factor tell us about equity climate investing?
In a previous blog post, we introduced the carbon-efficiency factor1 to help investors gain insights from a portfolio’s sector-relative carbon intensity.2 We define a stock as more “carbon-efficient” if it has a lower carbon intensity than its sector peers.3 Companies with greater carbon efficiency than sector peers may benefit by paying less in carbon taxes over time, or be less susceptible to public-policy directives that disadvantage companies based on carbon emissions. This sector-relative definition sets the measure apart from weighted average carbon intensity (WACI), which can be reduced by underweighting high-carbon-emitting sectors such as energy, utilities and materials.
While WACI and total carbon emissions have provided insights for managing overall decarbonization, the carbon-efficiency factor seeks to help investors understand carbon intensity within sectors across a broad opportunity set regardless of region or country. We analyzed a group of global active climate equity funds and examined how the carbon-efficiency factor may have helped investors approach stock selection within sectors.4
We separated the climate funds into terciles by average carbon-efficiency-factor exposure (low, mid and high). From December 2020 through December 2022, exposure to the carbon-efficiency factor increased for all terciles (for the low-exposure tercile, negative average exposure means that, for each fund, the constituents had higher carbon emissions relative to sector peers). For comparison, we included some of the MSCI ACWI Climate Indexes, which all had positive exposure to the carbon-efficiency factor. While the indexes were not constructed to target high carbon efficiency, they generally included stocks with lower carbon intensity across sectors.
Exposure to the carbon-efficiency factor increased over the study period
We found that active climate funds across terciles selected stocks that had higher carbon efficiency in December 2022 than in December 2020. How did carbon-efficiency exposure of these funds increase over time? To answer this question, we compared the sector weights and carbon-efficiency-factor exposure of the high-exposure tercile, where carbon efficiency increased by almost 50% over the period.
Carbon-efficiency exposure of high-exposure tercile
During 2020, the weight of the information-technology and industrial sectors held at about 20%. However, the carbon-efficiency exposure of information technology at 0.27 versus 0.05 for industrials resulted in a higher contribution to the portfolio-level carbon-efficiency exposure. We also observe that while the weight of materials and utilities (both high-carbon-intensity sectors) held at 7% and 3%, respectively, the carbon-efficiency exposure of both sectors (0.74 for materials and 0.85 for utilities) was twice as high as that of all other sectors. This means that stocks selected in the materials and utilities sectors were among the most carbon-efficient in those sectors. In contrast, stocks selected within health care and real estate (both low-carbon-intensity sectors) had negative carbon-efficiency exposure: -0.06 for health care and -0.49 for real estate.
Carbon efficiency: a different tool for a different purpose
While many climate-aware investors will continue focusing on lowering carbon intensity, carbon efficiency would have provided additional insights for investors who seek to select stocks with low carbon emissions or engage with high emitters within a sector.
1The carbon-efficiency factor is part of the MSCI Global Equity Factor Model.
2We define carbon intensity as the sum of Scope 1, Scope 2 and Scope 3 emissions relative to enterprise value including cash (EVIC).
3Within a sector, stocks with lower carbon intensity have higher exposure to the carbon-efficiency factor and stocks with higher carbon intensity have lower exposure to the carbon-efficiency factor.
4For our study we used the same funds as those from our recent blog post “Parallel Benchmarking for Climate Alignment.”
Further Reading
Global Markets One Year After Russia’s Invation of Ukraine
ESG Indexes Lifted by Carbon-Efficient Firms but Underperformed