Case study

Incorporating climate tilts into our clients’ growth portfolios


How we helped our clients reduce exposure to climate transition risks

The background

Across our client base, the trend is clear: investors want to be climate-aware in their investments, and they’re looking to us to understand how their portfolios could be made consistent with the transition to a low carbon economy.

For many of our clients, equities are the natural place to take the first step. The challenge in this space is selecting the “right” fund given the range of options available; ­­you’d be hard-pressed to find a large investment manager that hasn’t launched a fund featuring the acronym “ESG” or “climate” in the past few years.

Our approach

Many of our clients invest in low-cost index-tracking equity products and, when looking to include climate factors in their mandates, they would like to keep costs low. This naturally leads to looking for managers with an index-tracking or quantitative approach (ie constructing the portfolio in a rules-based way).

Equity funds in this area often cast a wide net, focusing not just on climate risk but on other ESG issues as well (such as social trends and governance issues). However, many ESG factors are difficult to quantify, open to various interpretations, and high-quality data may not be available.

When we reviewed this space in 2020, none of the funds in the market ticked all our requirements. Our preference for climate investing is to “tilt” stock weights away from the standard market-capitalisation weighted index, but only based on robust climate-related data. The use of sector constraints limits the distortion of the portfolio relative to the traditional equity index, helping to ensure that the risk of underperforming the standard index (measured by the “tracking error”) is relatively modest. We also wanted a simple, transparent index construction, a tax-efficient fund vehicle and market-leading stewardship practices. Even though this is a low-cost fund, we still wanted a manager who would use the considerable voice their shareholding gives them to pursue change in a considered and well thought out way.

As an independent consultancy, we review the whole market of products. We aren’t tied to working with a particular investment manager nor have incentives to create our own products. We, therefore, ran a competitive tender process, reviewed submissions from 10 of our preferred managers, and selected one to work with us to design an innovative low carbon equity fund that reflects our view of “best in class”. The manager has retained control of the design decisions and is solely responsible for its launch, operation, and ongoing review.

The outcome

Our chosen investment manager is currently launching the resulting fund range: six regional funds, a developed markets fund and an all-world fund. We will not benefit financially from our clients choosing these funds over alternatives that are available (thereby avoiding any potential conflict of interest).

The funds meet the criteria we set at the outset and also incorporate a decarbonisation strategy that aims to achieve carbon neutrality by 2050, in line with the goals of the Paris Agreement on climate change. On day one, we’re expecting an investor to see a 70% reduction in their exposure to the emission of greenhouse gases compared to a traditional equity index.

The tracking error relative to traditional equity funds is expected to be around 0.75% pa, meaning our clients have mitigation from climate transition risks whilst, in normal market conditions, expecting to experience broadly similar returns to those they otherwise would have obtained.

We use all of our institutional scale (we advise on over £250bn of assets) to negotiate hard on fees. During this exercise we were able to negotiate standard fee rates that are attractive to even our largest clients, with many seeing reductions over 50% compared to their current passive funds. This has made it difficult for even our most sceptical clients to justify putting off the transition.