Climate transition risk and performance

Chart of the week

Everybody is talking about the pandemic accelerating major trends. We find it has also favored companies responding to climate change.

Climate change continues to be a big issue for investors. Extreme weather events may cause financial losses. Assets may lose value as the world transitions to a low-carbon economy and laws and regulations shift to accelerate action on climate change. But it is also our view that climate change offers investment opportunities across all sectors of the world economy.

DWS has designed and implemented a proprietary climate-transition-risk (CTR) rating which seeks to identify the risks and opportunities associated with the transition to a low-carbon economy (see our September 2019 CIO View Quarterly ESG article for more details). Its A to F rating system helps to identify climate-transition leaders and laggards by amalgamating data from the latest generation of climate-risk measures from MSCI, ISS-ESG and Morningstar Sustainalytics.

Using our proprietary CTR rating, we have looked at those companies for which climate change presents an opportunity (CTR leaders) and compared them with those for which it presents a risk (CTR laggards). As our Chart of the Week illustrates, there has been a remarkable divergence between CTR leaders' and laggards' performance this year. While the leaders outperformed the MSCI AC World Index by 41% in the year to date (as of 7/31/20), the laggards underperformed by 22%.

Climate transition risk is often industry-specific so it shouldn't surprise anyone that the sector weights for these groups differ significantly. CTR leaders are found mainly in consumer discretionary (29%), industrials (25%) and information technology (IT) (38%). Electric vehicles (consumer discretionary), electrical-equipment and building products (industrials) as well as IT products are providing important contributions to climate solutions. CTR laggards are found mainly in energy (45%), materials (22%) and utilities (22%), where oil exploration, metals extraction and coal mining are examples of operations typically associated with environmental risks.

While we would not attribute the outperformance of the CTR leaders to environmental, social and governance (ESG) factors alone, in the midst of the pandemic stocks with high CTR ratings have, in aggregate, done better. "ESG quality remains an important driver for investors and performance across companies, sectors and sub-sectors," confirms Petra Pflaum, CIO for Responsible Investments at DWS. She adds that " integrating ESG information into financial analysis allows us to identify true ESG leaders and laggards to benefit from investment opportunities while reducing risks."

In the highly volatile environment we find ourselves in this year, striking the right balance between risk and return is of particular importance. As we have seen, analyzing companies from an ESG perspective can reveal valuable insights. Even the Covid pandemic might well have increased investors' attention to ESG topics overall and climate change in particular, contributing to CTR leaders' outperformance.

20200828_CotW_China Equities_CHART_EN_72DPI.png

* MSCI All-Country World Index
** Climate-transition-risk rating A-B
*** Climate-transition-risk rating E-F
Sources: MSCI Inc., DWS Investment GmbH as of 7/31/20

Appendix: Performance over the past 5 years (12-month periods)


07/15 - 07/16 07/16 - 07/17 07/17 - 07/18 07/18 - 07/19 07/19 - 07/20
MSCI AC World Index -2.5% 14.8% 8.8% 0.9% 5.3%

Sources: Bloomberg Finance L.P., DWS Investment GmbH as of 7/31/20
Past performance is not indicative of future returns.

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This information is subject to change at any time, based upon economic, market and other considerations and should not be construed as a recommendation. Past performance is not indicative of future returns. Forecasts are based on assumptions, estimates, opinions and hypothetical models that may prove to be incorrect.

DWS ESG signals that DWS uses in its investment management are sourced or derived from data that DWS receives pursuant to licenses with third -party commercial ESG data providers. Sources: ISS ESG, Sustainalytics, S&P Trucost Limited, MSCI ESG Research Inc. and Morningstar, Inc., Arabesque S-RAY as well as information publicly available.

These signals do not constitute investment advice or recommendations by such Licensors. All rights in the data and reports provided by third-party licensors vest in such licensors and/or their content providers licensors. None of such licensors or their affiliates, or their licensors content providers, accept any liability for any errors, omissions or interruptions in such data/reports and none warrants their data as to completeness, accuracy or timeliness. No copying or further distribution of such data/reports is permitted.

DWS Investment GmbH as of 8/25/20
CRC 077985 (08/2020)

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