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.
* 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.