Carrie Ho
Lily Hsu
FTSE Russell is extending its transparent and flexible toolkit to help investors align their fixed income benchmarks to the targets of the 2015 Paris Climate Agreement.
- The Fixed Income EU Climate Benchmark index series are designed to capture the goals of the 2015 Paris Climate Agreement within the fixed income asset class. FTSE Russell launched a series of phase 2 indices in June 2024.
- The newly launched index universe was expanded from investment-grade to high-yield securities, as well as to emerging and Asian fixed income markets. We anticipate different behaviour in sector distribution and performance due to this expansion.
Introduction
In April 2023, we launched the first phase of the FTSE Fixed Income EU Climate Benchmark index series, a set of corporate bond indices that are designed to capture the goals of the 2015 Paris Climate Agreement within the fixed income asset class.
The FTSE Fixed Income EU Climate Benchmark index series shares an overall objective and design approach with our equity index series of a similar name, the FTSE EU Climate Benchmarks index series.
However, the FTSE Fixed Income EU Climate Benchmark index series incorporates design elements that are tailored to the fixed income asset class. The indices launched in phase 1 also focus on investment-grade fixed income securities.
In June 2024, we launched the second phase of the index series, expanding the index universe from investment-grade to high-yield securities, as well as to emerging and Asian fixed income markets. The new indices launched under phase 2 include:
- The FTSE World High-Yield PAB Bond Index (in the rest of this article, shortened to “WHYM PAB”)
- The FTSE US High-Yield PAB Bond Index (“HYM PAB”)
- The FTSE World High-Yield CTB Bond Index (“WHYM CTB”)
- The FTSE US High-Yield CTB Bond Index (“HYM CTB”)
- The FTSE Emerging Markets USD Broad CTB Corporate Bond Index (“EMUSDBBI CTB Corp”)
- The FTSE Asian Broad CTB Corporate Bond Index (“ABBI CTB Corp”)
[EU Climate Transition Benchmarks (CTB) and Paris-Aligned Benchmarks (PAB) pursue similar objectives, but vary in their level of ambition, with the EU PAB setting more challenging goals aligned to 2015 Paris Climate Agreement and the EU CTB seeking more general low carbon goals of climate transition.]
The construction methodology of the new indices follows that of the indices launched under phase 1 (more detail of the index design and its rationale can be found in this 2023 FTSE Russell research paper).
In this article, we focus on the characteristics and performance of the indices launched under the two phases of the FTSE Fixed Income EU Climate Benchmark index series. This is because we anticipate some differences in the behaviour of investment-grade bonds by comparison with high-yield and emerging market bonds.
What happens to sector weights in sustainable bond indices?
The constituents of Paris-Aligned and Climate Transition Benchmarks are decided by the sustainable investment (SI) performance of the fixed income issuer, as well as by the exclusion of issuers involved in certain product categories. We set the weightings of fixed income securities using FTSE Russell’s “target exposure” framework.
As a result, the final market weights of PAB or CTB indices deviate from those of their starting universes, where constituent weights are decided by the market value of debt outstanding. Below, we show the top underweight and overweight sectors of selected PAB / CTB indices by comparison with their starting universes.
Top Underweights and Overweights (WorldBIG PAB Corp) - (WorldBIG Corp)
Source: FTSE Russell as of July 2024. Please refer to appendix for the full index names.
Top Underweights and Overweights (World HY PAB) - (World HY)
Source: FTSE Russell as of July 2024. Please refer to appendix for the full index names.
For both the investment grade (upper chart) and high-yield (above chart) universes, the PAB approach results in a large underweighting of the energy sector. This is consistent with our expectations that energy companies are associated with higher carbon emissions.
Banks on the other hand, are the top underweight sector for WorldBIG PAB Corp. This is due to banks having lower coverage in carbon emission scope 3 data and therefore receiving a certain level of “punishment” by means of an underweight index position. In WorldBIG, banks are the biggest sector, accounting for 27.33% of total market value. However, if we look at World HY, the bank sector only accounts for 3.09%. As a result, the change in the weight of the bank sector is more significant for WorldBIG PAB Corp than for WHYM PAB.
Manufacturing is the second largest sector in both WorldBIG and World HY, but it is the top overweight for WorldBIG PAB Corp, while it receives an underweight in WHYM PAB. This is due to the difference in the exclusion levels of manufacturing issuers between WorldBIG PAB Corp and WHYM PAB.
Only 13% of manufacturing issuers are excluded from WorldBIG PAB Corp, while 48% of manufacturing issuers are excluded from WHYM PAB. This reflects a higher proportion of chemical companies in the WHYM manufacturing sector; these are more likely to be excluded from the index because of their areas of product involvement.
Top Underweights and Overweights (ABBI CTB Corp) - (ABBI Corp)
Source: FTSE Russell as of July 2024. Please refer to appendix for the full index names.
Top Underweights and Overweights (EMUSDBBI CTB Corp) - (EMUSDBBI Corp)
Source: FTSE Russell as of July 2024. Please refer to appendix for the full index names.
When comparing sustainable high-yield bond or emerging markets indices with their starting universes, we look at ABBI CTB Corp (upper chart) and EMUSDBBI CTB Corp (above chart). There’s a large degree of overlap between the underlying base indices (i.e., ABBI Corp and EMUSDBBI Corp): 60% of ABBI bonds overlap with EMDUSBBI bonds. This leads to similar sector profiles between the two.
After applying the exclusions and sustainability screens, the services sector is the top overweight in both ABBI CTB Corp and EMDUSDBBI Corp, while the energy sector is the top underweight. However, it’s worth noting that manufacturing receives an overweight in ABBI CTB Corp but an underweight in EMDUSDBBI CTB Corp. The opposite result can be mainly attributed to two reasons: 1) the subsector of metals/mining is usually underweighted due to higher carbon emissions and exclusions, and its weight in ABBI Corp manufacturing sector (14%) is only around half of the weight of EMUSDBBI Corp (31%), 2) data shows the subsector of electronics includes issuers generating higher green revenues and green bond issues, resulted in more allocated weights in the CTB index. There is significantly higher ratio of electronics issuers in ABBI Corp manufacturing sector compared to EMUSDBBI Corp (31% vs. 5%). From below 2 charts, we can see that metals/mining subsector is underweighted in ABBI Corp and EMUSDBBI Corp by -2.8% and -4.4%, respectively, whereas the electronic subsector receives more weights of +11.3% and +2.3% respectively. As a result, this leads to the opposite directions of the sector weights shift in manufacturing.
ABBI Corp – Selective Subsectors within Manufacturing
Source: FTSE Russell as of July 2024. Please refer to appendix for the full index names.
EMUSDBBI Corp – Selective Subsectors within Manufacturing
Source: FTSE Russell as of July 2024. Please refer to appendix for the full index names.
Historical Performance
In the table below, we compare the historical returns of the PAB/CTB indices and those of their respective base indices. The tracking difference between the sustainable high-yield and Asian indices and their base indices is higher than the tracking difference between the sustainable investment-grade indices and their base indices. This can be attributed to the more volatile nature of high-yield and emerging market debt. In addition, there is a higher proportion of index exclusions in the high-yield space, as more companies are involved in undesired product categories or have violated the United Nations Global Compact (UNGC) Principles. This has resulted in the sustainable index profiles deviating further from the base indices.
The volatility of returns also derives from the reweighting of issuers and sectors in CTB and PAB indices. Taking CTB ABBI Corp as an example, we note that in 2022 the return for CTB ABBI Corp was -19.81% while the return for ABBI Corp was -17.34% (a difference of -2.47%). The services sector was the top overweight for CTB ABBI Corp during the period, and its significant underperformance acted as a drag on returns.
| Index | 2019* | 2020* | 2021* | 2022* | 2023* | Since Inception |
|---|---|---|---|---|---|---|
| ABBI CTB CORP | 12.37% | 5.68% | -1.14% | -19.81% | 8.49% | 2.01% |
| ABBI CORP | 12.48% | 5.73% | -0.74% | -17.34% | 7.69% | 2.47% |
| Difference | -0.11% | -0.06% | -0.40% | -2.47% | 0.80% | -0.46% |
| EMUSDBBI CTB CORP | 13.35% | 5.14% | 1.74% | -20.29% | 6.85% | 2.56% |
| EMUSDBBI CORP | 13.02% | 5.15% | 1.98% | -20.88% | 7.42% | 2.31% |
| Difference | 0.33% | -0.01% | -0.24% | 0.59% | -0.56% | 0.25% |
| WHYM PAB | 10.14% | 3.98% | 7.42% | -17.27% | 8.69% | 3.78% |
| WHYM | 7.10% | 3.08% | 10.05% | -15.33% | 8.61% | 4.00% |
| Difference | 3.04% | 0.90% | -2.63% | -1.94% | 0.08% | -0.22% |
| HYM PAB | 11.48% | 4.13% | 7.72% | -11.42% | 5.32% | 4.78% |
| HYM | 7.66% | 2.91% | 10.69% | -10.99% | 5.66% | 4.59% |
| Difference | 3.82% | 1.23% | -2.97% | -0.43% | -0.34% | 0.19% |
| USBIG PAB CORP | 15.55% | 8.27% | 1.57% | -19.65% | 2.23% | 2.46% |
| USBIG CORP | 15.21% | 7.25% | 2.46% | -19.48% | 2.80% | 2.58% |
| Difference | 0.34% | 1.03% | -0.89% | -0.17% | -0.57% | -0.13% |
| EBIG PAB CORP | 4.81% | 5.89% | -0.74% | -27.12% | 11.06% | -0.83% |
| EBIG CORP | 4.56% | 5.74% | -0.49% | -27.23% | 11.20% | -0.85% |
| Difference | 0.25% | 0.15% | -0.25% | 0.11% | -0.13% | 0.02% |
| WBIG PAB CORP | 11.71% | 7.30% | 0.88% | -22.89% | 5.28% | 1.18% |
| WBIG CORP | 11.63% | 6.68% | 1.54% | -22.20% | 5.55% | 1.43% |
| Difference | 0.08% | 0.61% | -0.66% | -0.69% | -0.27% | -0.24% |
Conclusion
The FTSE Fixed Income EU Climate Benchmark Index Series is designed to provide a solution for investors looking to integrate climate risk and opportunities into their portfolio by means of alignment with the 2015 Paris Agreement.
EU Regulations specify certain targets and requirements to meet the Paris Agreement standards. These, in turn, require a reshuffling of constituent weights in the base universe to achieve the desired SI metrics.
Using FTSE’s target exposure approach (which incorporates constraints on the weightings shifts for issuers and sectors), we were able to control the deviation of PAB/CTB indices versus the base indices. For investment-grade fixed income universes, the tracking errors were minimal. For high-yield and Asian markets, we have observed slightly higher tracking error, resulted from a higher rate of exclusions and the more volatile behaviour of the underlying securities.
Appendix
Please refer to below for the index shortened names and full names which are used in this article:
- ABBI CTB Corp: FTSE Asian Broad Climate Transition Corporate Bond Index
- ABBI Corp: FTSE Asian Broad Corporate Bond Index
- EMUSDBBI CTB Corp: FTSE Emerging Markets USD Broad Climate Transition Corporate Bond Index
- EMUSDBBI Corp: FTSE Emerging Markets USD Broad Corporate Bond Index
- WHYM PAB: FTSE World High-Yield Paris-aligned Bond Index
- WHYM: FTSE World High-Yield Bond Index
- HYM PAB: FTSE US High-Yield Paris-aligned Bond Index
- HYM: FTSE US High-Yield Bond Index
- USBIG PAB Corp: FTSE US Broad Investment-Grade Paris-aligned Corporate Bond Index
- USBIG Corp: FTSE US Broad Investment-Grade Corporate Bond Index
- EBIG PAB Corp: FTSE Euro Broad Investment-Grade Paris-aligned Corporate Bond Index
- EBIG Corp: FTSE Euro Broad Investment-Grade Corporate Bond Index
- WBIG PAB Corp: FTSE World Broad Investment-Grade Paris-aligned Corporate Bond Index
- WBIG Corp: FTSE World Broad Investment-Grade Corporate Bond Index
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