Carrie Ho
Fixed income investors face a growing need to integrate climate considerations into their investment strategies. FTSE Russell is addressing this need by extending its climate investment framework from equities to fixed income by means of a series of new indices.
- FTSE Russell’s new indices: offer a fixed income solution that meets investors’ sophisticated demand to integrate climate considerations into their investment strategies.
- Through FTSE’s exclusive partnership with TPI: the index features forward-looking metrics and allow investors to evaluate company’s alignment with the climate transition.
- The sophisticated index design: delivers meaningful improvements across SI metrics and remains an investable benchmark with less tracking error, through control over issuer and industry weight movements.
Our fixed income climate indices follow the framework of the Transition Pathway Initiative (TPI), a global initiative led by asset owners and supported by asset managers and which assesses companies’ preparedness for the transition to a low-carbon economy. FTSE Russell is the data partner of the TPI, and our partnership with TPI has already enabled the design and development of the FTSE TPI Climate Transition (equity) index series. As of May 2024, FTSE Russell had launched 19 TPI Climate Transition equity indices, covering global, developed, emerging and regional markets. The index series is already used by a wide range of asset owners and asset managers. In a July 2024 research paper, we laid out a comprehensive analysis of this equity index family.
The new FTSE Fixed Income TPI Climate Transition index series offers a solution to support fixed income investors’ climate commitments by mitigating carbon risk, capturing green revenues and incorporating forward-looking metrics through the application of TPI data. In this blog, we outline its main design features.
Index Methodology
The FTSE Fixed Income TPI Index Series methodology is designed to reflect the performance of global and regional fixed income markets, where index constituent weights are varied to account for the risks and opportunities associated with the transition to a low-carbon economy. Constituent weights are adjusted based on five key climate considerations:
- Carbon emissions (scope 1&2)
- TPI Management Quality scores
- TPI Carbon Performance scores
- Green revenues
- Green bonds
In this article we illustrate how to embed such climate transition metrics into a global fixed income index. We start with the market value weights of the base index – in this case, the FTSE World Broad Investment-Grade Corporate Bond Index (referred to below as “FTSE WBIG Corp”), then we apply the following steps to create the TPI index (referred to below as “FTSE WBIG Corp TPI”):
Step 1: Rank companies based on the above-mentioned five sustainable investment (SI) metrics;
Step 2: Apply a minimum set of exclusions, where companies involved in certain products or in controversial conduct are removed from the index;
Step 3: Achieve the index objectives by applying fixed factor tilt strengths, adding additional constraints on industries and issuers to maintain sector neutrality and to avoid concentration.
In the following sections, we take a deeper look at the FTSE WBIG Corp TPI and introduce comparisons between FTSE WBIG Corp and the TPI version.
Sector Movements
Sector movements between the base index (FTSE WBIG Corp) and the TPI version result from combined effect of the five SI metrics—carbon intensity (CI), TPI MQ, TPI CP, green revenues (GR), and green bonds (GB) —and are outlined in the bar chart and table below.
As a design choice, we introduce industry-neutral adjustments into the carbon intensity and TPI MQ tilts, making sure we overweight the better-performing companies (from a sustainability perspective) within an industry, while maintaining similar industry exposure to that of the base index.
One thing worth noting is that TPI CP scores only cover companies in sectors with high carbon emissions (although TPI CP scores cover around 80% of the total emissions in the FTSE WBIG Corp index). In general, the sectors that lack CP coverage are those producing lower Scope 1 and 2 carbon emissions (for example, the technology, healthcare, and financials industries). Therefore, with the CP adjustment, the TPI index overweights companies that are committed to the climate transition.
FTSE WBIG Corp TPI Industry Over/Underweights vs. FTSE WBIG Corp
Source: Industry was defined according to TRBC Economic Sector. Data as of end of July 2024. Please see the end for important legal disclosures.
| Sector Weight | SI Metrics | |||||||
|---|---|---|---|---|---|---|---|---|
| Industry | Base Index | TPI Index | Diff | CI | TPI MQ | TPI CP | GR | GB |
| Utilities | 8.00% | 15.40% | 7.40% | 445.5 | 3.6 | 5.2 | 16.90% | 19.70% |
| Consumer Cyclicals | 8.60% | 11.50% | 3.00% | 25.6 | 3.2 | 5.8 | 14.30% | 4.70% |
| Real Estate | 3.40% | 4.40% | 1.00% | 7 | 3 | NA | 31.10% | 12.00% |
| Basic Materials | 2.80% | 2.80% | 0.00% | 477.9 | 3.6 | 4.6 | 12.20% | 4.60% |
| Industrials | 8.50% | 8.00% | -0.50% | 56.3 | 3.2 | 4.1 | 32.10% | 3.30% |
| Technology | 12.20% | 10.80% | -1.40% | 10.6 | 3.4 | NA | 13.20% | 1.90% |
| Healthcare | 9.00% | 7.40% | -1.60% | 5.3 | 3.1 | NA | 9.10% | 0.20% |
| Energy | 6.10% | 4.40% | -1.60% | 328 | 3.5 | 3.8 | 5.70% | 0.70% |
| Consumer Non-Cyclicals | 7.20% | 5.30% | -1.90% | 32.5 | 3.2 | 2 | 8.30% | 0.70% |
| Financials | 34.00% | 29.70% | -4.30% | 0.7 | 3.2 | 1 | 6.10% | 5.30% |
Source: Industry was defined according to TRBC Economic Sector. Data as of end of July 2024
Issuer Weight Changes
Constituent weights are adjusted according to an issuer’s scores across the five SI metrics. On top of that, we impose additional index constraints, including a 10% single issuer cap and a 10x cap on an issuer’s weight change vis-à-vis the base index. These design choices help ensure that the TPI index remains an investible benchmark and address potential concerns over concentration risk.
In the table below we show the weight changes among the top 10 issuers by weight of the TPI index and the rationale for the change in weight. In summary, companies that produce lower carbon emissions (compared to their peers in the same industry), assessed to have higher TPI MQ or TPI CP scores, generate higher green revenues and issue more green bonds, will receive higher TPI index weights than their original market value weights.
| Issuer Weight | SI Metrics | ||||||||
|---|---|---|---|---|---|---|---|---|---|
| Issuer | Industry | Base Index | TPI Index | Ratio x | CI | TPI MQ | TPI CP | GR | GB |
| E On Se | Utilities | 0.30% | 2.20% | 8.2x | 126.2 | 4 | 6 | 23.50% | 42.50% |
| Iberdrola Intl | Utilities | 0.20% | 1.90% | 10.0x | 96.3 | 4 | 6 | 4.10% | 69.70% |
| General Motors | Consumer Cyclicals | 0.60% | 1.80% | 3.2x | 30.7 | 4 | 6 | 0.90% | 4.10% |
| BP Cap Markets | Energy | 0.50% | 1.80% | 3.3x | 183.2 | 5 | 6 | 3.90% | 0.00% |
| Banco Santander | Financials | 1.00% | 1.60% | 1.6x | 0.1 | 4 | NA | 0 | 3.00% |
| Toyota Motor | Consumer Cyclicals | 0.50% | 1.60% | 3.1x | 16.1 | 4 | 5 | 29.90% | 1.30% |
| Mercedes-Benz | Consumer Cyclicals | 0.30% | 1.30% | 4.6x | 5.6 | 4 | 6 | 19.00% | 14.50% |
| AT&T Inc | Technology | 1.00% | 1.20% | 1.2x | 16.1 | 4 | NA | 0 | 0.00% |
| Oersted A/S | Utilities | 0.10% | 1.20% | 10.0x | 48.4 | 4 | 6 | 62.20% | 86.10% |
| Barclays | Financials | 0.70% | 1.20% | 1.6x | 0.1 | 4 | NA | 0 | 0.70% |
Source: Data as of end of July 2024. Please see the end for important legal disclosures.
Exclusions
In the table below, we show the top 15 issuers that are removed from the TPI index, ranked by their original market value weight in the base index.
There are three possible reasons for a company’s exclusion: any product involvement in prohibited categories; any violation of the United Nations Global Compact (UNGC); and non-alignment with the TPI carbon performance assessment.
As TPI CP scores assess companies’ commitments to emissions pathways that are aligned to the Paris Agreement and to 2 degree centigrade/below 2 degree centigrade warming scenarios, we observed that most excluded companies are in the energy sector and are therefore more prone to being assessed as not aligned.
| Excluded Companies | Industry | MKV % (In Base) | Product Involvement | UNGC | TPI Carbon Performance |
|---|---|---|---|---|---|
| ENERGY TRANSFER LP | Energy | 0.39% | No Involvement | Non-Compliant | Not Assessed |
| BAT CAP CORP | Consumer | 0.38% | Tobacco | Compliant | Not Assessed |
| PHILIP MORRIS INTL INC | Consumer | 0.37% | Tobacco | Compliant | Not Assessed |
| EXXON MOBIL CORP | Energy | 0.23% | No Involvement | Compliant | Not Aligned |
| ALTRIA GROUP INC | Consumer | 0.21% | Tobacco | Compliant | Not Assessed |
| MPLX LP | Energy | 0.21% | No Involvement | Compliant | Not Aligned |
| LOCKHEED MARTIN CORP | Manufacturing | 0.18% | No Involvement | Non-Compliant | Not Assessed |
| EQUINOR ASA | Energy | 0.17% | No Involvement | Compliant | Not Aligned |
| DIAMONDBACK ENERGY INC | Energy | 0.11% | No Involvement | Compliant | Not Aligned |
| PHILLIPS 66 | Energy | 0.11% | No Involvement | Compliant | Not Aligned |
| CHEVRON USA INC | Energy | 0.08% | No Involvement | Compliant | Not Aligned |
| VALE OVERSEAS LTD | Manufacturing | 0.07% | No Involvement | Non-Compliant | Not Aligned |
| RIO TINTO FIN USA LTD | Manufacturing | 0.06% | No Involvement | Watchlist | Not Aligned |
| BLACKSTONE PVT CREDIT FUND | Other Finance | 0.06% | Missing Data | Missing Data | Not Assessed |
| SUNCOR ENERGY INC | Energy | 0.05% | No Involvement | Compliant | Not Aligned |
Source: Data as of end of July 2024. Please see the end for important legal disclosures.
SI Metrics Uplift
In aggregate, the TPI solution delivers substantial improvements across all five SI metrics (see the bar charts below). Using historic figures, carbon intensity decreased by around 31% (8.6 vs. 5.9 in below chart), while TPI MQ scores, CP scores, green revenues and the green bond ratio increased by 0.4, 0.9, 85% and 164%, respectively. The index’s comprehensive framework provides an opportunity for investors to incorporate sustainable investment from a variety of perspectives.
Historical SI Metrics Comparison
SSource: 1) Carbon Intensity represents figures in 10Tons/million$, 2) TPI MQ scores range from 0-5, 3) TPI CP scores range from 1-6, 4) Green revenue ratio represents figures in %, 5) Green Bond Ratio represents figures in %, 6). Data as of end of July 2024. Please see the end for important legal disclosures.
Latest SI Metrics Comparison
Source: 1) Carbon Intensity represents figures in 10Tons/million$, 2) TPI MQ scores range from 0-5, 3) TPI CP scores range from 1-6, 4) Green revenue ratio represents figures in %, 5) Green Bond Ratio represents figures in %, 6). Data as of end of July 2024. Please see the end for important legal disclosures.
Analytics and Performance
By comparison with the base index, the TPI index overweights shorter-maturity bonds with a lower yield (and option-adjusted spread) and lower duration, which had an effect on the index’s past performance. And, given that FTSE WBIG Corp is a multi-currency index with a majority of bonds denominated in US dollars and euro, there is a slight difference in performance results between the unhedged USD and USD-hedged versions.
| Index Analytics | Base Index | TPI Index |
|---|---|---|
| Averaged Life | 4.48 | 4.13 |
| Yield To Maturity | 5.53 | 5.47 |
| Effective Duration | 3.78 | 3.51 |
| OAS | 137.6 | 132 |
| Index Performance (annualised) | Base Index | TPI Index |
| USD Unhedged Return | 1.94% | 1.90% |
| Volatility | 7.48% | 7.60% |
| Return/Vol | 26.00% | 0.25 |
| USD-hedged Return | 2.96% | 2.93% |
| Volatility | 6.14% | 5.95% |
| Return/Vol | 0.48 | 0.49 |
Note: Index analytics data as of end of July 2024; index performance data is calculated from end of September 2015 to end of July 2024. Please see the end for important legal disclosures.
Conclusion
As investor approaches to integrating climate considerations into their investment strategy and decision-making are increasing in sophistication, indices need to move beyond a narrow focus on reducing carbon. With the launch of the FTSE Fixed Income TPI Climate Transition index series, FTSE Russell has developed a solution that is sophisticated enough to meet different investment purposes. Our fixed income version of the TPI index framework not only addresses carbon emissions, but also captures potential opportunities from investments in the green economy, as well as integrating forward-looking metrics.
Based on this analysis of the past performance of the FTSE WBIG Corp TPI Index, we observed that the improvements in overall SI metrics are significant. The index design includes constraints on industry and issuer weights, controlling concentration risk and maintaining diversity. In addition, past risk-return figures show that the FTSE WBIG Corp TPI Index shares similar characteristics with the base index, and we can therefore expect tracking error to be small.
The index serves as an ideal candidate for investors with global fixed income assets wishing to migrate into a more climate-aware portfolio. The use of TPI data also allows an assessment of companies’ performance during the low-carbon transition.
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