Exploring Easyvest's climate portfolio

Easyvest offers the opportunity to invest in a "climate portfolio," guided by preferences for climate sustainability. While our default recommendation is a "global portfolio," unrestricted, here we explain what the climate portfolio entails and outline factors to consider in assessing its suitability for your investment goals and risk profile.

The rise of non-financial considerations in investment

Around the 2010s, the notion of creating a more responsible finance gained traction among the public, regulators, and investment professionals. In addition to financial performance, investors began incorporating non-financial considerations into their investment choices.

Specifically, they began assessing investment performance around three main themes: Environmental protection, Social rights, and good Governance. These themes were consolidated under an acronym, giving rise to the concept of "ESG."

ESG and sustainable investment

Initially used to monitor the environmental, social, and governance performance of publicly traded companies, ESG became a tool for filtering and comparing these companies.

Thus emerged ESG investment, along with other related approaches such as "sustainable," "impact," "green," "responsible," or "socially responsible" investing; each with its own specifics, sometimes fundamental, but generally grouped under the common term "ESG investment."

There is no universal definition of sustainable and responsible investment

Investing responsibly is complex because there are nearly as many opinions on what is sustainable or ESG filters as there are investors. To date, a universal framework for these criteria is unavailable, and individuals may assign varying importance to different dimensions.

For example, some investors support the nuclear industry for climate reasons, as it emits little CO2, while others oppose it due to long-term pollution risks. The same goes for the arms industry: should it be supported to defend national sovereignty interests, or excluded to promote peace globally?

As just explained, "ESG" is a subjective notion today. Attempts at international certification and control are very difficult, despite many efforts in this direction, notably regulatory efforts with the European "Taxonomy" regulation.

We are convinced: "Nobody beats the market"

Since Easyvest's launch in 2015, we have consistently promoted a simple and tested message: "In the long term, nobody beats the market". The notion of the "market" encompasses all publicly traded companies worldwide, regardless of sector, geography, or size.

Thus, we recommend equity investors to buy the market through global equity ETFs, including companies in proportions equal to to their market capitalization within the global market. Our belief is that this strategy is unbeatable in the long term.

Two strategies for responsible investing: exclusion or activism

To invest responsibly, an investor can employ two strategies. They can exclude poor performers from their portfolio, i.e., companies whose practices do not meet their sustainability/ESG criteria. This is called exclusionary investing. Alternatively, they can actively seek to influence the management of these companies to align their practices with their sustainability/ESG criteria. This is called activism and involves participating in company decisions by exercising voting rights attached to held shares.

ESG-labeled ETFs mostly follow an exclusion strategy

ESG funds or ETFs predominantly practice exclusion, meaning they avoid including certain companies or sectors that do not meet set ESG criteria in their composition.

For example, many ETFs replicate indices from MSCI. This company produces a series of sustainable indices, including the "ESG Leaders" indices, which exclude 50% of the worst ESG performers, or the "SRI" (Socially Responsible Investing) indices, which exclude 75% of companies from a specific basket.

Clarification: "I don't want my money to finance oil companies"

We frequently hear from investors wishing to apply an ESG filter that they want to exclude oil companies from their portfolio because they do not want their money to fund these companies.

This way of thinking is flawed. When an investor buys shares of an oil major, they do not buy them directly from that major but from another investor: the money does not end up in the major's pocket but in the seller's.

Only shares purchased on the "primary market," i.e., issued directly by a company in a fundraising event, go to that company. But when it comes to ETF trackers, shares are traded among investors on the "secondary market," without impacting the company's financial resources.

Does this mean exclusionary investing has no effect? Directly, no, but indirectly, yes. Investors excluding these companies from their portfolios reduce demand for this type of asset, which – in theory – leads to a decrease in the share price and thus the valuation of the company, potentially affecting its ability to finance itself and influence its energy transition strategy. However, as of now (early 2024), this theoretical process does not seem to have (yet?) occurred.

Today, it's less the natural effect of market supply and demand that plays out. Even more, the signaling effect sent by the growing number of exclusion adherents puts pressure on legislators and large institutional shareholders to influence oil majors.

"Activists" prefer to change the world from within

Activism is obviously not within reach for all investors. However, major global ETF issuers (BlackRock, Vanguard, State Street, or Amundi), given their weight in the capital of many multinationals, can play an active role in boardrooms and general meetings, especially in terms of driving ESG practices and mindsets. These issuers publish annual reports detailing actions taken within companies they are shareholders of, including on ESG matters.

In early 2024, Amundi, Europe's largest ETF issuer, and a group of activist shareholders announced they would submit a resolution to the general meeting of Shell, an oil multinational. The resolution calls on its executives to achieve the Paris Agreement objective of limiting global warming to 2 degrees Celsius above pre-industrial levels. This action made waves, much like the one led in 2021 by BlackRock, State Street, and Vanguard at Exxon's general meeting, another oil multinational.

What motivates activism in sustainable investment?

One might wonder what fundamentally motivates activist behaviors. Is it a moral stance by fund managers, keen on driving towards greater sustainability? Or the growing interest of their clients in ESG-type funds (by exclusion), which prompts them to act to "counterbalance" and not lose business?

We cannot exclude this second hypothesis, which would imply that exclusion strategies impact "inclusion" strategies on sustainability.

Undoubtedly, ongoing regulation, such as the SFDR (Sustainable Finance Disclosure Regulation), influences fund managers. Regardless, activism led by these influential shareholders within multinationals is a significant lever for change, as it pushes boards out of silence, awakens opinions, and drives action.

Easyvest favors change from within

Easyvest's investment philosophy is not inherently compatible with exclusionary strategies since our belief is that one should invest in the entire market, representing the widest range of companies.

Excluding certain companies or sectors, from this perspective, is akin to practicing a form of "stock picking," riskier, less diversified, and potentially less profitable for the long-term investor.

Our natural preference, therefore, leans towards an activist-type responsible investment strategy, through major global ETF issuers. This approach seems most appropriate for reconciling our fiduciary duty to maximize our clients' returns for a given risk profile while pushing decision-making towards a more responsible world.

We respect investors who prioritize exclusion

That being said, we understand the desire of some investors not to hold companies in their portfolio whose practices they disapprove of. We also understand that some investors are willing to accept potentially lower financial performance as long as their exclusion preferences are respected.

This preference can be reconciled with an index-based approach. In this case, we always advocate for a sufficiently diversified index and a long-term investment outlook. To maintain an adequate level of diversification, with hundreds of companies rather than just a few dozen, it is our opinion that one should be focusing on a predominant ESG dimension – prioritizing either Environmental, Social, or Governance factors. Pursuing all three dimensions simultaneously would lead to the exclusion of too many companies from the portfolio.

Easyvest emphasizes climate, with a "Climate Portfolio"

When we survey our clients to determine which aspect of sustainability resonates with them the most, the majority mention reducing CO2 emissions to preserve the climate. Climate is a subset that falls under the "E" for Environment in "ESG."

At the same time, these clients generally do not wish to invest in companies producing fossil fuels, such as oil and gas majors, nor in tobacco-related or arms-related companies.

This desire largely aligns with selecting companies that are in line with the goals of the 2015 Paris Climate Agreement, aiming to limit global warming to 2 degrees Celsius above pre-industrial levels.

It turns out that there are stock market indices constructed through exclusion around the Paris Agreement, as well as ETFs that track these indices. Therefore, it is possible to construct investment portfolios that integrate these constraints while maintaining the benefits of ETFs (diversification, transparency, liquidity, reduced management fees).

Alongside its "global portfolio" model, Easyvest has developed a "climate portfolio."

The Global and Climate portfolios differ in their asset allocation

In concrete terms, what is the difference between an Easyvest global portfolio and a climate portfolio? Each of these portfolios consists of a bond portion and an equity portion. Regarding the bond portion, the approach is identical: selecting a diversified basket of Eurozone government bonds. However, the equity portions of the two portfolios differ in their objectives, number, and types of holdings.

While the global index followed by Easyvest includes approximately 9.000 companies, the climate index aligned with the Paris Agreement only includes 600. Immediately, we observe that this index is less diversified, implying higher risk.

The global index aims to replicate the broadest possible market of listed equities without filtering by geography, industry, or size. Additionally, each company's weight corresponds to its representation in the global market capitalization.

The climate index, on the other hand, aims to invest in a set of companies that currently have a carbon intensity 50% lower than the global index and commit to reducing their carbon intensity by 7% each year.

Note that carbon intensity is defined as the number of tons of CO2 emitted directly or indirectly by these companies the previous year, divided by the current market value of these companies. The approach aims to include all CO2 emissions in the value chain of companies (technically, scopes 1, 2, and 3 emissions are considered).

Fossil fuel producers and controversial sectors are excluded

The current climate index selected excludes companies involved in (i) coal, gas, or oil, (ii) tobacco, (iii) arms, or (iv) severe ESG controversies. In this list of exclusions, the fossil fuel industry predominates (over 80%).

The index also excludes companies from emerging countries, small caps, and companies for which ESG data is missing, unreported, or incomplete.

Lastly, unlike the global index, which relies solely on capital weight, the climate index may overweight companies that best meet carbon intensity reduction objectives.

Due to the exclusionary strategy applied, the index aligned with the Paris Agreement is more concentrated on certain types of values, especially technological and American ones.

We also monitor the non-financial risks of the global portfolio

Regardless of the portfolio, at Easyvest, we select ETFs considering their ESG risks. Thus, just because the global portfolio does not specifically focus on climate does not mean we do not monitor its greenhouse gas emission score.

On the contrary, we monitor non-financial criteria for both the global and climate portfolios, based on four main sources: ETF issuers, index constructors (MSCI), Refinitiv, and Morningstar.

The results from these sources are compiled in the infographic. One striking aspect is the difference in conclusions from the sources. For example, for Refinitiv, the climate and global portfolios receive the same scores of 7/10 in terms of greenhouse gas emissions, whereas for Morningstar and MSCI, the climate portfolio and index clearly outperform.

This underscores the lack of universality in non-financial criteria analysis and the importance of treating these results with caution. From our perspective, MSCI data, available for free on their site via the MSCI Index Profile Tool, is the most relevant, given its richness, transparency, and the certainty of comparing comparable things through a uniform methodology.

Financial performance and risk of the global portfolio vs. climate portfolio

If we examine the performance history of the two indices between 2018 and 2023, we find that the climate index aligned with the Paris Agreement outperformed the global index. However, this outperformance was also associated with higher volatility and therefore a higher level of potential loss risk, depending on when the investor started their investment during this period (see graphs).

This additional degree of risk can be explained by the climate index's stronger concentration compared to the more diversified global index. As for the additional performance, one must question whether it is due to the climate angle or because the climate index over-represented large American technology companies (especially the "Magnificent Seven": Apple, Microsoft, Meta, Amazon, Alphabet, NVIDIA, and Tesla), which over the same period drove the markets upwards.

Also, note that six years of analysis is relatively short to deduce a definitive trend. And since we are talking about past performances, it is important to remember that, regardless of the investment, future performances could be significantly different from those in the past and result in losses.

How to choose between the global portfolio and the climate portfolio?

If the choice is between selecting either the global portfolio or the climate portfolio, which one should you choose? There can be no single answer because Easyvest's duty, as a regulated portfolio management company, is to construct and manage a portfolio personalized to each client's situation, particularly their investment goals and investor profile.

Thus, if the goal is to maximize future returns for a given level of risk, our opinion is that the global portfolio model is probably the most appropriate. We firmly believe that it is impossible to beat the market in the long run and, therefore, one should construct a portfolio as diversified as possible, without excluding any companies or sectors.

Moreover, from an ESG perspective, this global strategy aims, indirectly through the ETF issuers we select, to influence the practices of certain multinational corporations towards greater consideration for the environment, social well-being, and governance. This "activist" approach, therefore, is not without sustainability goals.

Easyvest's climate portfolio may be more suitable for investors who (i) prioritize limiting climate change, (ii) wish to signal this by excluding companies whose products and activities contribute to temperature increases, and (iii) place these goals ahead of return and risk considerations.

Scientific rigor and excellence for all

If you decide to open an investment portfolio with Easyvest, you will be asked questions about your financial objectives, investment profile, and sustainability preferences.

If your preferences lead you there, our managers may propose a climate-oriented portfolio aligned with the Paris Agreement, whose allocation will be optimized with the same scientific rigor as our global portfolios.

Regardless of their preferences, all our clients have access to the same personalized services, human contact, and advanced digital tools that make Easyvest unique.