FlexShares takes a unique approach to managing volatility and carbon risk in our forward-looking, sustainable developed markets low volatility ETF.
Our key design features include:
A portfolio construction process that maintains sector and region neutrality to the global
A scoring methodology to identify sustainability leaders in each sector
Targets for minimum carbon footprint reduction and improved climate risk score
Investors typically look to low volatility stocks for their defensive characteristics. What they might not realise is that traditional low volatility strategies may introduce unintended risks to a portfolio because of excessive exposure to carbon-intensive sectors like utilities.
As the world transitions to a low-carbon economy, this concentration could cause a low volatility strategy to fall short of investors’ risk-management expectations and run counter to their sustainability goals. Does this mean low volatility investing is incompatible with climate objectives? Not if the strategy incorporates sector constraints and climate considerations within a low volatility portfolio.
Controlling for sector and region risk
Low volatility stocks traditionally have been concentrated in certain sectors, which can cause portfolios to end up with significant overweight and underweights compared to the broader market. For example, the MSCI World Minimum Volatility index had a 5.1% overweight to utilities compared to the MSCI World, but a 4.3% underweight to technology, as at 31 March, according to Bloomberg.
These sector concentrations can make portfolios sensitive to macroeconomic risks. And they may be especially challenging for investors with sustainability goals because traditional low volatility sectors tend to have higher carbon intensity and greater exposure to climate risk. Take the utilities sector, which represents just 3-4% of the global developed universe, but contributes 40-50% of the universe’s total carbon footprint.
To help manage this risk, FlexShares uses sector and region constraints in our low volatility portfolio to maintain neutral weightings to the STOXX Global 1800 index. Controlling for sector concentration in this way is a first step in reducing carbon risk in a low volatility strategy. But there are more opportunities to refine a portfolio to meet investors’ climate objectives.
Screening stocks for sustainability
FlexShares scores stocks in the global developed universe according to a proprietary sustainability methodology that’s diversified across the three considerations of environment, social, and governance. Using data from the Sustainability Accounting Standards Board (SASB) and the Task Force on Climate-Related Financial Disclosures (TCFD), FlexShares examines low volatility stocks across a spectrum of potential risks:
Physical risk, such as an energy company with significant carbon-related assets and infrastructure. Legal risk, including potential new regulations that may prohibit or limit certain carbon-intensive activities and potential exposure to liability related to climate change.
Transition risk, such as companies relying on carbon-intensive assets that may be left behind as the world transitions to a low-carbon economy.
This methodology allows us to examine a company’s sustainability relative to its sector or industry peers. It also provides an assessment of a company’s current carbon footprint, along with a forward-looking carbon risk analysis that helps identify how companies are positioned to manage a changing economy.
Using these scores allows us to assemble a portfolio that seeks lower volatility within specific sustainability targets, including:
A 50% reduction in carbon emission intensity
A minimum 20% increase in Carbon Risk Rating
As governments and companies continue to focus on addressing climate risk and other sustainability issues, those factors may increasingly affect economic opportunities and market volatility. We believe advisors can help their defensive-minded clients avoid unintended, uncompensated risks in a low-volatility strategy. Understanding how traditional strategies potentially can introduce unintended sector concentrations and excessive carbon risk is the first step in finding approaches that are compatible with both risk-management goals and sustainability objectives.
In our view, FlexShares’ use of constraints to maintain proper diversification and neutrality to a global benchmark, combined with sustainability scoring, can help create a portfolio that’s better aligned with investors’ sustainability goals. What is more, this can make it more likely to maintain its low volatility characteristics in a changing world.
To find out more, visit: https://go.flexshares.com/en/sustainablefunds
Important Information: This material is directed to eligible counterparties and professional clients only and is not intended for retail clients. For Asia-Pacific markets, it is directed to expert, institutional, professional and wholesale investors only and should not be relied upon by retail clients or investors. For legal and regulatory information about our offices and legal entities visit flexshares.com/disclosures. Information contained herein has been obtained from sources believed to be reliable, but its accuracy and completeness are not guaranteed. Information is only current as of the date stated and is subject to change without notice. Fund performance data provided herein should not be relied upon as a basis for investment decisions; performance data may be revised. This information does not constitute a recommendation for any investment strategy or product described herein.
This information is not intended as investment advice and does not take into account an investor’s individual circumstances. The prospectus is available in English and the key investor information document is available in [English, Dutch and German] at www.flexshares.com/ funds. Investing involves risk – no investment strategy or risk management technique can guarantee returns or eliminate risk in any market environment. The Funds are sub-funds of FlexShares ICAV which is a regulated collective investment scheme in Ireland under Central Bank of Ireland UCITS regulations. FlexShares Developed Markets Low Volatility Climate ESG UCITS ETF (QVFD), FlexShares Developed Markets High Dividend Climate ESG UCITS ETF (QDFD), FlexShares Emerging Markets Low Volatility Climate ESG UCITS ETF (QVFE), and FlexShares Emerging Markets High Dividend Climate ESG UCITS ETF (QDFE) are registered for marketing and sales in Ireland, United Kingdom, the Netherlands, Germany, Austria, Sweden, Finland and Denmark.
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