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How to Invest in Change: A Guide to Thematic Investing

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The following content is sponsored by MSCI.


MSCI Thematic Investing

Investing in Change: Thematic Investing 101

The world is undergoing structural economic changes at a rapid pace.

Technological breakthroughs and scientific discoveries that used to take decades are happening in years, and shifting demographics and climate change are causing upheaval around the globe. With the onset of Industry 4.0 and constantly shifting capabilities and consumer priorities, the global investment landscape is transforming as well.

How do you prepare for this transformation? This graphic from MSCI highlights thematic investing, its characteristics and benefits, and how themes are constructed and utilized.

Thematic Investing: Characteristics and Benefits

The key to thematic investing is a thorough understanding of megatrends.

Megatrends are long-term structural trends that can have a transformative effect on global economies, in areas of high disruption and innovation and with significant growth potential. These can include transformative technologies like driverless vehicles and 5G-enabled robotics, or societal changes like an aging society.

As megatrends solidify, they also become increasingly important drivers of earnings and equity returns. Investors traditionally have partial exposure to these themes as part of a portfolio’s growth allocation, but thematic investing allows for specific themes to be targeted in a more focused way.

Characteristics of Thematic Investing

  • Secular Trends: Focuses on long term political, economic, technological, and social trends.
  • A Changing World: Captures trends that reflect how the world is changing.
  • Sector Independent: Cuts across countries and traditional sectors.
  • Security Selection: Identifies companies with exposure to different target themes.

All together, these characteristics allow thematic investing to complement traditional portfolio design by enabling investors to take active control of themes impacting their portfolios.

Benefits of Thematic Investing

  • Gives investors exposure to long-term structural trends.
  • Positions portfolios relative to long-term risks and stranded business models.
  • Provides exposure to several themes that can be quantified, analyzed, and managed.

Thematic Investing In Action

Over the past decade, thematic investing has gained traction across financial circles.

In 2015, the global thematic fund market was estimated at $155 billion assets under management (AUM). By 2020, the market had grown to $426 billion AUM, with thematic ETFs growing at an impressive 20% CAGR over the five-year time span.

As the leading provider of global investment indexes, MSCI constructs thematic indexes that directly capture megatrends using a comprehensive rules-based methodology. They include indexes focused on the digital economy, efficient energy, genomic innovation, and the food revolution.

Here’s how MSCI creates a thematic index:

  1. Build a clear expression of the theme to capture the key trends.
  2. Identify aligned business activities incorporating expert insights.
  3. Map products, services, and concepts linked to the theme in a consistent, rules-based approach using Natural Language Processing (NLP).
  4. Establish economic linkage between companies and theme, measured by relevance scores.
  5. Select and re-weight stocks using relevance scores.

Breaking Down a Theme

Through a broad understanding of megatrends and their sub-themes, the use of NLP allows MSCI to comb through company descriptions and business line items to ensure (and measure) total thematic coverage.

For example, the Future Mobility theme is broken down into sub-themes of batteries, smart mobility, sharing economy, high speed transport, and vehicle automation.

From there, each sub-theme is further broken into key concepts that highlight key players in the market, such as batteries being broken down into battery packing, charging infrastructure, recycling, and technologies.

There’s a flux of emerging technological, macroeconomic, and geopolitical megatrends that have already started to unfold. Thematic investing is all about defining tomorrow’s investable trends and impacting your portfolio today.

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An Introduction to MSCI ESG Indexes

With an extensive suite of ESG indexes on offer, MSCI aims to support investors as they build a more personalized and resilient portfolio.

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An Introduction to MSCI ESG Indexes

There are various portfolio objectives within the realm of sustainable investing.

For example, some investors may want to build a portfolio that reflects their personal values. Others may see environmental, social, and governance (ESG) criteria as a tool for improving long-term returns, or as a way to create positive impact. A combination of all three of these motivations is also possible.

To support investors as they embark on their sustainable journey, our sponsor, MSCI, offers over 1,500 purpose-built ESG indexes. In this infographic, we’ll take a holistic view at what these indexes are designed to achieve.

An Extensive Suite of ESG & Climate Indexes

Below, we’ll summarize the four overarching objectives that MSCI’s ESG & climate indexes are designed to support.

Objective 1: Integrate a broad set of ESG issues

Investors with this objective believe that incorporating ESG criteria can improve their long-term risk-adjusted returns.

The MSCI ESG Leaders indexes are designed to support these investors by targeting companies that have the highest ESG-rated performance from each sector of the parent index.

For those who do not wish to deviate from the parent index, the MSCI ESG Universal indexes may be better suited. This family of indexes will adjust weights according to ESG performance to maintain the broadest possible universe.

Objective 2: Generate social or environmental benefits

A common challenge that impact investors face is measuring their non-financial results.

Consider an asset owner who wishes to support gender diversity through their portfolios. In order to gauge their success, they would need to regularly filter the entire investment universe for updates regarding corporate diversity and related initiatives.

In this scenario, linking their portfolios to an MSCI Women’s Leadership Index would negate much of this groundwork. Relative to a parent index, these indexes aim to include companies which lead their respective countries in terms of female representation.

Objective 3: Exclude controversial activities

Many institutional investors have mandates that require them to avoid certain sectors or industries. For example, approximately $14.6 trillion in institutional capital is in the process of divesting from fossil fuels.

To support these efforts, MSCI offers indexes that either:

  • Exclude individual sectors such as fossil fuels, tobacco, or weapons;
  • Exclude companies from a combination of these sectors; or
  • Exclude companies that are not compatible with certain religious values.

Objective 4: Identify climate risks and opportunities

Climate change poses a number of wide-reaching risks and opportunities for investors, making it difficult to tailor a portfolio accordingly.

With MSCI’s climate indexes, asset owners gain the tools they need to build a more resilient portfolio. The MSCI Climate Change indexes, for example, reduce exposure to stranded assets, increase exposure to solution providers, and target a minimum 30% reduction in emissions.

An Index for Every Objective

Regardless of your motivation for pursuing sustainable investment, the need for an appropriate benchmark is something that everyone shares.

With an extensive suite of ESG indexes designed specifically for sustainability and climate change, MSCI aims to support asset owners as they build a more unique and personalized portfolio.

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Tracked: The U.S. Utilities ESG Report Card

This graphic acts as an ESG report card that tracks the ESG metrics reported by different utilities in the U.S.—what gets left out?

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NPUC Utilities ESG Report Card Share

Tracked: The U.S. Utilities ESG Report Card

As emissions reductions and sustainable practices become more important for electrical utilities, environmental, social, and governance (ESG) reporting is coming under increased scrutiny.

Once seen as optional by most companies, ESG reports and sustainability plans have become commonplace in the power industry. In addition to reporting what’s needed by regulatory state laws, many utilities utilize reporting frameworks like the Edison Electric Institute’s (EEI) ESG Initiative or the Global Reporting Initiative (GRI) Standards.

But inconsistent regulations, mixed definitions, and perceived importance levels have led some utilities to report significantly more environmental metrics than others.

How do U.S. utilities’ ESG reports stack up? This infographic from the National Public Utilities Council tracks the ESG metrics reported by 50 different U.S. based investor-owned utilities (IOUs).

What’s Consistent Across ESG Reports

To complete the assessment of U.S. utilities, ESG reports, sustainability plans, and company websites were examined. A metric was considered tracked if it had concrete numbers provided, so vague wording or non-detailed projections weren’t included.

Of the 50 IOU parent companies analyzed, 46 have headquarters in the U.S. while four are foreign-owned, but all are regulated by the states in which they operate.

For a few of the most agreed-upon and regulated measures, U.S. utilities tracked them almost across the board. These included direct scope 1 emissions from generated electricity, the utility’s current fuel mix, and water and waste treatment.

Another commonly reported metric was scope 2 emissions, which include electricity emissions purchased by the utility companies for company consumption. However, a majority of the reporting utilities labeled all purchased electricity emissions as scope 2, even though purchased electricity for downstream consumers are traditionally considered scope 3 or value-chain emissions:

  • Scope 1: Direct (owned) emissions.
  • Scope 2: Indirect electricity emissions from internal electricity consumption. Includes purchased power for internal company usage (heat, electrical).
  • Scope 3: Indirect value-chain emissions, including purchased goods/services (including electricity for non-internal use), business travel, and waste.

ESG Inconsistencies, Confusion, and Unimportance

Even putting aside mixed definitions and labeling, there were many inconsistencies and question marks arising from utility ESG reports.

For example, some utilities reported scope 3 emissions as business travel only, without including other value chain emissions. Others included future energy mixes that weren’t separated by fuel and instead grouped into “renewable” and “non-renewable.”

The biggest discrepancies, however, were between what each utility is required to report, as well as what they choose to. That means that metrics like internal energy consumption didn’t need to be reported by the vast majority.

Likewise, some companies didn’t need to report waste generation or emissions because of “minimal hazardous waste generation” that fell under a certain threshold. Other metrics like internal vehicle electrification were only checked if the company decided to make a detailed commitment and unveil its plans.

As pressure for the electricity sector to decarbonize continues to increase at the federal level, however, many of these inconsistencies are roadblocks to clear and direct measurements and reduction strategies.

National Public Utilities Council is the go-to resource for all things decarbonization in the utilities industry. Learn more.

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