Members of the ETF industry weighed in on the changes suggested to S&P Dow Jones Indices’ (SPDJI) clean energy index and what impact these will have on BlackRock’s popular thematic ETFs.
Having exploded in popularity and grown tenfold in the 12 months through February this year, the iShares Global Clean Energy UCITS ETF (INRG) and iShares Global Clean Energy ETF (ICLN) underwent a complete course change during H1, as SPDJI hurried to resolve immediate concerns around illiquidity and over-concentration.
Not intended to be a permanent fix, the follow-up to these changes came at the end of August, when the index provider held an additional consultation to set out changes to its global clean energy benchmark, including an expansion of its investment universe, weighting scheme changes and the incorporation of new screens and inclusion metrics.
One notable change was the inclusion of companies listed in emerging markets, with the goal of more fully capturing the ‘global’ nature of the transition to clean energy.
Seeing this as a positive shift, Athanasios Psarofagis, ETF analyst at Bloomberg Intelligence, said: “I think the expansions to emerging markets is important as most of the large clean energy ETFs tend to be more developed markets focused, so expansion will make it more comprehensive.”
In agreement, Kenneth Lamont, senior fund analyst, passive fund research at Morningstar, noted: “The inclusion of EM makes it a very different investment proposition over the long run – but considering the global shift to alternative energy – it would be rather shortsighted to leave EM out.”
The next adjustment was SPDJI’s decision to amend its definition of clean energy to incorporate what it coined as clean energy ‘non-production’ companies. These include those working in the clean energy value chain outside of clean energy utilities, including battery production, alternative fuels, solar PV manufacturing and more.
On this, Lamont cautioned: “The decision to include clean energy subsectors is fine, although it leaves space in the market for more focused exposures.”
Another change was the inclusion of new metrics to help offer more tangible definitions for SPDJI’s definitions of clean energy exposures.
Candidates must now derive at least 25% of their aggregate revenue from clean energy production or non-production-related businesses; general utilities stocks must generate at least 20% of their power from renewable sources; or be classified as a ‘renewable utilities’ company by the GICS sub-industry renewable electricity.
John Leiper, CIO of Tavistock Wealth, thought the addition of these metrics creates a sense of permanence that was missing after SPDJI’s previous consultation.
“This time around the proposed changes seem more wholesome in nature and clearly focused on the index’s environmental, social and governance (ESG) credentials,” Leiper said. “The proposed changes seek to incorporate additional data, improve classification and increase transparency around the underlying methodology used in the exposure score calculation process.”
Detlef Glow, head of Lipper EMEA Research at Refinitiv, added: “I think it is very useful. To measure the criteria with a percentage of revenue, or percentage of turnover, whichever you choose it is a good thing to do and helps with transparency.”
SPDJI also said it will use FactSet’s Revere Business Industry Classification System (RBICS) data to achieve more precise classification of global companies and their business units.
Psarofagis said: “The switch to FactSet is also interesting and I think we will see more of this as GICS is pretty outdated and cannot really properly classify some of the more niche areas, so this is an opportunity for other (more granular) classification methods.”
Finally, investors in INRG and ICLN can expect new screens to be added to their ETFs’ underlying investment universe, including reviews of companies' reputational risks.
The indexer also highlighted changes to its carbon intensity screen, with the footprint of new constituents now being compared to the mean average footprint of only pure-play stocks from the preliminary universe.
“We particularly welcome the proposed changes to the carbon intensity screening process which seeks to further reduce the index’s overall carbon footprint,” Leiper said.
What remains contentious is the fact that the clean energy ETFs will retain holdings of up to 4% apiece in companies with only limited exposure to clean energy.
Additionally, its ESG screen is far from stringent. Companies are allowed to be up to 25% involved in generating electricity from thermal coal, up to 10% involved in providing products and services that support military weaponry and have up to 25% significant ownership of controversial weapons and still be eligible for inclusion.
“Light ESG exclusions are becoming the norm so this makes sense,” Lamont observed. “Although including an energy producer which generates almost a quarter of its electricity from thermal coal might not suit everyone tracking the index.”
Even less phased, Glow continued: “On the inclusion of thermal coal and other fossil fuels, I am not so negative about this.
“I am also not so negative about fossil fuels like oil companies getting a good ESG score. On one hand side, yes, oil can be used in bad ways. But on the other, oil is in so many products, and will remain important for the foreseeable.
“So with regards to whether it is good that ESG related and impact investors are buying into these companies, they can start to influence the management boards there and I hope that S&P Dow Jones also try to influence the boards of those companies to operate more sustainably.”
Despite the seemingly positive takeaway, most participants thought the latest reshuffle was the result of earlier complacency and a rushed first attempt by SPDJI to resolve issues that progressed over a matter of months.
Lamont concluded: “The move does suggest the first consultation and change was rushed. Perhaps there are lessons to be learned here.”
Richard Philbin, CIO at Wellian Investment Solutions, was more pensive about the changes, saying they demonstrate how SPDJI are learning on the job and ultimately mean investors in BlackRock’s clean energy strategies are now invested in ETFs that are markedly different from the products that began the year.
Philibin said: “I do wonder what original investors in the funds make of it. To say the pre and post situation are the same is not correct - there are now different risks.
“I am not saying this makes the risk higher or lower, but there are different considerations needed today compared to yesterday for instance.”
“As more stocks come to the market and the indices mature, I expect to see less consultation and less changes, but considering the flow, market cap, rules relating to size and increasing the universe size it does show that the index provider is aware of some of the risks (partly brought on by itself mind you) and is addressing some of the pinch points.”
Going forward, INRG and ICLN will look exponentially more diversified than they were for the first 14 years of their lifespans, with – hopefully – fewer dramatic moments in terms of performance and methodological shifts.
