In a recent paper researchers from Singapore’s GIC, FTSE Russell and asset management group GMO explain why investors should integrate green revenues into their portfolio construction, arguing that the sustainability metric Weighted Average Green Revenue (WAGR) is a useful tool for investors looking to assess and integrate green opportunities.
Investors know that transitioning to a net-zero economy requires solutions that enable the economy to decarbonise like renewable energy, electric vehicles, and recycling technologies. The green economy is growing faster than broader equity markets, with a compound annual growth rate of around 13 per cent over the last decade while companies providing climate and environmental solutions have been outperforming the market since the early 2000s. Yet how best to measure portfolio exposure to climate-related investment opportunities remains an enduring challenge.
Focusing on specific themes such as renewable energy infrastructure is narrow and risks overlooking other critical segments of the green economy, such as long-range transportation, technology and resources. Comparability is further limited by varying definitions and methodologies for what constitutes a ‘green asset’.
“It needs an overarching metric applied consistently across asset classes, to compare the performance among asset classes and aggregate the results up to the portfolio level,” write the authors.
Additionally, the way asset owners disclose green investment exposure is often binary—a company or investment is tagged as green or not. This approach focuses on pure plays and does not consider the nuanced nature of a company’s business model, whereby some business lines are green, and others less so. It also fails to capture companies’ transition progress.
The right tools
The best and most comprehensive metrics to measure portfolio exposure to green solutions comprise green revenue, green capex, green patents and avoided emissions, states the report. Of all these, green revenue is easier to interpret; directly links to companies’ cash flows and real-world impact, and the data is more readily available and comparable.
WAGR calculates the green revenue percentage (GR per cent) of a portfolio by applying company GR per cent to the portfolio weight of each company. Investors can set portfolio-level targets of climate solutions using WAGR, such as a minimum level, an improvement relative to the benchmark, or to track specific WAGR pathways such as decarbonisation trajectories.
The calculation of WAGR is straightforward and easy to implement. It is also highly comparable across equity portfolios and indices given most of them use market capitalisation to determine stock weight. This makes it easier to compare portfolio performance against benchmarks. In addition, it echoes the method recommended by the Technical Expert Group (TEG) on Sustainable Finance for measuring alignment of equity investment with the EU Taxonomy.
The modular nature of the underlying green revenues data allows investors to measure portfolio exposures to individual climate solutions. WAGR can be broken down into different technologies across sectors, subsectors and micro sectors providing flexibility for investors seeking investment opportunities in specific sectors, states the paper.
Moreover, by using the Weighted Average Green Revenue (WAGR) to measure and analyse portfolio exposure to climate solutions investors can build on the portfolio weighting methodology used in carbon metrics such as Weighted Average Carbon Intensity (WACI), already widely adopted.
Green revenue companies by market capitalisation are diverse across industries, although they tend to be clustered in certain large sectors, such as technology and industrial goods and services. Several industries have higher WAGR particularly the automotive sector (36 per cent) and utilities (29 per cent), driven by demand for electric vehicles and renewable energy generation.
Growth in the auto industry’s green revenue weighted market cap is a more recent trend, having increased by over 350 per cent between 2019 and 2020. While climate solutions are often thought of as solely focused on renewable energy and electric vehicles, in reality, they represent a diverse set of activities spanning multiple points up and down value chains. For instance, energy management and efficiency have constituted at least a third of the green economy since 2016, driven by building and industry energy efficiency measures.
A portfolio can use WAGR to target an increase in its exposure to climate solutions and the broader green economy.
Using WAGR, the researchers analyse portfolio exposure to climate solutions, including size, growth, industries, green sectors, regions, and the level of ‘greenness.’
Potential investor applications of WAGR include climate reporting against frameworks such as the Task Force on Climate-related Financial Disclosures (TCFD), target setting, thematic investing and corporate engagement. However, investors should acknowledge the constraints and trade-offs when building portfolios with a significantly greater WAGR, such as sector and country concentration, volatility and the size of the universe.
The transition to a green economy is still in its early stages, resulting in relatively low WAGR for market capitalisation based indices. In 2022, the WAGR of the FTSE All-World Index was less than 8%. To achieve portfolios that resemble an index but have a significantly greater WAGR, large positioning deviations are necessary.
“We also find these portfolios have concentrated exposures to certain countries and industries. For example, a portfolio with 50% WAGR has a 14% overweight on China and an 18% underweight on the United States,” write the authors.
The researchers note other challenges like a lack of disclosures based on green revenues. In addition, climate-related disclosures in private markets, including green revenue data, continue to be in short supply, limiting access to comparable data across different asset classes for investors.
However, by raising greater awareness of the value of WAGR to assess and integrate green opportunities into portfolio construction the authors hope to encourage greater disclosures. In conjunction with other sustainability metrics, WAGR can be a useful tool to calibrate and measure exposure to climate solutions in a portfolio management context, they conclude.