Indexology^® Blog

2018 is set to be a major year for sustainable business. The new year is a time to take stock of where we are going—and we are grateful for the opportunity to dig deep into our data to answer the question: “Is the needle moving on sustainable business?”

Each year in the State of Green Business Report, we assess more than 30 indicators of corporate sustainability performance across the world’s top companies.

First, the good news.

• The carbon emissions of the world’s largest businesses continue to decrease in absolute terms, reaching the lowest level in the past five years as a result of a switch to cleaner fuels.
• There have been some global improvements in water use and waste management.
• The number of companies setting carbon and water reduction targets has increased by about 10% over the past five years.

However, the carbon reduction targets set by the 1,200 largest global companies and 500 largest U.S. companies fall short of the contribution needed to align with the 2°C target to limit global warming in the Paris Agreement.

Given that top global companies account for 10% of total emissions, Trucost calculates that the proportional reductions these companies need to make by 2050 and 2100 to align with the 2°C target are 3 and 5 metric gigatons of carbon dioxide equivalent, respectively. U.S. companies, which account for 4% of total emissions, would need to make proportional reductions of 1.2 GtCO2e by 2050 and 1.9 GtCO2e by 2100 in order to align with the 2°C goal (see Exhibit 1).

Yet the carbon targets set by top global and U.S. companies (0.7 and 0.2 GtCO2e, respectively) account for only 22% and 20% of their share of reduction needed by 2050, respectively. The targets currently in place are even smaller compared with the reduction needed by 2100, accounting for 13% and 12% by global and U.S. companies, respectively.

What’s Going to Change?

Carbon prices will need to reach USD 120 per metric ton by 2030 to achieve the Paris Agreement goal, according to modeling using the Trucost Corporate Carbon Pricing Tool. During this transition period, companies will need to understand how the intricacies of diverse carbon pricing policies could affect their operations, revenues, and supply chains—making use of forward-looking data and analytical tools capable of assessing carbon pricing risk under a variety of scenarios in different sectors and regions. The use of such tools by businesses is being encouraged by the Financial Stability Board’s Task Force on Climate-related Financial Disclosures.

Research by Trucost shows the potential impact of increasing carbon prices on companies. It found that 30% of profits in the automobile sector could be at risk by 2050, while the chemicals sector could have 60% of its profits at risk. The power sector could have its profits wiped out completely.

Many market participants we speak to agree that understanding carbon pricing risk is the key to unlocking more ambitious carbon reduction initiatives and greater investment. Scenario analysis can be used to make the case for setting ambitious carbon targets that are aligned with climate science. Investors want to understand how companies are using carbon pricing scenarios to mitigate risk and direct capital to innovations that will succeed in the transition to a low-carbon economy.

So yes, the needle is moving—and it’s time to get ahead of it.

Find out more in The State of Green Business 2018.

The first Exchange Traded Funds (ETFs) tracking municipal bonds were launched in September 2007. Since then the municipal ETF market has grown to 40 ETFs representing over $30.5billion in assets under management.

Municipal Bond ETF Market Snap Shot:

• 40 ETFs all but one represents tax-exempt municipal bonds. There is one ETF tracking taxable municipal bonds.
• $30.5billion in ETF assets (4.4% of total ETF and mutual fund assets)
• 8 ETFs have assets over $1billion
• 16 ETFs have assets between $100million and $1billion
• 16 ETFs have assets of less than $100million
• 29 ETFs are passively managed (representing over 99% of assets)
• 11 ETFs are actively managed (representing less than 1% of municipal ETF assets)

Chart 1: Municipal ETF and Mutual Fund Assets:

Chart 2: Number of Municipal ETFs and Accumulated Assets:

Chart 3: Active & Passive Municipal Bond ETFs:

For more information on the municipal bond market performance please go to our website www.spindices.coom

Please also join me on LinkedIn: www.linkedin.com/in/james-j-r-rieger-9324558

Most S&P and Dow Jones Shariah-compliant benchmarks outperformed their conventional counterparts for the year as information technology companies—which tend to be overweight in Islamic Indices—gained a whopping 39.4% beating the overall market by a wide margin, and financials—which are underrepresented in Islamic indices—experienced some weakness. This marked a reversal from 2016 where a surge in the financial sector late in the year caused Shariah-compliant benchmarks to lag. One notable exception to the 2017 trend was in the middle-east where conventional and Islamic benchmarks tracked closely together since technology stocks are not a meaningful portion of the regional market.

Despite Strong Absolute Returns, U.S. Equities Lag Global Markets for the First Time Since 2012

Global equity markets powered higher in the 4^th quarter capping a very strong 2017. The S&P Global BMI Shariah and Dow Jones Islamic Market World each gained about 25% for the year, beating their conventional counterparts by more than 300 basis points. Emerging markets continued to lead the way as the DJIM Emerging Markets Index closed the year up more than 40% supported by huge gains in large-cap Chinese technology companies such as Tencent and Alibaba. Developed Asia-Pacific markets also experienced notably strong performance in 2017 as the DJIM Asia-Pacific Index finished the year up nearly 36%. Despite closing near a record high and gaining about 20% on the year, the S&P 500^® lagged international markets for the first time since 2012.

MENA Equity Markets Continue to Lag

MENA equities continued to lag broader global equity markets as geopolitical concerns weighed on sentiment and the regional equity market has seen little benefit from the weak dollar and boom in technology stocks that has powered emerging markets more broadly. The S&P Pan Arab Composite Shariah edged slightly higher in the 4^th quarter, finishing the year virtually unchanged. Despite a double-digit rebound in December, the S&P Qatar BMI experienced the steepest losses on the year, falling almost 17%. Meanwhile, the S&P Egypt BMI rose 21% in 2017 as the country has experienced stability following the implementation of the IMF-supported economic reform program in November 2016. 

The ten year Treasury note closed with a yield over 2.5% this week, sparking talk that interest rates may have bottomed. The first chart shows the yield on the 10 year treasury going all the way back to 1953.  As seen there, the bottom in July 2016 at 1.5%. Last March the yield was 2.5%, it then fell to 2% in September before rebounding.

The bigger picture is revealed in the chart. We have either recently passed or appear to be approaching a major bottom in the bond markets.  With a few dips during recessions, Treasury note yields climbed steadily from 1954 until 1981, turned and began what was once called The Great Intergalactic Bond Rally. Starting in September 1981yields fell for the next 35 years.  While picking the precise bottom is challenging, it is increasingly likely that the long term decline in bond yields is drawing to a close.

Among the factors arguing that we are at a turn in bond yields are the economy’s current strength and momentum and the Fed’s decision to shrink its balance sheet and move away from quantitative easing as they raise the Fed funds rate.  Real US GDP growth in the second and third quarters of 2017 topped 3%. Real business fixed investment grew at 6% in the first three quarters of 2017. The unemployment is down to 4.1%. The economy is growing faster than its long term potential growth, putting upward pressure on interest rates.

The monetary policy that brought interest rates close to zero and supported the recovery from the financial crisis is over. The Fed’s attention is now directed at establishing a safety margin with the Fed funds rate well above zero so that it can cut rates when the next recession arrives.

A short term result of the Fed’s continuing increase in the Fed funds rate is a flatter yield curve as seen in the chart of the spread between the 10-year and two-year treasury notes.  Some analysts argue that a flattening yield curve may be pointing to future economic softness and might persuade the Fed to stop raising the funds rate. However, the current increase in the yield on the ten year treasury is giving the Fed more room for raising the Fed funds rate going forward.

Two by-products of the economy’s strength also support the idea that we may be close to a bottom in bond yields. Inflation expectations (see next chart) are no longer falling. Market participants and the Fed will be watching expectations and the unemployment rate for hints of when inflation could pass 2%.  Rising oil prices, now over $60 per barrel, are another sign that inflation could creep upward and encourage investors to seek higher interest rates.

Over the last decade, beta commodity exposure has offered investors inefficient access to the commodity market, mostly due to front-month roll methodologies and fixed commodity weights. The Dow Jones RAFI Commodity Index is a broad commodity index based on Research Affiliates’ commodity strategy that utilizes price momentum and roll yield to provide (1) dynamic commodity weighting exposure and (2) intelligent futures contract selection.

The Dow Jones Commodity Index, as one of the oldest and most recognizable broad commodity indices, provides diversified broad commodity exposure to 24 commodities. Research Affiliates utilizes the Dow Jones Commodity Index as the starting point to build the Dow Jones RAFI Commodity Index, which is intelligently built to offer equal weight exposure to the energy, metals and agricultural sectors in order to maximize diversification.

The Dow Jones RAFI Commodity Index utilizes a dynamic roll process that considers both roll yield and contract liquidity in selecting which commodity contract to own. In addition, the strategy reevaluates contract selection on a monthly basis to ensure the optimal contract is owned.

Understanding How Roll Yield and Momentum Affect the Dow Jones RAFI Commodity Index

The Dow Jones RAFI Commodity Index utilizes two key factors in constructing its commodity strategy: High Roll Yield and High Momentum.

Roll Yield takes into consideration the shape of a commodity’s futures curve. The shape of the curve can serve as an important indicator of a commodity’s inventory levels. Low inventories can potentially create positive roll yield scenarios, where an investor can theoretically purchase a contract further out on the curve at a lower price than what they could purchase at a nearer-term contract. The strategy is designed to  increase its exposure to commodities with a positive roll yield. Conversely, high inventories can potentially create negative roll yield, where an investor purchases a contract further out on the curve at a higher price than what they could purchase at a nearer-term contract. The strategy is designed to decrease its exposure to commodities with a negative roll yield.

Momentum takes into consideration the price movement of commodities. Imbalances in supply or demand can create positive or negative price momentum which may persist over time. A decrease in supply created by a crop drought, for example, can drive prices higher. Conversely, a new discovery of oil can drive prices lower. The strategy is designed to increase its exposure to commodities with high price momentum.

Why Fundamental Commodities?

• Strong hedge against Inflation
• Broad, dynamic commodity exposure
• Low cost, transparent institutional solution
• Protection against negative roll yields

A Top Performing Broad Commodity Strategy

In 2017, The Dow Jones RAFI Commodity Index finished as the top performing* popular broad based commodity index. In addition, the Index provided superior return/risk statistics relative to both the Bloomberg Commodity Index and the S&P GSCI Index. While past performance is no guarantee of future results, the strategy of the Dow Jones RAFI Commodity Index has thus far proven to be one of the most intelligent strategic beta strategies in the broad commodity space.

*Source: Bloomberg L.P. as of 12/29/2017. All data based on total return figures.