US Treasuries under spotlight in new sovereign fixed income climate index

FTSE ups weighting of UK Gilts after assessment of physical and transition risk, and climate resilience

FTSE Russell has created the first climate-screened sovereign bond index, which sees the US’s position slashed while UK Gilts receive the greatest boost.
The firm has taken its mainstream World Government Bond Index, which has 22 investment-grade constituents, and re-weighted it based on their exposure to physical and transition risk, and climate resilience.

“The US is underweighted largely because of the transition risk component of the model… whereas The Netherlands and Belgium are underweighted largely due to physical risk” – FTSE Russell’s Samad

“Increasingly, we’ve been hearing from investors that they are moving into the ESG and climate finance space… but that there doesn’t seem to be much by way of tools or analysis in the sovereign bond space,” FTSE Russell CEO Waqas Samad told RI. “The scale of the challenge that’s facing countries from a climate risk point of view… will play through into their financing activities, which will be reflected in their government debt profile. And therefore, government bond investors need a way to incorporate those risks into their investment process.”
It’s estimated that up to $1trn of assets under management track the WGBI.
In the climate version, US treasuries are underweighted by 3.22% in absolute terms, although the issuer still dwarfs the other 21 constituents.On a relative basis, the Netherlands sees the biggest slash, at 80%, with Singapore and Malaysia also hit heavily (reductions of 70% and 73% respectively). Belgium, Canada, Ireland, South Africa, Poland, Mexico and Australia are also underweighted.
“What’s interesting is that the US is underweighted largely because of the transition risk component of the model,” pointed out Samad. “Whereas the Netherlands and Belgium are underweighted largely due to physical risk.”
The countries that get a relative increase are all European: Denmark, Finland, France, Germany, Italy, the UK, Sweden, Spain, Norway and Austria. UK gilts get the highest absolute boost in the new index, at 2.49% against the benchmark.
FTSE says the index can be a “portfolio performance measurement tool as well as the basis for investment portfolios”. Samad stressed that the adjustments are entirely risk-based and “not about how investors can influence policy”. However, he added, “to the extent that investors adjust their holdings in government bonds as a means of expressing their sentiment about how governments are dealing with climate policy, there may be a secondary effect”.
The index is underpinned by research from FTSE Russell’s recent acquisition, Beyond Ratings, which specialises in climate risk for government bonds. Samad said that the new product was just a “first step” and that FTSE Russell was planning to develop other tools in the space.
There are currently no investors licensed to the index.