Fiduciary duty and decarbonizing market beta

Current cap-weighted benchmarks represent a 3.3°C warming climate scenario, not aligned with the Paris Agreement. New benchmarks are needed to guide the capital flow in response to a transition to the low-carbon economy. Focusing on mandates and materiality, the Bloomberg Paris-Aligned Indices additionally offer market-like performance, investment capacity, market representation and modest turnover – all traditional elements of fiduciary responsibility.

Fiduciary duty and decarbonizing market beta

Many believe fiduciary duty in the 21^st century has been expanded to include exposures to climate risk. At the same time, many investors continue to expect efficient access to market beta as economies decarbonize. We have already discussed how the decarbonization trajectory, corporate targeting and DNSH features are designed to manage carbon transition risk. We now turn to discussing how the Bloomberg Paris-Aligned Indices continue to offer market-like performance, investment capacity, market representation and modest turnover – all traditional elements of fiduciary responsibility.

Desirable characteristics of a benchmark
While the decarbonization objectives are ambitious, our objective is also for the index to remain a broad-market benchmark like market-cap weighted benchmarks are today. The current market-cap indices exhibit many desirable characteristics: broad market representation, high investment capacity and low turnover. The turnover of market-cap indices is attributable only to additions and deletions, leading to the lowest turnover among all equity indices.

Leverage portfolio construction to get there
To inherit these desirable investment characteristics, Bloomberg's equity and fixed income optimization formulation minimizes a mathematical proxy of turnover and tracking error. The idea is to allow cap-weighted benchmarks to make appropriate adjustments, simultaneously considering investment objectives (e.g., investment capacity, turnover and market representation) and climate considerations such as temperature alignment.

To this end, we provide evidence that our portfolio construction technique produces portfolios with low tracking error to today’s market-cap indices, at least initially, and exhibit low to modest turnover, giving confidence that fiduciary objectives remain well-met.