Building a Carbon Efficient Sustainable ETF

    by Willem Keogh, Head, Passive & ETF Investment Analytics, UBS AM
    & Davide Guberti, Passive & ETF Investment Analytics, UBS AM

    As climate change has risen to the top of investors’ agendas UBS has continued to evolve, enhancing its existing ETF offering, adjusting benchmarks, launching Paris aligned ETFs and most recently unveiling the ESG Universal Low Carbon Select ETF family. In our experience, a few bad names from traditionally polluting industries are responsible for the majority of portfolios’ carbon intensity.


    What drives the carbon footprint of a portfolio?

    Taking MSCI ACWI as a starting universe, we can analyze the Carbon Intensity of each company in order to understand what the key drivers of the portfolio’s carbon footprint are. In figure 1 we highlight the 10 companies with the highest carbon intensity (Scope 1 + Scope 2 t CO2e / USD m Sales) and we can see how these few names, despite having a relatively small weight (~50bps, keeping in mind that ACWI has ~2960 constituents), are contributing 5.42% to the MSCI ACWI Weighted Average Carbon Intensity (WACI), which is quite high. This confirms that a limited number of names are responsible for the vast majority of the carbon intensity in a portfolio, suggesting that we could substantially improve the carbon profile of a portfolio by performing targeted exclusions.

    By being able to identify and exclude the most carbon intense names, we could achieve certain climate-related objectives while maintaining the risk-return characteristics of the initial portfolio.

    What is the definition of a “highest emitter”?

    We have seen in the previous section how the carbon footprint of the portfolio is influenced by a relatively small number of companies. What is less intuitive is how to define the threshold for exclusion that balances the trade-off between carbon footprint reduction and portfolio representativeness.

    In order to illustrate this problem, in figure 2 we show the marginal contribution to Weighted average carbon intensity of each company in the MSCI ACWI. All the constituents of the portfolio are sorted in descending order based on their carbon intensity (Scope 1 + Scope 2 t CO2e / USD m Sales) and the red line shows the rolling WACI, obtained by recursively excluding the most carbon intense company remaining in the portfolio. The steepness of this curve indicates the marginal benefit of each exclusion, and it can help us understand the optimal cut-off point based on the number of exclusions.

    In the chart we highlighted two potential thresholds for the highest emitters: the worst 5% and worst 10%. Taking the latter as an example, a 10% threshold means that the 10% companies with the highest carbon intensity are classified as “highest emitters” which, out of the ~2964 of MSCI ACWI, amounts to 296 companies excluded. As shown in the chart, removing these 10% highest emitters reduces the portfolio constituents to 2966, but has a substantial impact on the carbon emission which is reduced by almost 70%.
    Similarly, by excluding the worst 5% emitters (~148 companies) the WACI decreases by ~50%. Both these examples confirm how a limited number of targeted exclusions can substantially improve the carbon emission profile of a portfolio.

    The challenges of a practical implementation

    As described in the previous section, it is apparent how a few companies drive most of the carbon intensity of a portfolio, making this concept of “highest emitters” intuitive and relatively easy to apply at first glance. Nevertheless, it is important to note how the companies flagged as highest emitters belong essentially to a couple of sectors: Utilities, Materials, Energy and Industrials. This is to be expected, as the business model of an Utility or Energy company tend to be, by nature, more carbon-intense compared to sectors like Financials or Communication Services. As shown in figure 3, the average Utility company is likely to have higher emissions than the highest emitting IT or Communication Services company. 

    Given these large sectoral differences in carbon intensity, a “blind” exclusion simply based on the company’s carbon emissions would cause certain sectors to be almost entirely excluded from the portfolio. 

    Looking at figure 4, we can see how an exclusion of the 10% highest emitters from MSCI ACWI would remove almost 70% of the “Utilities” sector and 40% of the “Materials” sector. In order to mitigate this problem, we have introduced a capping threshold which, within each GICS sector, limits the number of exclusions only up until a maximum of 30% of the weight of that sector in the portfolio. In case this limit is reached for any sector, no further securities are excluded from that sector. The capping on the maximum weight excluded helps, up to a certain extent, to keep a sector allocation that is the most in line with the initial portfolio as possible granted that the carbon emission improvement remains the first objective.

    Another positive outcome of the sector-constrained exclusion approach is that it allows us to keep the most carbon-efficient company within each sector, while removing the laggards of each sector. As shown in figure 4, thanks to the 30% capping, the fewer exclusions in the Utility, Materials and Industrials then spill over to other sectors like Energy and Financials, where the least carbon-efficient are removed as well.

    Additional exclusions and selection criteria

    The concept of “highest emitters” and their exclusion is a cornerstone of two families of ESG ETFs offered by UBS: the MSCI ESG Universal Low Carbon Select family, and the MSCI SRI Low Carbon Select family. The former aims to be a “core-replacement” that achieves certain ESG and carbon objectives while limiting the tracking error. The latter instead looks to select only the crème de la crème of companies from an ESG perspective, and is suitable for investors with more restrictive exclusion criteria as well as having ambitious ESG goals. For this reason, in the ESG Universal Low Carbon Select family the worst 5% emitters are excluded while in MSCI SRI Low Carbon Select, being a “darker green” approach, the threshold for exclusion is set at 10%.
    As shown in figure 5, the severity of the “high emitters” filter is not the only differentiating factor between these two ETF families. Other differentiating factors pertains to the exclusion criteria, with the “light green” (ESG Universal Low Carbon Select) excluding a selected set of business activities while the “dark green”(SRI Low Carbon Select) has a more comprehensive and stricter set of exclusion. 

    The last key difference between these two approaches relates to the ESG selection, with the “light green” approach that aims to reweight companies in order to increase the allocation to ESG Leaders and ESG Improvers, while decreasing the weight assigned to ESG Laggards and to companies with deteriorating ESG profiles. On the other hand, the “dark green” has a best-in-class ESG approach which selects only the top 25 % ESG rated companies per GICS sector.

    As shown at the bottom of the table, these different screening criteria drive sustainability characteristics (ESG Score and Carbon Footprint) as well as the tracking error.

    UBS ETF – different shades of green

    Our shelf offers our clients “different shades of green”: some funds use a light-green screening approach that excludes only a limited number of controversial business activities as well as ESG laggards (e.g. ESG Universal Low Carbon Select, S&P 500 ESG), while other products have a dark-green approach that selects only highly rated companies and excludes a broader list of controversial business activities (e.g. SRI Low Carbon Select, S&P 500 ESG Elite). Our sustainable shelf also covers Fixed Income, with several products on Corporate bonds developed with Bloomberg. Next to the large families of ETFs, through the years we have also developed more thematic exposures like Sustainable Bank Bonds or Gender Equality, as well as starting with Fixed Income sustainable ETFs already in 2015. These products are all classified as Article 8 funds under SFDR.

    Our family of Paris-aligned ETFs are classified as Article 9 funds under SFDR. The aim is to support investors in reducing their transition and physical climate risks, benefit from opportunities arising from the transition to a lower-carbon economy, while aligning with the EU Paris-Aligned Benchmarks minimum standards.

    If you would like to get in touch with UBS ETF, please contact:
    Florian Cisana
    Head of ETF & Index Funds Sales Strategic Markets EMEA
    UBS Asset Management.
    [email protected]


    For marketing and information purposes by UBS.
    Befor investing in a product please read the latest prospectus and key investor information document carefully and thoroughly. The information and opinions contained in this document have been compiled or arrived at based upon information obtained from sources believed to be reliable and in good faith, but is not guaranteed as being accurate, nor is it a complete statement or summary of the securities, markets or developments referred to in the document. Members of the UBS Group may have a position in and may make a purchase and / or sale of any of the securities or other financial instruments mentioned in this document. Units of UBS funds mentioned herein may not be eligible for sale in all jurisdictions or to certain categories of investors and may not be offered, sold or delivered in the United States. The information mentioned herein is not intended to be construed as a solicitation or an offer to buy or sell any securities or related financial instruments. Past performance is not a reliable indicator of future results. The performance shown does not take account of any commissions and costs charged when subscribing to and redeeming units. Commissions and costs have a negative impact on performance. If the currency of a financial product or financial service is different from your reference currency, the return can increase or decrease as a result of currency fluctuations. This information pays no regard to the specific or future investment objectives, financial or tax situation or particular needs of any specific recipient. The details and opinions contained in this document are provided by UBS without any guarantee or warranty and are for the recipient’s personal use and information purposes only. This document may not be reproduced, redistributed or republished for any purpose without the written permission of UBS Asset Management Switzerland AG or a local affiliated company. Source for all data and charts (if not indicated otherwise): UBS Asset Management
    This document contains statements that constitute “forward-looking statements”, including, but not limited to, statements relating to our future business development. While these forward-looking statements represent our judgments and future expectations concerning the development of our business, a number of risks, uncertainties and other important factors could cause actual developments and results to differ materially from our expectations.
    A summary of investor rights in English can be found online at:
    More explanations of financial terms can be found at
    © UBS 2021. The key symbol and UBS are among the registered and unregistered trademarks of UBS. All rights reserved.


    Latest Posts