How We Build Our Sustainable, Climate-Focused Portfolios

What’s included and excluded? How is the Climate Index constructed? How will it all get updated in the future?

Intro:

How do you define climate-focused investing? Why should one company be included over another? Especially given that most of the world still runs on fossil fuels. 

Ethical investing can get complicated quickly. In building our climate-focused portfolios at Carbon Collective, we wanted a strategy that: 

  • Was simple enough that anyone could double check every decision
  • Could be easily updated during our annual rebalancing
  • Would drive as much climate impact as possible. 

Read on to dig into the details of how we do it.


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How we Build our “Core” Portfolios

We built our Core Portfolios to be a replacement for a standard index-tracking portfolio. With exposure to over 1,500 stocks, our Core Portfolios offer a similar diversity and risk/reward profile as their equivalent benchmarks on the New York Stock Exchange but in a package that is built to drive climate impact. Here’s how we do it: 

Step 1: Remove the high-carbon sectors. Collectively, the utilities, energy, materials, and industrial sectors are responsible for >85% of the carbon emissions (Scope 1 and 2) of all publicly traded companies. These sectors represent ~20% of the total value of the stock market. As most of the companies in these sectors are dependent upon fossil fuels, we remove this 20% of the stock market, entirely. 

Step 2: Give their share to the Climate Index. The Climate Index is our collection of publicly traded companies who are building Drawdown solutions to climate change. Our core portfolios allocate the ~20% that was freed up by removing the companies making climate change worse to those who are building solutions. 

Step 3: Hold the remaining, low-carbon sectors (with a few tweaks). The remaining sectors (technology, communications, healthcare, consumer staples, consumer discretionary, financials, and real estate) are already comparatively low-carbon and largely do not depend on fossil fuels for their core business. While these companies are not necessarily building climate solutions, they can most easily switch to zero-emission alternatives. We invest in them to take a seat at the table and push these companies to transition, faster. 

Step 4: Balance with green and government bonds. To hit your desired risk/reward tolerance, we balance the stock portion of our Core Portfolios with a combination of green and government bonds. 

Learn more about how we build our Core Portfolios

How we Build our “All Green” Portfolios

If you want your entire investment account to be invested in solving climate, you may want to look at our All Green portfolios. Invested in only the Climate Index and green bonds, they are far less diversified than our Core Portfolios and have a higher/risk return profile. 

The portfolio construction is simple. Whereas in our Core Portfolios, the stock allocation is split between the Climate Index and the companies in low-carbon sectors, the All Green Portfolios only have the Climate Index. And instead of a combination of green and government bonds, they only have green bonds. 

See the historical performance of our All Green Portfolios

How we Build and Update the Climate Index

The Climate Index is our full list of every publicly traded company building solutions to climate change on the New York Stock Exchange.  

To build it, we begin with an inclusionary ethical filter, finding every publicly traded company that is building a climate change solution listed in project Drawdown. Next, we apply an exclusionary filter, removing the companies that make more revenue from sales to the fossil fuel industry than from their climate solution. This process works for all but two sectors: utilities and waste management companies. For these we use more specific inclusionary criteria.  

Finally, we use a financial filter. The company must be trading on the New York Stock Exchange (no OTC or pink slips) for at least $0.50/share at the time of our annual update. The remaining companies get weighted based upon their current market caps (with a ceiling at 5% of the total index and a floor of 0.01%). 

We go through this process annually, adding new companies that come onto the market and removing any who no longer meet our ethical criteria for inclusion. 

See the full details of how we build and update the Climate Index. 

How we Calculate Carbon Emissions Data

Fossilfreefunds.org is a great, free tool that allows you to see the carbon footprint breakdown of the top mutual funds and ETFs from across the globe. (We only use free, open-source tools because we believe you should be able to replicate our analysis without needing to go over any paywalls). 

To build our Core portfolios we used their tool to analyze the carbon footprint of each sector of the stock market under the ownership principle. Under the ownership principle, if you own 1% of a company’s stock, you own (and are responsible for) 1% of its emissions. 

Fossilfreefunds.org provides the carbon footprint per $1m invested. We combine their data on sector ETFs with the total valuation of each sector of the stock market to get an approximation of the total Scope 1 and 2 carbon footprint of each stock market sector. This method also gives us some indication of Scope 3. By looking at the stock market as a whole, we can see the B2B supply chain. 

Using the same methodology, we compare the carbon footprint of Carbon Collective’s core portfolios with a series of other popular index-based portfolios. 

See the results of the comparison and learn more about how we calculate emissions data. 

Learn More

  • Want to learn more about green investing? Check out Sustainable Investing 101
  • Looking for some inspiration? See the awesome companies of the Climate Index
  • Or see how our climate-focused portfolio performed in our backtesting
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