Indexology^® Blog

On Aug. 16, 2022, President Joe Biden signed the Inflation Reduction Act into law, which includes the largest ever climate-related investment by the U.S. federal government. Devoting USD 370 billion to climate and energy programs, the act commits the U.S. to a roughly 40% emissions reduction by 2030.

This landmark bill is the latest example of the global commitment to explore and embrace renewables. Launched in 2007, some might say the S&P Global Clean Energy Index was ahead of its time, but in recent years, many have come to consider this index to be the leading benchmark for this movement as it gains momentum worldwide.

In this blog, we will reexamine the S&P Global Clean Energy Index and explore its recent performance following the signing of this bill. Furthermore, we will look at how renewables, as a percentage of global energy production, are estimated to grow through 2050 as reported by the U.S. Energy Information Administration (EIA).

S&P Global Clean Energy Index Has Rallied

The S&P Global Clean Energy Index seeks to track global companies that generate power from renewable sources or are involved in clean-energy-related businesses. The index includes not only companies that produce clean energy but also those involved in related technologies. Therefore, it attempts to measure a broad cross section of companies in the global renewable energy ecosystem. Furthermore, by weighting companies proportional to the product of their float market cap and exposure score, the index overweights those most focused on clean energy.

The index began to rally in late July coinciding with Senator Joe Manchin’s announcement of his support for the Inflation Reduction Act on July 27, 2022 and experienced further increases when the bill passed in the Senate on Aug. 7, 2022.

Exhibit 1 shows that since July 27, 2022, the S&P Global Clean Energy Index was up 14.92%, outperforming the S&P Global BMI by 9.4%.

Continuation of the Global Trend to a Cleaner Future

While the U.S. is the latest country to make great strides toward affecting change, many parts of the world are embracing renewables and developing clean technologies. A significant impetus behind the shift from fossil fuels to renewables is an international desire to lower the global carbon footprint as established in the landmark Paris Agreement. Exhibit 2 demonstrates that progress is already being made—the renewable energy industry has grown from approximately 10.8% of all energy produced globally in 2010 to 14.8% as of 2020.

Looking ahead, Exhibit 3 shows that the U.S. EIA estimates that the renewable energy industry will grow to account for approximately 26.5% of all energy consumed globally by 2050.

Given that the initiative to move toward renewables is a global one, it is fitting that the S&P Global Clean Energy Index provides exposure to both developed and emerging markets. While the U.S. has the largest weight, as Exhibit 4 shows, over 50% of the index weight is attributed to other countries.

If we focus on the U.S. again, it is compelling to examine the role that renewables are already playing in electricity generation, accounting for 21% in 2021 as reported by the EIA. The EIA is further forecasting that renewables will overtake all other energy sources, contributing 44% of new capacity by 2050.

Examining the types of renewables used in U.S. electricity generation in Exhibit 6, we see a mix of solar, wind, geothermal and hydroelectric sources. The S&P Global Clean Energy Index approach aims to track companies involved in those sources.

As these projections show, renewables are expected to play an increasingly significant role in energy production over the next few decades and beyond. It is certainly an exciting time to follow this sector, and the S&P Global Clean Energy Index is a prominent benchmark for those who want to keep a pulse on where renewables go from here.

For additional details, please refer to S&P Global Clean Energy Index methodology.

When it comes to climate change, one of the most effective mitigation options is to decarbonize the economy.¹ Not only does the world need to rethink energy systems, transport technologies and materials production processes, but also the role of capital in financing the low-carbon transition. Low-carbon indices offer market participants an efficient way of managing and mitigating carbon-related financial risks within investments. Launched in August 2021, the S&P Carbon Control Indices seek to systematically reduce index-level carbon intensity² relative to its underlying benchmark while maintaining similar industry group and country composition. Here, we explore how.

How Are the S&P Carbon Control Indices Constructed?

Exhibit 1 highlights how the S&P Carbon Control Indices are constructed. First, within each underlying universe, the carbon control index excludes based on a variety of factors, including:

• Companies with poor S&P DJI ESG Score³ relative to their GICS industry group peers;
• Companies involved in detrimental business activities; and
• UNGC violators and companies involved in controversies.

Then, the index reweights stocks to minimize index-level-weighted average carbon intensity compared to that of its market-cap-weighted benchmark.⁴

Understanding Sources of Emissions

Unsurprisingly, when looking at sectors more closely, we find that Utilities, Materials and Energy have been the largest carbon emitters of direct and first-tier upstream emissions per unit of revenue,⁵ accounting for more than 80% of total emissions. It’s also interesting to note how Utilities and Materials companies within emerging markets are more carbon intense than their counterparts in the developed market region (see Exhibit 2). It follows that the S&P Carbon Control Indices underweighted those sectors while overweighting Financials, Information Technology and Communication Services, whose products and services have been generally low-carbon intense (see Exhibit 3).

Systematically Reducing Carbon Intensity

As seen in Exhibit 5, the S&P Carbon Control Indices minimized index-level weighted average carbon intensity by 70% and 80%, for the developed and emerging market regions, respectively. Further, they also reduced fossil fuel reserves emissions by 100%, mostly due to the fossil fuel exclusions. As these indices also incorporate the S&P DJI ESG Score into the selection stage of index constituents, it also provides an overall improvement of the index-level S&P DJI ESG Score and its sub-dimensional scores. This is a beneficial outcome: S&P DJI ESG Scores cover far more areas than carbon emissions, thus only incorporating carbon intensity would not guarantee that broader ESG objectives would be accounted for.

The S&P Carbon Control Indices have shown positive performance relative to their market-cap-weighted benchmarks, both in the back-tested and live periods of the indices, with a three-year tracking error of 1.16% and 1.36% for the emerging and developed market regions, respectively.

As the world pushes to transition to a greener economy, carbon will continue to represent an imminent risk for businesses and the investment community alike. The S&P Carbon Control Indices combine selection and reweighting approaches that significantly reduce index-level carbon intensity relative to their underlying benchmarks. Simply put, these indices provide a relative improvement—not an absolute one. For carbon-conscious market participants, this may be just the right fit.

¹ According to the IPCC, to keep warming below 1.5°C as called for in the Paris Agreement, by 2030, global emissions need to be reduced by 45% and reach net zero by 2050. Please note that the S&P Carbon Control Indices do not seek to align with the objectives of the Paris Agreement to keep warming below 1.5°C.

² Carbon intensity is defined as the metrics tons of operational and first-tier supply chain carbon emissions per USD 1 million in revenues.

³ For more information on S&P DJI ESG Scores, please see here.

⁴ For more information on the S&P Carbon Control Indices, please refer to the methodology.

⁵ For more information on greenhouse gas emissions calculated by Trucost, please see here.

⁶ For more information on index carbon metrics, please see here.

If the first six months of 2022 were defined by the woes of equities, the year’s second half has been defined (so far!) by a comeback. Since hitting a low in mid-June, the S&P 500^® has gained an impressive 17.1% through Aug. 18, 2022. In such an environment, low volatility strategies are expected to underperform, and, reliably, the S&P 500 Low Volatility Index (which has historically tempered the performance of the benchmark) gained “just” 14.5%, underperforming 2.6% in the same period. This reflects an upside capture of 85%. (Historically, the low volatility index’s upside capture has averaged 72%.)

Volatility has generally risen since the low volatility index’s last rebalance, with the biggest increase in the Consumer Discretionary and Energy sectors.

The latest rebalance for the S&P 500 Low Volatility Index shifted an additional 3% weight to the Health Care sector. Consumer Discretionary, despite notching the highest volatility increase, also added weight to the portfolio, pointing to pockets of relative stability within the sector. Information Technology, which in recent years has had a higher allocation relative to its presence historically, has been paring back its allocation in the past three rebalances. It now takes up just 3% of the low volatility index. Energy’s weight remains at 0%. The latest rebalance is effective after the market close on Aug. 19, 2022.

With inflation being a major issue in the current economy, consumers are increasingly looking for ways to combat their loss of purchasing power. One way to achieve this is to have sources of income that keep pace with, or even exceed, the inflation rate. Over the past four decades, dividends have played an increasing role as a source of income, growing from just 2.88% of all income in December 1981 to 6.25% of all income in March 2022.¹

During inflationary periods, history has shown the importance of focusing on companies that have consistently increased dividends. A company’s ability to consistently increase dividends may signal a quality company that is able to continually generate increasing cash flows as well as high returns on capital.

Dividend Growers Methodology

In this blog, we will focus on the S&P U.S. Dividend Growers Index and S&P Global ex-U.S. Dividend Growers Index, which provide exposure to companies that have consecutively increased dividends for 10 and 7 years, respectively. In addition to the dividend policy filter, the top 25% of stocks ranked by indicated annual dividend yield are also excluded from these indices. This diminishes the risk of owning “yield traps,” or companies that have high dividend yields simply due to large stock price declines.

Dividend Growth Rate Outpaces the Inflation Rate over the Long Term

Exhibit 1 shows the average year-over-year annual percentage dividend growth rate for current S&P U.S. Dividend Growers Index constituents. The average year-over-year dividend growth rate over the past 15 years was 13.71%, surpassing the average year-over-year U.S. CPI rate of 2.21% over the same period.

IHS Markit Forecasted Dividend Growth Rate

Exhibit 2 shows the year-over-year forecasted dividend growth rate for current S&P U.S. Dividend Growers Index constituents using the IHS Markit Dividend Forecasting data set.² S&P Global’s Dividend Forecasting team provides discrete forecasts of the size and timing of dividend payments for over 30,000 stocks worldwide. Forecasts for stocks in the core Dividend Forecasting universe are generated by analysts using fundamental research, market announcements and unique quantitative insight. Over the next four quarters, forecasted dividend growth is expected to remain robust, at 6.7% year-over-year. The forecasted growth rate for the following four quarters (Q3 2023 to Q2 2024) is 7.4% year-over-year.

Performance During Inflationary Periods

Exhibit 3 displays the outperformance of the S&P Dividend Growers Indices versus their respective benchmarks in periods when the year-over-year CPI rate exceeded 3% for at least six consecutive months. Both S&P Dividend Growers Indices significantly outperformed their benchmarks in the three most severe inflationary periods dating back to 2006.

Exhibit 4 shows the trailing 12-month return on equity (ROE) for both S&P Dividend Growers Indices versus their respective benchmarks. The outperformance of the S&P Dividend Growers Indices during inflationary periods may be due to their substantially higher ROE. This is significant because companies that earn low returns on their capital can lose value in real terms, when the capital they invest earns a lower return than the inflation rate.

Full-Period Performance

Exhibit 5 details the full-period performance comparison. Both S&P Dividend Growers Indices generated superior full-period risk-adjusted returns versus their benchmarks. Importantly, the S&P Dividend Growers Indices outperformed their benchmarks YTD as well as over the past year.

The S&P Dividend Growers Indices have historically outperformed their benchmarks on a risk-adjusted basis. Notably, they have significantly outperformed in recent inflationary periods, possibly due to their high-quality characteristics. Hence, the S&P Dividend Growers Indices may be a good option to consider if current inflation trends continue.

¹ Source: Bureau of Economic Analysis. Data as of March 31, 2022.

² See https://cdn.ihsmarkit.com/www/pdf/0822/IHS_Markit_Dividend_Forecasting_Methodology.pdf