Is the Transition Risk Material? Testing the Net Environmental Contribution Metric on a Universe of Listed European Equities

12th Financial Risk International Forum, Institut Louis Bachelier, Paris, March 2019

23 Pages Posted: 7 Oct 2020

Date Written: March 18, 2019

Abstract

In 2017, BNP Paribas Securities Services and Sycomore AM joined forces to accelerate the testing and enable the quicker deployment of a new advanced metric. This metric had been designed to measure the alignment of any economic activity with globally established goals around energy and ecological transition, and climate change mitigation. This metric, the Net Environmental Contribution™ or NEC, provides a single figure on a scale ranging from -100% (negative net contribution/obstruction) to +100% (clear positive contribution/full alignment). Sycomore AM provided BNP Paribas Securities Services with the individual NEC for each of a set of +1,200 companies, covering its whole invested universe and major European indices. This article explores the financial and environmental performance of stocks within the STOXX 600 universe, using the evidence produced by the NEC.

Key learnings are:

• The NEC key features - distribution and scope of application - are different from environmental (E) ratings provided by extra-financial agencies and high E ratings do not automatically translate into a high contribution to the environmental transition;

• Patterns between the NEC and stocks prices emerge when studying three- and five-year periods;

• Among the tested strategies, a portfolio of stocks with NECs ranging from +10% to +100% and an average NEC of +25% appears to offer both the highest return and the highest risk-adjusted return (approximated by the Sharpe ratio) over three-year and five-year periods;

• As the NEC is a proxy for the degree of alignment with the environmental and energy transition, the preliminary results show it could be material to equity returns and risk-adjusted returns over a period as short as three years.

In conclusion, the NEC beta version we tested seems to be useful already, both for constructing an investment strategy and for meeting French article 173 reporting requirements and some of the TCFD recommendations. It seems the NEC methodology, which is moving towards an open-source model, is worth being further improved and rolled out to a broader universe.

Keywords: environmental impact, stock markets, financial performance, risk-adjusted return, Sharpe ratio, transition risks and opportunities, Net Environmental Contribution, NEC, TCFD, natural capital, life cycle assessment, green investment

JEL Classification: G11, G12, Q50, Q51, Q56

Suggested Citation

Peladan, Jean-Guillaume, Is the Transition Risk Material? Testing the Net Environmental Contribution Metric on a Universe of Listed European Equities (March 18, 2019). 12th Financial Risk International Forum, Institut Louis Bachelier, Paris, March 2019, Available at SSRN: https://ssrn.com/abstract=3630338 or http://dx.doi.org/10.2139/ssrn.3630338

Jean-Guillaume Peladan (Contact Author)

Sycomore AM ( email )

+33144401638 (Phone)

HOME PAGE: http://www.sycomore-am.com

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