Introduction

In recent years, environmental, social and governance (ESG) themes have rapidly risen to prominence within equities and fixed income. In commodities however, this discussion is still in its infancy. While there is now a vast body of literature on incorporating aspects of ESG in stock and bond portfolios, there has been relatively little guidance for commodities investors. In order to develop an investment framework to incorporate ESG into commodities portfolios, we need to identify the key metrics, understand whether these can be standardized across sectors, and construct investible portfolios that reflect these metrics.

Using Bloomberg corporate ESG data and the Bloomberg Industry Classification Standard (BICS), we construct greenhouse gas (GHG) estimates for each metal that is a constituent of the Bloomberg Commodity Index (BCOM) benchmark. The estimation procedure is regression-based and incorporates an error measure for full transparency. As an alternative to a carbon offset-based approach, we identify three possible routes by which commodities investors can control for the different aspects of ESG within their portfolios.

This research is intended to be the first in a series of publications aimed at generalizing our approach across the five commodities sectors and main ESG themes—in much the same way cross-asset risk premia investing has been covered over the past decade. In this publication we:

• Highlight the unique interpretation issues for commodities investors with regard to ESG investing;
• Provide a summary of the factors that need to be considered when estimating GHG emissions for metals production;
• ​​​​Propose a transparent, rules-based approach for estimating GHG emissions per metal using primary data available to all Bloomberg users; and
• Construct systematic portfolios incorporating GHG-based scores.

Kartik Ghia, PhD
+1 212 617 5649
kghia6@bloomberg.net

AJ Lindeman, PhD
+1 212 617 7491
alindeman@bloomberg.net

Michael Zhang, CFA
+1 646 324 5620
mzhang556@bloomberg.net

The past few years has seen a rapid rise in the popularity of ESG investing. On the back of regulation and evolving investment principles, equity and fixed income investors have integrated environmental, social and governance pillars into their core portfolios. As this has become increasingly commonplace, attention has turned to commodities portfolios. While tempting, it is not a straightforward step to extend the framework used for equities and fixed income to commodities.

Equity and fixed income investors are often motivated by the potential to alter corporate behavior through ownership stakes and providing project financing. For commodities, we make a more modest claim. Commodities are typically included in wider investment portfolios as a source of returns diversification and a hedge against inflation. The aim of investors is to maintain these investment characteristics while reducing portfolio exposure to sources of pollution, social injustice and bad governance. In other words, given ESG characteristics displayed by individual commodities and/or sectors, how can investors optimize exposure?

This approach assumes commodities investors are passive participants in the ESG movement which can be illustrated by way of a stylized example. Equity investors might take a stake in different mining companies to actively seek a reduction in GHG emissions during the extraction processes.

With limited ability to affect corporate behavior or spot demand, commodities investors likely need to assume the level of GHG emissions are given (exogenous), and might choose to a different investment mix (via futures contracts) to reflect the differences in emissions levels

Introducing the concept of ESG to commodities is further complicated for a variety of reasons—ranging from the claim that commodities themselves might be contra to the philosophy of ESG investing, to the lack of a clear causal relationship between futures and physical production to investor objectives. In the course of this publication series, we address these issues and in doing so hope to provide readers with different lenses with which to view ESG investing in commodities.