FTSE Russell has launched the FTSE Climate Risk-Adjusted World Inflation-Linked Securities Index, the first index to target the global inflation-linked government bond market while tilting towards countries considered more resilient to climate change.

FTSE Russell has launched the first inflation-linked government bond index that is adjusted for climate risk.

According to the London-based index provider, the index is suitable for use as a benchmark for performance measurement or as an underlying for index-linked investment funds, including segregated mandates and ETFs.

The index launch is timely, coming amid a surge of interest in sustainable investing, particularly low-carbon investment strategies, and heightening inflation expectations due to ongoing fiscal stimulus and early signs of a vaccine-driven economic recovery.

Scott Harman, Global Head of Fixed Income Product Management at FTSE Russell, said: “Government bond investors face several significant risks to the long-term performance of portfolios, including climate risk and inflation risk. Yet, investors have faced no index solution that simultaneously seeks to address these risks in what is a multi-trillion-dollar market.

“Our new index combines FTSE Russell’s leading position in the global linkers market with its innovative climate risk-adjusted government bond market indexes.”

Methodology

The index is based upon the parent FTSE World Inflation-Linked Securities Index which measures the performance of investment-grade government bonds with fixed-rate coupon payments that are linked to a consumer price index. The parent index currently consists of debt from thirteen countries denominated in their respective local currencies.

The new climate risk-adjusted index incorporates a forward-looking assessment of sovereign climate risks using analysis from LSEG-owned ESG analytics firm Beyond Ratings.

Each country is assessed by three core climate risk pillars: transition risk, physical risk, and resilience.

Transition risk represents the impact on the country and its economy from the required efforts to meet the Paris Accord 2.0°Celsius target, measured on 15 variables including GDP per capita, the energy intensity of GDP, and carbon intensity of energy production.

Physical risk refers to the climate-related risk to the country and its economy from the physical effects of climate change including sea-level rise, exposure of the economy to potential agricultural damages, and climate-related natural disasters such as extreme weather.

Lastly, resilience indicates a country’s preparedness and actions to cope with climate change, measured based on the strength of national institutions, and the level of social and economic development.

Countries are scored across each of the pillars and a single combined score is derived for each country. Country scores are then used to reweight the country’s exposure in the index to provide higher exposures to countries that are better prepared for climate change risks. Correspondingly, the methodology lowers exposure to countries that are more threatened by climate change risks.

As of the end of March, the index yielded 0.99% and had an average duration of 10.34 years. More than three-quarters (79.4%) of the index was allocated to bonds rated AA. Relative to its parent universe, the index was overweight bonds from the UK (+11.4%) and underweight bonds issued by the US (-8.4%) and Mexico (-1.9%).