- Most of the MSCI ACWI Climate and MSCI ACWI ESG Indexes outperformed the MSCI ACWI Index in the first half of 2023, driven mainly by stock-specific effects and positive returns in the information-technology sector.
- The financed-emissions intensity (FEI) of the MSCI ACWI, MSCI USA, MSCI Europe, MSCI Pacific and MSCI Emerging Markets (EM) Indexes has fallen since 2017. The MSCI EM Index had the lowest reduction despite its being the most carbon-intensive.
- Carbon emissions of consistently held positions fell for all but the MSCI EM Index, indicating that index-level elements, such as index rebalancing, were responsible for its FEI reduction.
During the first half of 2023, seven of the 10 flagship MSCI ACWI Climate and ESG Indexes outperformed their parent benchmark, the MSCI ACWI Index. The three remaining indexes underperformed the MSCI ACWI Index by 0.20% or less.
Active return of the MSCI ACWI Climate and MSCI ACWI ESG Indexes
*Calculated with monthly data from Dec. 30, 2022, to June 30, 2023. **Calculated with monthly data from Nov. 30, 2018, to June 30, 2023.
Performance attribution can help investors understand their portfolios’ drivers of risk and return. Investors may also want to examine how and if their portfolios are decarbonizing at the regional and company levels given the emissions-mitigation initiatives adopted by governments and companies.
Governments around the globe have pledged to reduce carbon emissions, yet the paths to decarbonization differ across countries. While most developed countries have committed to reduce absolute emissions, several emerging markets have committed instead to reduce carbon intensity.1 Companies have also committed to reduce their carbon emissions. As of March 1, 2023, approximately 40% of the 9,171 constituents in the MSCI ACWI Investable Market Index had set climate targets. What are the regional deviations in decarbonization, if any, among the developed and emerging markets? An analysis of these variations can help investors gain a better understanding of how country- and company-level actions have translated into decarbonization of their equity portfolios.
How rapidly are equity markets decarbonizing?
We used the MSCI ACWI Index and the regional sub-indexes for Europe, Pacific, the U.S. and emerging markets as proxies for equity portfolios to analyze Scope 1 and 2 financed-emissions intensity (FEI)2 over the five-year period ending December 2022. The exhibit below illustrates our results.
Regional trends in financed-emissions intensity
Emerging markets = MSCI Emerging Markets (EM) Index, Europe = MSCI Europe Index, Pacific = MSCI Pacific Index, ACWI = MSCI ACWI Index, USA=MSCI USA Index.
While the FEI of all five indexes decreased during the analysis period, the reduction was the highest for the MSCI Pacific Index at 42% and the lowest for the MSCI Emerging Markets Index at 21%, despite its having the highest carbon intensity.
A key question is whether decarbonization is occurring organically as companies strive to meet decarbonization goals or is being achieved through other measures. Multiple drivers, such as rebalancing or a change in a company’s enterprise value including cash (EVIC), could contribute to a portfolio’s decarbonization. Exploring answers to this question could also highlight any similarities or differences in the abilities of companies to decarbonize.
To identify the contribution of different decarbonization drivers, we conducted an attribution analysis on the five indexes. We provide an example of the analysis using the MSCI Emerging Markets Index.
Attribution analysis of financed-emissions intensity of the MSCI Emerging Markets Index
The analysis period is from Dec. 29, 2017, to Dec. 30, 2022.
Three key observations emerge based on our FEI attribution analysis:
- Organic change in the carbon emissions of consistently held positions can inform investors about their portfolios’ real-world decarbonization. All five indexes had a five-year decrease in FEI ranging from 20.8% to 42.7%; however, the contribution by reductions in the constituent companies’ absolute emissions was substantially lower, ranging from 4.0% to 19.1% for four of the indexes. For the MSCI Emerging Markets Index, we observed an increase of 16.9% in absolute emissions, although emissions intensity dropped by 4.5%.
- A change in EVIC can make a substantial contribution to reducing FEI. Over the five-year analysis, each of the five indexes had a reduction in FEI due to change in EVIC, which ranged from -5.3% to -18.2%. This finding highlights the situation in which a change in a portfolio’s FEI due to a change in the constituent securities’ EVIC could incorrectly be interpreted as an improvement or deterioration in a portfolio’s carbon emissions despite limited reductions in the companies’ emissions.3
- Rebalancing can contribute to the decarbonization of a portfolio. Over the analysis period, all five indexes divested themselves of carbon-intensive stocks in favor of less-carbon-intensive positions. A change in the weight of existing positions can also contribute to a portfolio’s decarbonization, which was true in four of the indexes. In the MSCI Europe Index, however, the weight of carbon-intensive companies increased.
Attribution analysis of financed-emissions intensity
The “Other drivers of FEI changes” category includes the change in data coverage and the interactions between weight and intensity and between emissions and EVIC. The analysis period is from Dec. 29, 2017, to Dec. 30, 2022.
Getting specific can broaden insights into portfolio-level decarbonization
Understanding the sources of carbon-emissions reduction at the portfolio level can help investors differentiate the decarbonization of their portfolios and the decarbonization of companies in their portfolios. Conducting such specific analysis for different regions may inform investors about the directional consistency of portfolio companies with the broad ambitions of the countries in those regions.
1Taryn Fransen, et al. “The State of Nationally Determined Contributions: 2022.” World Resources Institute, March 2023.
2At the index level, financed-emissions intensity is computed as 𝐹𝐸𝐼 = ∑ 𝑊𝑒𝑖𝑔ℎ𝑡𝑖 × 𝐺𝐻𝐺 𝑒𝑚𝑖𝑠𝑠𝑖𝑜𝑛𝑠𝑖 / 𝐸𝑉𝐼𝐶i , where 𝑊𝑒𝑖𝑔ℎ𝑡𝑖, 𝐺𝐻𝐺 𝑒𝑚𝑖𝑠𝑠𝑖𝑜𝑛𝑠𝑖 and 𝐸𝑉𝐼𝐶i are the index weight, Scope 1 and 2 emissions and enterprise value including cash, respectively, for the ith constituent in the index.
3To reduce the impact of market volatility, the EU proposed in its Climate Benchmark Regulations to adjust the EVIC of each portfolio constituent, dividing it by an enterprise-value inflation-adjustment factor (EVIAF). The EVIAF is calculated by dividing the average EVIC of the benchmark constituents at the end of a calendar year by the average EVIC of the benchmark constituents at the end of the previous calendar year. “ANNEX to the Commission Delegated Regulation (EU) .../... supplementing Regulation (EU) 2019/2088 of the European Parliament.” EU Commission, April 2022.