Author Details

Ashish Lodh

Ashish Lodh

Executive Director, MSCI Research

Guido Giese

Guido Giese

Managing Director, MSCI Research

Afsaneh Mastouri

Afsaneh Mastouri

Executive Director, MSCI Research

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Net-Zero Alignment for Multi-Asset-Class Portfolios

  • Asset owners with net-zero pledges are committing to short- and medium-term carbon-footprint reduction targets for their portfolios.
  • A building-block approach can be the basis for investors who want to meet their targets on climate footprints and green revenues.
  • In a simulation, we show that a gradual shift of capital from market to climate portfolios could result in a 71% reduction in the total portfolio’s carbon footprint, with a tracking error of 95 basis points.

Asset owners who want to keep global warming below 1.5 degrees Celsius (1.5°C) have a tough row to hoe. In the short term, the Net-Zero Asset Owner Alliance (NZAOA) says they would need to reduce absolute emissions between 22% and 32% from 2020 to 2025, by lowering their financed emissions and increasing their allocations to green-tech companies. In the medium term, the emissions reduction ranges between 49% and 65% over the 2020 base year.1

The challenge for asset owners is figuring out how to build multi-asset-class portfolios that follow these predefined target pathways, while keeping their portfolios broad and diversified and minimizing risk against a standard market benchmark.

In general, asset owners may pursue one of two approaches for constructing net-zero portfolios, or a combination of the two approaches. They could shift capital from high to low emitters over time to achieve decarbonization, or they could reallocate capital toward companies that have ambitious emissions-reduction targets and a strong track record of achieving them. In this blog post, we explore the first approach, using MSCI Climate Indexes as proxies for climate portfolios. Although we use a building-block approach that includes both market- and climate-based methodologies, in theory one could combine these approaches in a single portfolio to achieve similar outcomes.


A building-block approach

We deployed the MSCI Climate Change and Paris Aligned Indexes as building blocks for both equity and fixed income. Both index methodologies, implicitly or explicitly, 1) target lower carbon intensity/carbon emissions than the market, 2) have higher weightings in green-revenue companies and 3) have self-decarbonization objectives.2 Historically these methodologies have resulted in diversified indexes with low to moderate levels of tracking error from the parent (market-cap) indexes.


Key metrics for MSCI Climate Indexes

MSCI equity indexes
  Returns (%) Risk (%) Tracking
Error (%)
Number of
Weighted average
carbon intensity
Rev (%)
ACWI 7.26 14.04 - 2686 343 5.2
ACWI Climate Change 8.05 14.13 1.36 1337 107 10.8
ACWI Cl. Paris Aligned 8.13 14.05 1.15 1337 107 10.8
MSCI fixed-income Indexes
  Returns (%) Risk (%) Tracking
Error (%)
Number of
Carbon Emissions Green
Rev (%)
USD IG -2.46 7.98 - 3466 53.7 2.8
USD IG Climate Change -2.46 7.50 0.95 3346 31.3 4.8
USD IG Cl. Paris Aligned -2.20 7.36 0.90 1585 25.8 5.5
EUR IG -6.95 10.36 - 3403 53.0 4.7
EUR IG Climate Change -6.95 10.63 - 3403 53.0 4.7
EUR IG Cl. Pris Aligned -7.08 10.6 0.19 1793 18.6 9.3
USD HY -1.55 11.8 - 2292 17.9 2.6
USD HY Climate Change -1.93 9.64 2.82 1843 10.4 4.1
USD HY Cl. Paris Aligned -2.37 9.56 2.85 1557 7.5 4.6
EUR HY -6.28 15.43 - 658 15.7 3.7
EUR HY Climate Change -6.46 14.83 0.89 461 11.6 4.7
EUR HY Cl. Paris Aligned -6.05 15.29 0.55 426 7.4 5.7

For the equity indexes, weighted average carbon intensity, or WACI (measured in tons of CO2 equivalent/USD 1 million of enterprise value including cash), and green revenue (%), as of June 2022. Other metrics are from Nov. 30, 2013, to June 30, 2022. For the corporate-bond indexes, carbon emissions (measured in metric tons of CO2) and green revenue (%) as of June 30, 2022. Other metrics from Dec. 31, 2019, to June 30, 2022. Frequency monthly.


Building smooth transition pathways

We looked at two examples of asset owners that currently hold a 60/40 equity/fixed income portfolio: We used the MSCI ACWI Index as a proxy for global equities and a combination of MSCI corporate-bond indexes for global bonds.3 We assumed they have set the following short- and medium-term targets for carbon footprints and green-revenue exposure, with Investor B being more ambitious than Investor A.


Investor targets

    2025 2030
Investor A Net decarbonization 25% 50%
Green-revenue ratio 1.2X 1.5X
Investor B Net-decarbonization 35% 70%
Green-revenue ratio 1.4X 1.8X


Next, we simulated pathways for both investors, assuming they gradually shift their allocations from market-cap approaches to climate-based methodologies, using indexes as proxies. The pathways were defined by 2025 and 2030 targets (in line with NZAOA recommendations), using interim target levels between these dates. The 60/40 equity/bond mix was kept constant. We assumed that the market indexes don’t decarbonize, while the MSCI Climate Change and Climate Paris Aligned Indexes self-decarbonize at a rate of 7% and 10%, respectively.4 We used MSCI Climate Change Indexes for Investor A and Climate Paris Aligned Indexes for Investor B as a proxy for climate allocations. For Investor B, the pathway resulted in a capital move of 16.7% per year from market to climate allocations until 2025 and a 6.9% annual shift from 2025 till 2030. For Investor A, these numbers were marginally lower.


Simulated capital allocation over time using MSCI equity and bond indexes as proxies

This exhibits shows how capital allocations for two 60/40 equity/bond could shift over time to net-zero portfolios, using MSCI Climate Indexes as market proxies.

For both investors, the hypothetical portfolios (resulting from simulated pathways) would have achieved their respective climate targets.5 By 2030, Investor A would have reduced the carbon footprint of the portfolio by 52% and Investor B by 71%. Since the two MSCI climate indexes also target higher exposure to companies with green revenues, their green-revenue targets were also met, under the assumption that index-level green revenues don’t change over time. Investor B would have met the more ambitious climate targets by selecting a faster-decarbonizing climate index and by adopting a more aggressive capital shift from broad-market to climate portfolios.


Simulated path of carbon footprint and exposure to green revenues

This charts shows how the two investors would have reduced the carbon footprint and met their green-revenue targets, using MSCI Climate Indexes as market proxies.

The equity allocation’s carbon footprint is calculated using WACI, and the fixed-income allocation using carbon emissions (metric tons of CO2). Simulations based on index characteristics as of June 2022.


What is the relative risk?

Relative risk remains a major concern for asset owners who want to embark on a net-zero journey. The exhibits below show the simulated active share (the difference between the simulated portfolio’s holdings and the benchmark) and tracking error of the hypothetical portfolios, with the assumption that the climate indexes’ active share and tracking error do not change over time.6 While the hypothetical portfolios in 2030 ended up with a 72% to 84% share of climate allocations, their relative risk (as measured by tracking error) was not large. The active share for Investor B (ambitious targets) would be about 36% and tracking error about 1%.


Simulated path of active share and tracking error

This exhibit shows the simulated active share and tracking error for the hypothetical portfolios. Active share for Investor B (the more aggressive portfolio) would be about 36% and tracking error about 1%. Active share of Investor A was much smaller (12%) and tracking error was also limited.

Simulations are based on index characteristics as of June 2022.


The path forward?

Using MSCI climate indexes as market proxies, we simulated a building-block approach that gradually shifts a hypothetical multi-asset-class portfolio from a broad market-based approach to one based on climate-change considerations. In our simulation, this approach would have resulted in moderate levels of relative risk.



1“UN-convened Net-Zero Asset Owner Alliance: Target Setting Protocol: Second edition.” United Nations Environment Programme, January 2022.

2The MSCI Climate Change Index and MSCI Climate Paris Aligned Index target 7% and 10% year-on-year self-decarbonization trajectories, respectively. The equity and fixed-income indexes’ self-decarbonization trajectories are based on weighted average carbon intensity (tons of CO2 equivalent/USD 1 million of enterprise value including cash) and carbon emissions (metric tons of CO2), respectively. The current MSCI Climate Change Corporate Bond Indexes have achieved a high degree of decarbonization, but they require some customization to achieve 7% decarbonization consistently.

3Within the corporate-bond portfolio, the split is USD IG (60%), EUR IG (20%), USD HY (15%) and EUR HY (5%).

4Decarbonization target for equity and fixed income are based on WACI (tons of CO2 equivalent/USD 1 million of enterprise value including cash) and carbon emissions (metric tons of CO2), respectively.

5The analysis assumes no change in index-level green-revenue exposure, tracking error and active share over time. It also assumes that climate indexes decarbonize over time, but that the market indexes don’t. Since future index characteristics are not predictable, characteristics of these hypothetical portfolios may differ from the simulations.

6Depending on the future decarbonization of the broad market, the climate indexes may exhibit tracking error different from their current levels.



Further Reading

TCFD-Aligned Climate Risk Reporting

Climate Indexes Brought Short-Term Gloom with Blooming Offshoots

Why Your Portfolio May Be Hot, Cold or Just Right - MSCI

MSCI Climate Indexes