- Investors globally are committing to reduce the carbon footprint of their portfolios to align with the goal of global net-zero emissions by 2050.
- They have adopted varied climate investment strategies, their choice shaped by their views on the best, or most likely, economy-wide transition path.
- We illustrate how indexes can be a basis for investors who wish to finance the transition as well as encourage companies to set and meet net-zero targets.
Many investors have deployed low-carbon investment strategies that are designed to reduce exposure to carbon-intensive companies and “stranded” assets while increasing exposure to companies with “green” assets or revenues. However, such strategies may lead to lower exposure to, or even divestment from, carbon-intensive industries and companies that will likely need the greatest capital to transition. Clearly there will still be energy and materials sectors in a future low-carbon economy. Moreover, low exposure to those sectors has brought nearer-term risks from supply shocks and price volatility in 2022.
An evolving climate investment strategy
Some investors have recognized the need to provide capital and support this historic transition, with their focus broadening from reducing portfolio emissions to reducing financed emissions1 and financing emissions reductions.2 These investors typically adopt a more bottom-up approach to efficiently directing capital while maintaining a balanced exposure to all sectors of the economy. The portfolio may then decarbonize through the action of the investee companies.
To reflect (and support) this evolving approach to climate investing, we designed the MSCI Climate Action Indexes to employ a balanced assessment of a company’s net-zero target setting and emission reduction actions alongside its climate risk management to select securities within each the Global Industry Classification Standard (GICS®)3 sector and thereby deliver a broad and diversified index based on market-cap weighting.
Assessing the transition readiness of companies: An indexed approach
For these “transition capital” investors, how might a company be assessed for its net-zero commitment credibility? Companies may be assessed, relative to their sector peers, based on their current direct and indirect emissions as well as their plans and actions to manage the low-carbon transition. Such an assessment balances a company’s current transition risk, measured by its emission intensity,4 with its commitment to reduce emissions or emission intensity, its track record of emissions reduction, its proportion of revenue from green businesses, and the strength of its climate-related risk management.
By selecting the top half of securities within each sector based on this approach, the MSCI ACWI Climate Action Index achieved a near-50% reduction in weighted-average carbon emission intensity (WACI), overweighted companies with Science Based Targets (SBTi), and maintained modest tracking error relative to the MSCI ACWI (see below).
MSCI ACWI vs. MSCI ACWI Climate Action Index
|MSCI ACWI||MSCI ACWI
|Total return (%)||5.5||6.2|
|Total risk (%)||18.7||18.7|
|Tracking error (%)||1.5|
|Climate profile||Financed emissions (tCO2/$M EVIC)||361||186|
|% reduction in financed emissions||49%|
|Companies with SBT (%*)||31||39|
|Companies with Credible Track Record (%*)||9||12|
|Companies reporting scope 1 & 2
|Implied Temperature Rise||2.9||2.4|
|Product & Operational Transition^ (%*)||15.7||12.2|
|Carbon-related assets^^ (%*)||8||5.9|
* % represents aggregate weight of constituents. ^ Companies with moderately to highly carbon intensive product or services. ^^ Companies belonging to GICS energy equipment and services (101010), oil, gas and consumable fuels (1010120), electric utilities (551010), gas utilities (551020) and multi-utilities(551030). Simulated index history between Nov. 30, 2018, and Sept. 30, 2022. Financed emission calculated as of Sept. 30, 2022. Constituents of MSCI ACWI with approved Science-Based Targets (SBTi) as of Sept. 30, 2022.
Transition capital strategies and decarbonization
Companies have been committing to emission-reduction targets and actively planning their transition journey, and will be held to such commitments5 to lower their emissions (direct, from their operations, and indirect, from their value chain). For example, by the end of 2021, 1,171 companies had SBTi commitments while 1,085 had approved targets, more than double the 2020 figures and ten times the number in 2018.6 It is plausible to expect this strong growth to continue and extend to smaller companies. The assessment above favors companies with emission-reduction targets and a strong emission-reduction track record. Hence, the decarbonization efforts of the index constituents lead to decarbonization over time of the indexes.7
In an index simulation between June 2020 and June 2022, the WACI of MSCI ACWI Climate Action declined 8%.8 The aggregate weight of companies that saw a drop in emissions, rose by 4.6%. The biggest increase in aggregate was seen in the energy sector.
Exposure to companies whose emissions dropped over the period
Data from June 2020 to June 2022.
The graphic below also illustrates how decarbonization can be delivered through diverse mechanisms for decarbonization. The attribution of change in WACI for the MSCI ACWI Climate Action Index shows that a substantial portion arose from a reduction in emissions of its constituents. In contrast, the MSCI Climate Paris Aligned Index maintained only a small exposure to fossil-fuel-based energy companies (because of prescribed exclusions). Thus, only a small portion of its WACI reduction can be explained by the change in constituent emissions.
Changes in index WACI
Drop in Index WACI. June 2020 to June 2022.
The road to net zero
Investors have recognized the need to maintain a balanced exposure to all sectors while providing capital to transitioning companies. For such investors, a comprehensive assessment of a company’s transition readiness irrespective of its business and operations mix may be helpful. We have illustrated how this process may be engineered and supported with an indexed approach.
1Financed emissions aligned with the Partnership for Carbon Accounting (PCAF) standards.
2“Recommendations and Guidance: Financial Institution Net-zero Transition Plans.” Glasgow Financial Alliance for Net Zero, June 2022.
3GICS®, the Global Industry Classification Standard jointly developed by MSCI and S&P Global.
4Calculated by a company’s emissions from Scope 1,2 and 3 per dollar of its enterprise value, including cash.
5“Measurement, Reporting and Verification (MRV),” Science Based Targets.
6“SBTI Progress Report 2021: Progress Dashboard,” The Science Based Targets initiative (SBTi), June 2022.
7Portfolio decarbonization could also be achieved by a cap-weighted investor choosing to make a (partial) allocation from their original fund to one tracking the MSCI Climate Action Index.
8WACI calculation was not adjusted for inflation in EVIC. The date period was chosen to allow a like-for-like comparison with scopes 1, 2 and 3 emissions for both index methodologies within the attribution.
The Road to Science-Based Corporate Net-Zero Target
Net-Zero Alignment for Multi-Asset-Class Portfolios