What’s Been Driving the Carbon Footprint of MSCI’s ESG Indexes?
Key findings
- Understanding the drivers of carbon footprint at the index and portfolio level, both in terms of financed emissions and emissions intensities, can help investors make better-informed decisions.
- The MSCI ACWI ESG and Socially Responsible Investing (SRI) Indexes saw a larger decline in index-level carbon footprint than the MSCI ACWI Index, with most of the reduction due to rebalancing and growth in enterprise value including cash (EVIC).
- The organic issuer-level decarbonization we observed over this time reflected the global economic slowdown that occurred during the emergency phase of the COVID-19 pandemic.
Addressing carbon risks in investment portfolios is becoming increasingly important. With the assets under management of ESG-related exchange-traded funds seeing exponential growth over the last few years, investors may wish to know how MSCI's standard ESG indexes have addressed carbon risks in the past.
While MSCI ESG Indexes are not explicitly designed for and thus do not target an improved carbon footprint,[1] they do address some climate-investing objectives by excluding companies involved in thermal-coal power, fossil-fuel extraction and ownership of fossil-fuel reserves. Furthermore, they integrate financially relevant climate risks and opportunities by integrating MSCI ESG Ratings, which consider climate change as one of the financially relevant ESG risks under the environmental pillar.
In this blog post, we dive deeper into the carbon footprint of MSCI's standard ESG indexes relative to their parent indexes.
MSCI ACWI ESG and SRI Indexes vs. MSCI ACWI Index
The MSCI ACWI ESG and SRI Indexes had lower emissions intensities than the parent MSCI ACWI Index, both at the start and end of the five years ending December 2022, with both index-level financed emissions and emissions intensities declining over that period.[2]
Financed-emissions trend (Scope 1 + 2) of select MSCI indexes
Source: MSCI ESG Research
Financed-emissions-intensity trend (Scope 1 and 2) of select MSCI indexes
Source: MSCI ESG Research
Emissions-intensity attribution
Our analysis then focused on the attribution of emissions intensity year over year over the same time period for these same indexes. Using the methodology outlined in our recent research paper, we calculated emissions changes for the new, divested and consistently held positions. Additionally, emissions changes for the consistently held positions are further decomposed to the main driving factors of emissions intensity — i.e., position weight, issuer-level emissions and the denominator, EVIC. Here, we group new positions and divested positions into the category of rebalancing.
In the interactive exhibit below, we calculated the year-over-year emissions attribution for the MSCI ACWI, MSCI ACWI ESG and SRI Indexes. We observed that the index-level carbon-footprint changes were mostly due to rebalancing, change of weight (i.e., portfolio composition) and change of EVIC. The contribution from organic changes in carbon emissions at the issuer level was miniscule.
The carbon-emissions change in 2020 for the MSCI ACWI ESG Focus, MSCI ACWI ESG Leaders and MSCI ACWI SRI Indexes mostly came from rebalancing, where new controversial-business-involvement criteria were added for fossil-fuel reserves and fossil-fuel extraction, and the screen for thermal coal was adjusted.
Emissions-intensity attribution of select MSCI indexes
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Source: MSCI ESG Research
Issuer-level carbon emissions
Next, we took a closer look at the organic changes in greenhouse-gas (GHG) emissions at the issuer level. Overall, these changes were small relative to other driving factors, such as the contribution from rebalancing and the change of the denominator.
Issuer-level carbon emissions increased by a small percentage in 2018 and 2019. During the pandemic, there was then a noticeable decrease in these emissions, reflecting the emergency phase of the COVID-19 pandemic. After the emergency phase of the pandemic, as the economy recovered, issuer-level carbon emissions once again increased.
Changes in issuer-level carbon emissions of select MSCI indexes
Source: MSCI ESG Research
In summary, over the five years to December 2022, changes in organic GHG emissions at the issuer level have been small,[3] except during the emergency phase of the COVID-19 pandemic between 2020 and 2021. Most of the index-level carbon-footprint changes were due to other factors, such as rebalancing, change of ownership share and weight.
From understanding to action
As observed, MSCI ESG Indexes demonstrated an overall improved carbon profile at a global level during the study period. This was achieved through a combination of fossil-fuel exclusions and/or integrating financially relevant carbon risks and opportunities. At the implementation level, the majority of the decarbonization was driven by portfolio rebalancing and the change of the denominator rather than organic changes in GHG emissions at the issuer level. Understanding the drivers of index and changes in portfolio carbon footprint can cut through noise and help inform investor actions.
1 Except for the MSCI ESG Screened Index, which targets a minimum 30% reduction in emissions intensity relative to the underlying parent index and was not analyzed as part of this study.2 Per the “Global GHG Accounting and Reporting Standard for the Financial Industry” developed by the Partnership for Carbon Accounting Financials, the financed emissions of an equity position are defined as the product of an attribution factor and emissions. The attribution factor is the ratio of the market value of the equities to the enterprise value including cash (EVIC). Portfolio-level financed emissions are the simple sum of the positions' financed emissions. At 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 EVIC, respectively, for the ith constituent in the index.3 Changes in organic GHG emissions at the issuer level have been negative for the MSCI ACWI, ESG Universal and ESG Focus Indexes and positive for the MSCI ESG Leaders and SRI Indexes.
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