Can you provide a simple definition of carbon footprinting and explain why it’s relevant for wealth managers and their clients?

Broadly speaking, carbon footprinting is the process of quantifying the greenhouse gas (GHG) emissions caused directly or indirectly by an individual organisation, event or product. It is usually expressed in absolute terms – the total amount of CO2 equivalent that any individual or product generates. For wealth managers specifically, it’s important to understand the carbon-intensive hotspots in their portfolios, so they can take action to minimise exposure to assets with higher climate-related risks. If they want to set climate goals or report on climate, they will need to measure their portfolios’ carbon footprints to establish a baseline and track progress against a benchmark or targets.

How do you calculate carbon footprints for investment portfolios, and what data sources are typically used in this process?

Our ‘Carbon Footprinting Demystified’ guide identifies four main carbon footprint metrics that are adopted by policymakers and industry bodies.

• One is in absolute terms and the three others are in intensity terms. We call the absolute metric ‘financed emissions’. It is the total amount of GHG emissions financed by a portfolio. We calculate this by multiplying each portfolio company’s GHG emissions by the investor’s ownership share in that company and adding them together.
• For the intensity metrics, firstly we have ‘financed emissions intensity’, which is the financed emissions divided by portfolio value. It normalises the absolute amount and allows collaboration across portfolios of different sizes or against benchmark indexes. Secondly, we have ‘production-based intensity’. It’s also a normalised version of financed missions but uses the physical production amount as the denominator. For example, it could be megawatt hours for power generation companies or tonnes of steel produced for steel companies. Lastly, the ‘weighted average carbon intensity’ normalises each portfolio company’s GHG emissions by their revenue and then multiplies this by portfolio weight.
• These metrics may fit some objectives better than others. Our guide provides two decision trees. The first lists the recommended carbon footprint metrics for investors who are required or want to follow a specific reporting standard and the second highlights which metrics are best suited to which investment objective.

What are the main factors that contribute to a portfolio’s carbon footprint, and how do they impact investment decisions?

Three factors can drive a portfolio’s financed emissions in absolute terms.

1. First of all, there can be a change in the total amount of GHG emissions that a portfolio company generates, which we call real-world emission changes.
2. Secondly, the investor can buy or sell securities of the portfolio company, so their position value would change.
3. And thirdly, the financing structure of the company can change. For example, the company can issue new securities or buy back securities.

It’s important to differentiate which factor contributes to how much change. For the intensity metrics, there can be fluctuations in EVIC [enterprise value including cash] or revenue, so sometimes we make inflation or exchange rate adjustments to those metrics. Because there can be so many factors playing into changes in a portfolio’s carbon footprint, attribution analysis to identify where the changes come from is critical. Our guide offers an attribution framework created by MSCI ESG Research that is designed to help investors identify and separate the contribution of each factor.

Can you explain how carbon footprinting aligns with broader sustainability goals and investment strategies?

Multiple studies from the United Nations and World Bank have shown that climate change is the most significant challenge to achieving sustainable development¹. Carbon footprinting could be the first step for investors with sustainable investment objectives to mitigate or at least understand their exposure to climate change risks. It sets a baseline to inform future actions, such as setting goals or engaging with portfolio companies.

What are some common challenges or limitations wealth managers might encounter when integrating carbon footprinting into their investment approach, and how can they address them?

First of all, there could be data challenges. Company emissions are essential in the carbon footprint calculation, but companies don’t always report that number and when they do, disclosures can vary in quality, detail and the time taken to report. The latest MSCI Net-Zero Tracker, published in April, found that as of January this year, around 60% of listed companies globally disclosed their scope 1 and/or scope 2 emissions, and only 42% reported at least some of their scope 3 emissions. The current common practice amongst investors is to combine reported verified data with estimations across some or all three scopes of emissions. Many estimation models follow the Greenhouse Gas Protocol, which sets a global standard for emissions accounting. Accounting methods also continue to evolve and there are many variations of inputs investors may consider in their calculation of a portfolio’s carbon footprint such as whether to measure the three scopes together or separately, whether to align the measurement date of different calculation inputs and when and how to make inflation adjustments. We aim to provide answers to all these questions in our guide.

Are there any case studies where carbon footprinting has influenced investment decisions or improved portfolio performance?

Many banks, asset managers and asset owners, especially members of net-zero initiatives such as the Net-Zero Banking Alliance and Net-Zero Asset Owner Alliance, have been using carbon footprint metrics to set targets, perform investment due diligence and engage with portfolio companies². At MSCI, we have researched the carbon footprint of different indexes. Earlier this year, we published a study that showed the financed emissions intensity of the MSCI Climate Action Indexes was consistently lower than their parent indexes at both the index and sector levels over a three-year period. The MSCI ACWI Climate Action and MSCI ACWI Climate Change Indexes achieved USD active returns of 2.7% and 6.5% in 2023, respectively. Another study in late 2022 calculated the carbon footprint of the world’s 10 largest asset managers and found that big European players were marginally less carbon intensive than their US peers. This is a fast-evolving space and we’re closely monitoring developments. It’s important for investors to also watch out for new developments in accounting methods or common practices in the market.

[1] “Climate change undermines nearly all Sustainable Development Goals,” United Nations Environment Programme, September 2023; “Revised Estimates of the Impact of Climate Change on Extreme Poverty by 2030,” the World Bank Group, September 2020.

[2] “Net-Zero Banking Alliance 2023 Progress Update,” UNEP FI, December 2023.