Morgan Stanley
  • Institute for Sustainable Investing
  • Jul 10, 2020

5 Climate Change Metrics for Investors in a Decarbonising World

As the global economy moves toward decarbonisation, investors can harness new indicators to measure the potential risks and opportunities arising from climate change.

If you’ve ever wondered how to assess companies based on the risks and opportunities related to climate change, five key metrics—absolute carbon emissions, carbon intensity, emissions reduction targets, carbon earnings at risk and climate change revenues—can help, according to a new report from Morgan Stanley, jointly issued by its Institute for Sustainable Investing and the Portfolio Solutions Group at Morgan Stanley Investment Management.

For investors, it’s now critical to assess the threats that climate change poses to assets and the impact of changing policies on corporates in the urgent transition to a low-carbon world. Economic damage from climate change-related natural disasters, such as hurricanes, wildfires or heatwaves, has risen sharply in the past 40 years.1 Between 2016 and 2018, climate change-related weather events caused more than US$630 billion in losses worldwide.2 Meanwhile, global financial regulators increasingly treat climate change as a systemic financial risk: Last year, the Network of Central Banks and Supervisors for Greening the Financial System identified climate change as a unique source of structural risk affecting the financial system.3

Climate Disasters and Related Losses Have Risen Sharply in 40 Years

Source: NatCatSERVICE, Munich Re, March 2018

For their part, many companies and governments have committed, by 2050, to achieving net zero emissions, a state in which the amount of carbon produced is offset by the amount removed from the atmosphere. This milestone is critical to ensuring that the Earth’s average temperature increases no more than 1.5˚C above preindustrial levels, which the Paris Agreement defined in 2015 as necessary to substantially limit the impact and progression of climate change.

“There is real and growing interest in climate change from an investor perspective, and decarbonisation is a complex topic that’s increasingly important,” says Matthew Slovik, Head of Global Sustainable Finance at Morgan Stanley. “Key metrics provide a comprehensive way for investors to think about climate change in their portfolios.”

As the world moves toward decarbonisation, investors, especially stockholders, can look at the following five indicators to evaluate companies through the lens of climate change, according to the report.

5 Key climate metrics for investors

  1. Carbon emissions: A point-in-time measurement of absolute carbon emissions from a company’s direct and indirect activities.
  2. Carbon intensity: A measure of emissions efficiency, using revenue to normalise and compare emissions across companies of different sizes.
  3. Emissions reduction target: Akin to earnings guidance, a forward-looking indicator of a company’s ambitions to reduce its carbon emissions—increasingly assessed based on the breadth, quality and associated plans to achieve the target.
  4. Carbon Earnings at Risk (CEaR): Akin to value-at-risk, the estimated present value of future earnings loss, based on the projected price path of carbon and a company’s current emissions.
  5. Climate change revenues: The percentage of a company’s revenue tied to positive or negative climate impacts—which may be scored based on underlying products and services linked to climate change.

“Even if asset owners or asset managers want to embark on a path of decarbonisation, in practice this is impossible without effectively measuring the processes and outcomes that investors aim to manage,” says Rui De Figueiredo, Co-Head and Chief Investment Officer of the Solutions and Multi-Asset Group, which oversees the Portfolio Solutions Group at Morgan Stanley Investment Management. “This has been a key challenge for market participants from a data and methodological perspective and this provides a framework for investors to effectively advance a decarbonisation agenda.”

How can you use these metrics? Much as portfolio strategies are defined by sector, style or geography, these measurements can help investors define and articulate a clear decarbonisation strategy. Each indicator on its own presents a limited view: The first two metrics, which measure a company’s direct and/or indirect carbon emissions and carbon intensity, are point-in-time or backward looking, but they can help investors whose goal is to choose lower-emitting sectors or securities.

Meanwhile, forward-looking indicators can reflect proactive decarbonisation goals and provide a more complete assessment of climate change impacts. Some companies—about half globally across sectors—have set public targets for reducing carbon emissions,4 which portfolio managers can consider as guidance on future direction. While companies’ commitments to reduce emissions aren’t binding, pressure is mounting from investors, regulators and consumers for corporations to set interim emissions goals and to reach their milestones, according to the report.

About Half of Companies Have a Public Emissions Reduction Target
MSCI ACWI Universe as of 12/31/2019

Sources: ISS-ESG, MSCI Index, Morgan Stanley analysis

Another indicator, CEaR, estimates a company’s future potential earnings loss, based on the projected shift in the price of carbon, which will be driven by underlying factors including the transition to renewable energy from fossil fuel energy, as well as policy changes such as carbon taxes or requirements to purchase permits, known as carbon emissions trading schemes.5 A company’s geography and sector significantly determine its CEaR; for example, emerging economies that may rely upon fossil fuels are generally expected to have lower carbon pricing to account for universal energy access, while developed economies will have higher pricing because of emissions to date.6

Investors can also look at a company’s revenue streams to determine how likely it is to gain, or falter, as decarbonisation progresses. Companies tied to renewable energy or battery storage, for example, could be positioned for upside potential, while those reliant on fossil-fuel-based energy sources may be exposed to greater risk, as the economy and markets necessitate lower carbon emissions.

As technological innovation, shifting consumer preferences, changes in market prices and new policies drive the transition to a low-carbon economy in coming decades, it may be incumbent on investors to use an ever-evolving set of climate metrics, along with traditional measures of financial performance, to holistically assess companies.

Key climate change terms

  • Carbon emissions: The carbon dioxide equivalent of the six major greenhouse gases. As defined by the 1997 Kyoto Protocol, the six greenhouse gases contributing most to climate change are carbon dioxide (CO2), methane (CH4), nitrous oxide (N2O), hydrofluorocarbons (HFCs), perfluorocarbons (PFCs) and sulphur hexafluoride (SF6).
    • Scope 1 Emissions: Direct carbon emissions from owned or controlled sources.
    • Scope 2 Emissions: Indirect carbon emissions from the generation of purchased energy.
    • Scope 3 Emissions: Indirect emissions (not included in Scope 2) that occur in the value chain of the reporting company, including both upstream and downstream emissions
  • Decarbonisation: A systematic effort of companies and governments to align with a low-carbon economy by reducing carbon emissions.
  • Net Zero (Emissions): A state in which any carbon emissions produced are offset by removing carbon from the atmosphere. Reaching net zero emissions by 2050 is critical to limiting average global temperature rise to less than 1.5˚C above preindustrial levels.

 

For more on decarbonisation, speak to your Morgan Stanley financial adviser or representative. Plus, more Ideas from Morgan Stanley's thought leaders.    

 

Sources:

1 NatCatSERVICE, MunichRe, March 2018.

2 NatCatSERVICE, MunichRe. (https://natcatservice.munichre.com/overall/1?filter=eyJ5ZWFyRnJvbSI6MTk4MCwieWVhclRvIjoyMDE4LCJldmVudEZhbWlseUlkcyI6WzQsNSw3XX0%3D&type=1; accessed on 10/30/2019)

3 “A Call for Action: Climate Change as a Source of Financial Risk,” Network for Greening the Financial System, 2019 (https://www.banque-france.fr/sites/default/files/media/2019/04/17/ngfs_first_comprehensive_report_-_17042019_0.pdf; accessed on 10/30/2019)

4 ISS-ESG, MSCI ACWI index, Morgan Stanley analysis.

5 https://carbonpricingdashboard.worldbank.org/what-carbon-pricing#:~:text=For%20the%20power%20sector%2C%20the,decarbonize%20the%20sector%20by%202050.

6 See, for example, the Report of the High-Level Commission on Carbon Prices co-chaired by Nobel Laureate Joseph Stiglitz and Lord Nicholas Stern, https://www.carbonpricingleadership.org/report-of-the-highlevel-commission-on-carbon-prices.

 

RISK CONSIDERATIONS

ESG strategies that incorporate impact investing and/or environmental, social and governance (ESG) factors could result in relative investment performance deviating from other strategies or broad market benchmarks, depending on whether such sectors or investments are in or out of favor in the market. As a result, there is no assurance ESG strategies could result in more favorable investment performance.

There is no assurance that a portfolio will achieve its investment objective. Portfolios are subject to market risk, which is the possibility that the market values of securities owned by the portfolio will decline and that the value of portfolio shares may therefore be less than what you paid for them. Market values can change daily due to economic and other events (e.g. natural disasters, health crises, terrorism, conflicts and social unrest) that affect markets, countries, companies or governments. It is difficult to predict the timing, duration, and potential adverse effects (e.g. portfolio liquidity) of events. Accordingly, you can lose money investing in a portfolio.

In general, equity securities’ values also fluctuate in response to activities specific to a company. Investments in foreign markets entail special risks such as currency, political, economic, and market risks. The risks of investing in emerging market countries are greater than risks associated with investments in foreign developed countries. Fixed income securities are subject to the ability of an issuer to make timely principal and interest payments (credit risk), changes in interest rates (interest-rate risk), the creditworthiness of the issuer and general market liquidity (market risk). In a rising interest-rate environment, bond prices may fall and may result in periods of volatility and increased portfolio redemptions. In a declining interest-rate environment, the portfolio may generate less income. Longer-term securities may be more sensitive to interest rate changes. Real estate investments, including real estate investment trusts, are subject to risks similar to those associated with the direct ownership of real estate.

Alternative investments are speculative, involve a high degree of risk, are highly illiquid, typically have higher fees than other investments, and may engage in the use of leverage, short sales, and derivatives, which may increase the risk of investment loss. These investments are designed for investors who understand and are willing to accept these risks. Performance may be volatile, and an investor could lose all or a substantial portion of its investment.

DISTRIBUTION

This communication is only intended for and will only be distributed to persons resident in jurisdictions where such distribution or availability would not be contrary to local laws or regulations.

Ireland: Morgan Stanley Investment Management (Ireland) Limited. Registered Office: The Observatory, 7-11 Sir John Rogerson’s, Quay, Dublin 2, Ireland. Registered in Ireland under company number 616662. Regulated by the Central Bank of Ireland. United Kingdom: Morgan Stanley Investment Management Limited is authorised and regulated by the Financial Conduct Authority. Registered in England. Registered No. 1981121. Registered Office: 25 Cabot Square, Canary Wharf, London E14 4QA, authorised and regulated by the Financial Conduct Authority. Dubai: Morgan Stanley Investment Management Limited (Representative Office, Unit Precinct 3-7th Floor-Unit 701 and 702, Level 7, Gate Precinct Building 3, Dubai International Financial Centre, Dubai, 506501, United Arab Emirates. Telephone: +97 (0)14 709 7158). Germany: Morgan Stanley Investment Management Limited Niederlassung Deutschland, Grosse Gallusstrasse 18, 60312 Frankfurt am Main, Germany (Gattung: Zweigniederlassung (FDI) gem. § 53b KWG). Italy: Morgan Stanley Investment Management Limited, Milan Branch (Sede Secondaria di Milano) is a branch of Morgan Stanley Investment Management Limited, a company registered in the UK, authorised and regulated by the Financial Conduct Authority (FCA), and whose registered office is at 25 Cabot Square, Canary Wharf, London, E14 4QA. Morgan Stanley Investment Management Limited Milan Branch (Sede Secondaria di Milano) with seat in Palazzo Serbelloni Corso Venezia, 16 20121 Milano, Italy, is registered in Italy with company number and VAT number 08829360968. The Netherlands: Morgan Stanley Investment Management, Rembrandt Tower, 11th Floor Amstelplein 1 1096HA, Netherlands. Telephone: 31 2-0462-1300. Morgan Stanley Investment Management is a branch office of Morgan Stanley Investment Management Limited. Morgan Stanley Investment Management Limited is authorised and regulated by the Financial Conduct Authority in the United Kingdom. Switzerland: Morgan Stanley & Co. International plc, London, Zurich Branch Authorised and regulated by the Eidgenössische Finanzmarktaufsicht (“FINMA”). Registered with the Register of Commerce Zurich CHE-115.415.770. Registered Office: Beethovenstrasse 33, 8002 Zurich, Switzerland, Telephone +41 (0) 44 588 1000. Facsimile Fax: +41 (0) 44 588 1074.

U.S.: A separately managed account may not be appropriate for all investors. Separate accounts managed according to the Strategy include a number of securities and will not necessarily track the performance of any index. Please consider the investment objectives, risks and fees of the Strategy carefully before investing. A minimum asset level is required. For important information about the investment manager, please refer to Form ADV Part 2.

Please consider the investment objectives, risks, charges and expenses of the funds carefully before investing. The prospectuses contain this and other information about the funds. To obtain a prospectus please download one at morganstanley.com/im or call 1-800-548-7786. Please read the prospectus carefully before investing.

Morgan Stanley Distribution, Inc. serves as the distributor for Morgan Stanley funds.

NOT FDIC INSURED | OFFER NO BANK GUARANTEE | MAY LOSE VALUE NOT INSURED BY ANY FEDERAL GOVERNMENT AGENCY | NOT A DEPOSIT

Hong Kong: This document has been issued by Morgan Stanley Asia Limited for use in Hong Kong and shall only be made available to “professional investors” as defined under the Securities and Futures Ordinance of Hong Kong (Cap 571). The contents of this document have not been reviewed nor approved by any regulatory authority including the Securities and Futures Commission in Hong Kong. Accordingly, save where an exemption is available under the relevant law, this document shall not be issued, circulated, distributed, directed at, or made available to, the public in Hong Kong. Singapore: This document should not be considered to be the subject of an invitation for subscription or purchase, whether directly or indirectly, to the public or any member of the public in Singapore other than (i) to an institutional investor under section 304 of the Securities and Futures Act, Chapter 289 of Singapore (“SFA”); (ii) to a “relevant person” (which includes an accredited investor) pursuant to section 305 of the SFA, and such distribution is in accordance with the conditions specified in section 305 of the SFA; or (iii) otherwise pursuant to, and in accordance with the conditions of, any other applicable provision of the SFA. This publication has not been reviewed by the Monetary Authority of Singapore. Australia: This publication is disseminated in Australia by Morgan Stanley Investment Management (Australia) Pty Limited ACN: 122040037, AFSL No. 314182, which accept responsibility for its contents. This publication, and any access to it, is intended only for “wholesale clients” within the meaning of the Australian Corporations Act.

Japan: For professional investors, this document is circulated or distributed for informational purposes only. For those who are not professional investors, this document is provided in relation to Morgan Stanley Investment Management (Japan) Co., Ltd. (“MSIMJ”)’s business with respect to discretionary investment management agreements (“IMA”) and investment advisory agreements (“IAA”). This is not for the purpose of a recommendation or solicitation of transactions or offers any particular financial instruments. Under an IMA, with respect to management of assets of a client, the client prescribes basic management policies in advance and commissions MSIMJ to make all investment decisions based on an analysis of the value, etc. of the securities, and MSIMJ accepts such commission. The client shall delegate to MSIMJ the authorities necessary for making investment. MSIMJ exercises the delegated authorities based on investment decisions of MSIMJ, and the client shall not make individual instructions. All investment profits and losses belong to the clients; principal is not guaranteed. Please consider the investment objectives and nature of risks before investing. As an investment advisory fee for an IAA or an IMA, the amount of assets subject to the contract multiplied by a certain rate (the upper limit is 2.20% per annum (including tax)) shall be incurred in proportion to the contract period. For some strategies, a contingency fee may be incurred in addition to the fee mentioned above.

Indirect charges also may be incurred, such as brokerage commissions for incorporated securities. Since these charges and expenses are different depending on a contract and other factors, MSIMJ cannot present the rates, upper limits, etc. in advance. All clients should read the Documents Provided Prior to the Conclusion of a Contract carefully before executing an agreement. This document is disseminated in Japan by MSIMJ, Registered No. 410 (Director of Kanto Local Finance Bureau (Financial Instruments Firms)), Membership: the Japan Securities Dealers Association, The Investment Trusts Association, Japan, the Japan Investment Advisers Association and the Type II Financial Instruments Firms Association.

IMPORTANT INFORMATION

EMEA: This communication has been issued by Morgan Stanley Investment Management Limited (“MSIM”). Authorised and regulated by the Financial Conduct Authority. Registered in England No. 1981121. Registered Office: 25 Cabot Square, Canary Wharf, London E14 4QA.

There is no guarantee that any investment strategy will work under all market conditions, and each investor should evaluate their ability to invest for the long-term, especially during periods of downturn in the market. Prior to investing, investors should carefully review the strategy’s/product’s relevant offering document. There are important differences in how the strategy is carried out in each of the investment vehicles.

A separately managed account may not be appropriate for all investors. Separate accounts managed according to the Strategy include a number of securities and will not necessarily track the performance of any index. Please consider the investment objectives, risks and fees of the Strategy carefully before investing.

The views and opinions are those of the author or the investment team as of the date of preparation of this material and are subject to change at any time due to market or economic conditions and may not necessarily come to pass. Furthermore, the views will not be updated or otherwise revised to reflect information that subsequently becomes available or circumstances existing, or changes occurring, after the date of publication. The views expressed do not reflect the opinions of all investment teams at Morgan Stanley Investment Management (MSIM) or the views of Morgan Stanley as a whole, and may not be reflected in all the strategies and products that Morgan Stanley or its affiliates offer.

Forecasts and/or estimates provided herein are subject to change and may not actually come to pass. Information regarding expected market returns and market outlooks is based on the research, analysis and opinions of the authors or the investment team. These conclusions are speculative in nature, may not come to pass and are not intended to predict the future performance of any specific Morgan Stanley Investment Management product.

The description of ESG integration in MSIM’s portfolio management teams represent how the portfolio management teams generally implement their investment process under normal market conditions.

Certain information herein is based on data obtained from third party sources believed to be reliable. However, we have not verified this information, and we make no representations whatsoever as to its accuracy or completeness.

This material is a general communication, which is not impartial and all information provided has been prepared solely for informational and educational purposes and does not constitute an offer or a recommendation to buy or sell any particular security or to adopt any specific investment strategy. The information herein has not been based on a consideration of any individual investor circumstances and is not investment advice, nor should it be construed in any way as tax, accounting, legal or regulatory advice. To that end, investors should seek independent legal and financial advice, including advice as to tax consequences, before making any investment decision. Morgan Stanley Investment Management Inc., its affiliates and its and their respective directors, officers, employees, members, stockholders, general and limited partners, sponsors, managers, trustees, agents, advisors, successors, representatives and heirs shall not, to the fullest extent permitted by law, incur liability of any nature for any loss or damage incurred or alleged to be incurred directly or indirectly by any person or entity in connection with (i) the use or receipt of any information contained in this material or (ii) any aspect of such information’s purported or actual accuracy, completeness, fairness, reliability or suitability.

This communication is not a product of Morgan Stanley’s Research Department and should not be regarded as a research recommendation. The information contained herein has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research.

MSIM has not authorised financial intermediaries to use and to distribute this document, unless such use and distribution is made in accordance with applicable law and regulation. Additionally, financial intermediaries are required to satisfy themselves that the information in this document is appropriate for any person to whom they provide this document in view of that person’s circumstances and purpose. MSIM shall not be liable for, and accepts no liability for, the use or misuse of this document by any such financial intermediary.

This document may be translated into other languages. Where such a translation is made this English version remains definitive. If there are any discrepancies between the English version and any version of this document in another language, the English version shall prevail.

The whole or any part of this work may not be reproduced, copied or transmitted or any of its contents disclosed to third parties without MSIM’s express written consent. All information contained herein is proprietary and is protected under copyright and other applicable law.

Morgan Stanley Investment Management is the asset management division of Morgan Stanley.

CRC 3136733 Exp. 06/30/2021

View disclosures

MORE STORIES