Summary
The impacts of the coronavirus pandemic have reverberated aggressively across the globe. Immediateterm societal priorities are on protecting public health and stabilising financial and employment markets.
This period also serves as a reminder of global interconnectedness, systemic risk, and the vulnerabilities and tensions between economic, social, environmental, and governance considerations. The climate change resulting from anthropogenic emissions has already had a harmful effect on human and natural systems. Efforts to combat climate change by reducing greenhouse-gas, or GHG, emissions have taken on greater urgency. The 2015 International Paris Agreement to limit global warming to well below 2 degrees Celsius above pre-industrial levels recognised that any warming beyond that threshold would have devastating consequences. Many governments, particularly in Europe, have responded with policies to incentivize renewable energy and to tax carbon and greenhouse-gas emissions. Investors also are becoming increasingly aware of climate-change-related risks and the need to transition away from carbon-intensive activities. Pressure is mounting on asset managers, pension funds, and other asset owners, including in Australia, to more thoughtfully consider carbon risk.
In order to mitigate the impact of climate change as economies transition to low-carbon consumption, there will be opportunities for companies to innovate and adapt to a greener world. Conversely, companies that don't evolve will be threatened by stranded assets and outmoded business models. With this backdrop, Morningstar has developed a suite of carbon tools that empower investors in identifying carbon risks within investment portfolios.
In this report, we have utilized Morningstar's carbon tools to compare carbon risk in managed funds categorised within Morningstar's Australia-domiciled large world equity and large Australian equitymanaged fund categories. We compare the characteristics of Morningstar® Low Carbon Designation™ funds in Australia with global findings, so that climate-aware Australian investors can benefit from those insights, given sustainable investing in our region is still somewhat in its infancy.
Key Takeaways × Climate change poses both physical and transitional risk--Morningstar's carbon tools empower investors in identifying the risks and opportunities for companies and within portfolios. × Carbon risk, as calculated by Morningstar partner Sustainalytics (currently 40% owned by Morningstar), is a forward-looking view of a company's management of its risks and opportunities in the transition to a low-carbon economy. × Overall carbon emissions for the Morningstar Australia GR Index are 54% higher than the Morningstar Global Markets GR Index. This is driven by Australia's overweight in high-carbon-emission sectors such as energy and materials and the predominance of coal in electricity generation. ×Overall carbon risk for the Morningstar Australia GR Index is only 18% higher than the Morningstar Global Markets GR Index. This indicates overall stronger management of carbon risk by companies in the index, but it also reflects regulation in the operating environment. × Morningstar Low Carbon Designation denotes portfolios with low-carbon risk and low fossil-fuel exposure:
Key Takeaways × Climate change poses both physical and transitional risk--Morningstar's carbon tools empower investors in identifying the risks and opportunities for companies and within portfolios. × Carbon risk, as calculated by Morningstar partner Sustainalytics (currently 40% owned by Morningstar), is a forward-looking view of a company's management of its risks and opportunities in the transition to a low-carbon economy. × Overall carbon emissions for the Morningstar Australia GR Index are 54% higher than the Morningstar Global Markets GR Index. This is driven by Australia's overweight in high-carbon-emission sectors such as energy and materials and the predominance of coal in electricity generation. ×Overall carbon risk for the Morningstar Australia GR Index is only 18% higher than the Morningstar Global Markets GR Index. This indicates overall stronger management of carbon risk by companies in the index, but it also reflects regulation in the operating environment. × Morningstar Low Carbon Designation denotes portfolios with low-carbon risk and low fossil-fuel exposure:
- Twenty percent of all Australia-domiciled and U.S.-domiciled world large-equity funds received the Morningstar Low Carbon Designation. In comparison, 33% of Europe-domiciled world large-equity funds received this designation. The EU Action Plan on Sustainable Finance has been an impactful regulatory development.
- Only 6% of Australian large-equity funds received the Morningstar Low Carbon Designation. This proportion in vastly lower than large domestic-market equity categories in U.S. and Europe.
- Only one fund that received the Morningstar Low Carbon Designation in the Australian large-equity category had an explicit Sustainability objective within its product disclosure statement objective, adding complexity in the selection of funds for climate-aware investors.The limitations of the smaller universe size in this category is acknowledged.
- In large world categories and in large domestic equities in regions other than Australia, large-growth funds, received the highest proportion of the Morningstar Low Carbon Designations.
- The downside capture ratio for Australian large world funds receiving the Morningstar LownCarbon Designation was 78%, compared with 92% for large world blend category overall, indicating better protection in falling markets. Those funds also displayed quality factors such as higher returns on equity and lower debt/capital ratios.
- Few large Australian growth funds received the Morningstar Low Carbon Designation. In contrast, a significantly higher proportion of large Australian value funds received the Low Carbon designation than domestic-equity funds in other regions. This is explained by Australian large-value funds generally having higher exposure to financials with lowercarbon risk.