Morningstar Magazine - June/July 2018 - 82

Strategies

Risk Score

Rating

50+

Severe

30-49.9

High

246

Number of Companies

10-29.9
Medium
The
average carbon-risk
score for U.S. funds is 10.45.
Risk
scores
are
higher
for
0.1-9.99
Low emerging-markets
funds. Diversified emerging-markets equity funds
0
Negligible
have an average risk score of 15.59. Within
0
the emerging-markets group, Emerging Europe,
a group dominated by Russia funds, have
the highest average risk score (28.53), while Africa/
Middle East funds have the lowest (10.23).

the highest carbon risk scores (energy,2,090
utilities,
and744
materials), while U.S. large-growth funds have
less than one tenth of their assets invested
696
in those sectors. Large-value funds average just
1,800
a 6600
.4% weighting in1,200
technology, which
has one2,400
of the lowest carbon risk profiles, compared
with 17.8% for large-growth funds. Large-value and
large-growth funds have similar average exposure
to the healthcare sector, so both benefit
about equally from that sector's low carbon risk.

Carbon risk scores of funds can be explained, in
part, by their sector weightings. E X H I BI T 3
Fund Type
Lowest 5%
shows the carbon risk scores by sector, using
Global
iShares global sector exchange-traded funds as
proxies.
The energy sector, not surprisingly,
US
carries the largest carbon risk, at 43.01, more than
Canada
twice that of utilities, which has a carbon risk
Developed
Europe
ex-UKand industrials also have
. Materials
score of 19.71
higher
relative
scores.
On the low end of the
UK
range are technology, which weighs in at 2.91, and
Developed
ex-Japan
healthcare, Asia
which
has an ultralow score of 1.19.
Japan
U.S. large-value funds, which are overweight the
Australia/NZ
higher carbon risk sectors, have an average
Emerging
carbon riskMarkets
score of 12.83, considerably higher
7
.
1
average score of U.S. large-growth
than
the
Emerging Asia
funds. Large-value funds devote more than
Emerging Europe
one fifth of their assets to the three sectors with
Africa/Middle East

Middle 90%
Highest 5%
Average
Regional differences play a role as well. Emergingmarkets managers, for example, generally
must choose among higher carbon risk companies
compared with developed-markets managers.
In the automobile industry, emerging-markets firms
have an average carbon risk score of 41.2, in
the high risk range. Developed-markets auto firms
have a much lower average carbon risk score
of 26.3, in the medium risk range. Funds in
all emerging-markets regions, except for Africa/
Middle East, have average carbon risk scores
of 15 or more.
Considerable variation in fund carbon risk scores
exists within most fund categories. Intracategory
comparisons can highlight the possibilities for

Latin America

EXHIBIT 3

10
30
40
Portfolio Carbon Risk Scores0 by Sectors
Carbon20risk scores
of funds
can be50
partially explained by their sector weightings.
Sector Funds

Carbon Risk Score
43.01

Energy IXC
Utilities JXI

19.71

Materials MXI

17.23

Industrials EXI

15.55

Real Estate REET

11.96

Financials IXG

11.13

Telecom Services IXP

9.04

Consumer Discretionary RXI

8.29

Consumer Staples KXI

5.33

Information Technology IXN

2.91

Health IXJ
Source: Morningstar. Data as of April 2018.

Morningstar June/July 2018

1.19

investors wanting to lower the carbon risk in their
portfolios. Asset managers, for example, can
compare their risk scores with those of peer funds
to understand how lower-carbon-risk portfolios
differ from higher-carbon-risk portfolios across
other standard portfolio metrics. This information
can help asset managers assess the feasibility
of lowering carbon risk in their own portfolios. Fund
investors can set a goal for carbon-risk reduction
and use it to find lower-carbon alternatives.
We analyzed two Morningstar Categories, world
large-cap and diversified emerging markets, using
the Morningstar Risk Model to assess the
differences between average carbon risk funds
and lower carbon risk funds. For each of the two
categories, an iShares ETF was selected to
represent a market-cap-weighted average portfolio.
Next, the five funds in each category with the
carbon risk scores closest to 10% below the
iShares ETFs were selected and another five funds
with the carbon risk scores closest to 30% below
the iShares ETFs were selected. The 10% group and
the 30% group were then compared with the
iShares portfolios using the Morningstar Risk Model.
For world large cap, the average factor profile
of the funds with 10% less carbon risk was similar
to that of the iShares portfolio ( EXHIBIT 4 ).
This suggests that investors can lower their carbon
risk by 10% without otherwise altering their factor
exposures significantly. The 10%-lower-carbonrisk funds are somewhat more growth-oriented
(value-growth), but otherwise their factor
premiums are close to those of the market-capweighted portfolio. Investors wanting to lower
carbon risk more significantly in their global equity
exposure would experience a more noticeable
shift in style and quality. The 30%-lower-carbonrisk funds are more growth-oriented (value-growth,
valuation) and higher quality (economic moat).
For diversified emerging markets, the results were
similar. The 10%-lower-carbon emerging-markets
funds do not differ markedly from the iShares portfolio. Modest differences in the average premiums
of ownership risk, price volatility, and size
suggest the 10% group is somewhat less risky in
traditional investment terms and invests in smaller
companies. Emerging-markets investors
could lower carbon risk without otherwise making

Table of Contents for the Digital Edition of Morningstar Magazine - June/July 2018