Morningstar Magazine - June/July 2018 - 83

EXHIBIT 4

Effects of Reducing Carbon Risk, World Large-Cap Stock Funds The factor profile
of funds with 10% less carbon risk was similar to that of an index of the category.
There's a more noticeable factor shift for funds with a 30% carbon-risk reduction.

level of exposure to fossil fuel than that of major
global indexes. The S&P 500, MSCI ACWI,
MSCI World, and MSCI Europe indexes all have
exposures between 10% and 11% to companies
involved in the activities listed above.

Morningstar Risk Model Factor Profile Relative to a Market-Cap-Weighted Portfolio
World Large-Cap Stock

ACWI

10% Lower Carbon Risk

30% Lower Carbon Risk

Valuation

0.02

0.04

-0.06

Economic Moat

0.82

0.87

1.04

-0.77

-0.83

-0.74

Financial Health

0.58

0.56

0.65

Ownership Risk

-0.42

-0.42

-0.35

Ownership Popularity

-0.38

-0.42

-0.34

0.05

0.20

0.43

-1.43

-1.43

-1.41

Liquidity

0.21

0.24

0.22

Momentum

0.19

0.22

0.27

-0.60

-0.63

-0.61

Valuation Uncertainty

Value-Growth
Size

Volatility
Source: Morningstar. Data as of 04/30/2018.

significant changes to the overall risk profile
of their investment. As was the case with global
equity, the 30%-lower-carbon-risk funds exhibit
greater differences from the market-cap-weighted
average portfolio across several factors in the
risk model. The 30%-lower-carbon-risk funds are
more growth-oriented (value-growth, valuation),
less volatile (price volatility, valuation uncertainty)
and higher quality (moat, financial health).
The Morningstar Low Carbon Designation

Portfolios that exhibit low overall carbon risk and
have lower-than-average fossil-fuel exposure
will receive the Morningstar Low Carbon
Designation. This designation, represented by a
green leaf icon, is meant to help investors quickly
identify low-carbon-risk funds and, in general,
to educate key stakeholders and the public about
the availability of low-carbon investment
choices. The designation is an indicator that
a portfolio's holdings are in alignment with the
transition to a low-carbon economy.
For a fund to receive the Low Carbon Designation,
it must have a Morningstar Portfolio Carbon
Risk Score below 10 for the trailing 12 months

and fossil-fuel exposure below 7% over the
same period. The initial carbon risk scores were
calculated in April and applied to quarterly
portfolios over the prior year, with fossil-fuel
exposure calculated over the same period.
A new list of funds that receive the designation
will be created every quarter.
The fossil-fuel exposure requirement is designed
to highlight the degree to which a portfolio is
exposed to this most significant carbon risk.
Companies with fossil-fuel exposure are defined
as those with involvement, based on a percentage
of revenue, in the following five activities:
Revenue Threshold (%)

Thermal coal extraction

5

Thermal coal power generation

5

Oil & gas production

5

Oil & gas power generation

5

Oil & gas products and services

50

In the Morningstar database, approximately
6,000 portfolios out of 30,000 receive the
Low Carbon Designation initially. The designation
will help investors better understand what
areas of the market are intrinsically low-carbon.
Many diversified portfolios also receive
the designation. This will highlight the fact
that investors have low-carbon-risk fund
choices across all investment styles and regions.
Portfolio-Level Look at Carbon Risk

The Morningstar Portfolio Carbon Risk Score
provides interested stakeholders with unique
portfolio-level carbon-risk information on
approximately 30,000 funds globally. Using
Sustainalytics' innovative new company carbon
risk ratings, the Morningstar Portfolio Carbon
Risk Scores go beyond traditional carbon
footprinting, taking account of management
actions to mitigate a firm's carbon risk. The vast
coverage of the global funds universe and
the uniqueness of the measure itself open new
doors for investors analyzing the carbon
risk of portfolios.
Based on the initial scores, we observed a range
of carbon risk scores by Morningstar Categories.
Funds investing in Europe ex-UK and in the
United States have the lowest average carbon risk,
while those investing in Asia ex-Japan and
in emerging markets have the highest average
carbon risk. Most categories of diversified
funds, however, have low-carbon-risk fund choices
regardless of their average risk levels. The
Morningstar Portfolio Carbon Risk Scores and the
Morningstar Low Carbon Designation identify
such funds. Investors can now incorporate carbon
risk into their due diligence process alongside
traditional investment criteria. K
Jon Hale, Ph.D., CFA, is director of sustainability research
with Morningstar Research Services. He is a member of
the editorial board of Morningstar magazine.

The portfolio exposure threshold was set at 7%
because it represents about a one third lower

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