Morgan Stanley
  • Investment Management
  • Oct 4, 2022

Managing Climate Change Risks with High Quality, Low Carbon Portfolios

For carbon-conscious investors armed with the relevant data and methodology, one compelling strategy may be as simple as investing in high-quality businesses with low carbon footprints.

Whether it’s the wildfires ravaging the U.S. West Coast or the hurricane-beset Gulf Coast and other disaster-struck regions around the world, the evidence of climate change-related devastation and damage has mounted. Many regulators now recognize global warming as a systemic financial risk, and investors have increasingly focused on assessing climate-change threats to their assets.

An increasing number of asset owners cite the need to address climate change in their portfolios as a leading priority, but they often feel ill-equipped to meet the challenge. In addition to accounting for the physical risks to companies’ properties, supply chains or employees, they must grapple with how to measure transitional costs, such as policy changes and shifting consumer behavior, which could also affect market valuations.

One compelling strategy to address climate change in portfolios may at the same time offer the advantage of simplicity: Invest in steady compounders, or companies with high-quality, franchise businesses and a high return on operating capital. Not only can they compound their earnings over time, but they typically also have a low-carbon footprint.  

Scoping the Emissions Value Chain

How do we go about identifying such opportunities? As active stock-pickers, we believe that by seeking businesses with intangible, rather than physical, assets which sell products or services that typically have a lower-than-average carbon footprint, we can also address climate change risks in our portfolios. In addition, we analyze the various sources of greenhouse-gas emissions across the value chain, to which companies may be exposed.

Let’s start with parsing greenhouse-gas accounting, which divides all emissions into three scopes:

  • Scope 1 emissions comprise a company’s own direct  emissions from its coal or natural-gas power plants, cement kilns, steel furnaces or trucks.

  • Scope 2 emissions are embedded in the organization’s electricity purchases. They depend on the energy intensiveness of the factory or production and the electricity provider’s energy mix, whether renewables or fossil fuels—now a matter of choice in many countries.

  • Scope 3 emissions comprise indirect sources related to a company’s supply chains or customer logistics and product use. 

The first two types of emissions are reasonably straightforward to assess, and most companies regularly report such data. Just three sectors in the MSCI World Index—utilities, energy and materials—account for around 80% of these emissions. But, comparing companies’ Scope 3 emissions can be more difficult, due to lack of data and double-counting. For example, the same carbon-dioxide emissions from aluminum produced for a soft drink can may be included in the calculations by the aluminum smelter, can manufacturer, bottler and retailer. Whose emissions are they?

However, if companies—and in turn, investors—can better understand the full value chain of emissions, including Scope 3, and identify where the risks are, they can help set reduction targets, engage with suppliers and other partners, and improve communications and corporate reputations.

For more information on decarbonization basics, see our full report.

Options for Managing Carbon in a Portfolio

Now, let’s look at three traditional approaches by public equity investors to reduce carbon exposure in their portfolios.

  1. Invest in companies that directly contribute to decarbonization, such as renewable energy producers. While clear-cut, this approach has hard limits: According to Factset, the subset of Alternative Power Generation companies constitutes a mere 0.24% of the MSCI World Index free float.1 Given the scarcity of such pure play companies, another related approach is to invest in companies that have small but growing exposure to business areas that contribute to energy transition, e.g. ‘mainstream’ industrials that provide smart grid or renewable energy equipment. While this approach casts the net wider, it is still relatively niche.

  2. Divest from companies that own fossil-fuel reserves, given their potential for significant future carbon emissions. Some might argue, however, that this fails to address current emissions across other carbon-heavy sectors that don’t directly own fossil-fuel reserves, such as utilities.

  3. Invest in index strategies, which can help dilute a portfolio’s carbon impact to achieve a desired target. In a sample of 20 exchange-traded funds classified as low-carbon by Morningstar, for example, the weighted average carbon intensity reduction vs. the relevant benchmark was 49%.

High-Quality, High-ROOCE Companies

It’s possible to do better. For those seeking an active investment approach, you don’t have to explicitly allocate to an environmentally focused strategy to achieve a low carbon footprint.

Because carbon emissions are in fact capital-intensive, a strong inverse correlation exists between return on operating capital employed (ROOCE, a key metric to assess company quality) and carbon intensity. High-quality and high-ROOCE companies aren’t just steady compounders, they also have a structurally smaller carbon footprint.

Examples of this abound. Consider software and IT service providers, or consulting firms and media content companies that by definition have low total carbon footprint per unit of revenue, which is limited to their offices, data centers and staff travel. Even with the remarkable growth of cloud computing services, major software companies’ Scope 1 and 2 intensity remain relatively low, and many have made significant progress sourcing renewable power for their data centers.

Other examples include companies that sell physical goods. Take, for example, manufacturers of healthcare or consumer products, which have Scope 1 and 2 emissions-per-million of sales that are still significantly lower than a broad market index because they operate in the low-carbon, high-value-added part of the supply chain. Their products also typically have relatively low to no product-use-related Scope 3 emissions, compared with more energy-intensive activities—such as driving petrol cars or flying planes. These companies also face lower disruption risk from the decarbonization trend due to their strong pricing power and indispensable nature of their products.

For these reasons, investing in a concentrated portfolio of high-return-on-capital compounders may significantly reduce carbon exposure, without sacrificing long-term performance.

Risk Considerations

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 value of securities owned by the portfolio will decline. 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 this strategy. Please be aware that this strategy may be subject to certain additional risks. Changes in the worldwide economy, consumer spending, competition, demographics and consumer preferences, government regulation and economic conditions may adversely affect global franchise companies and may negatively impact the strategy to a greater extent than if the strategy’s assets were invested in a wider variety of companies. 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. Stocks of small-capitalisation companies carry special risks, such as limited product lines, markets and financial resources, and greater market volatility than securities of larger, more established companies. The risks of investing in emerging market countries are greater than risks associated with investments in foreign developed markets. Non-diversified portfolios often invest in a more limited number of issuers. As such, changes in the financial condition or market value of a single issuer may cause greater volatility.


This material 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.

MSIM, the asset management division of Morgan Stanley (NYSE: MS), and its affiliates have arrangements in place to market each other’s products and services.  Each MSIM affiliate is regulated as appropriate in the jurisdiction it operates. MSIM’s affiliates are: Eaton Vance Management (International) Limited, Eaton Vance Advisers International Ltd, Calvert Research and Management, Eaton Vance Management, Parametric Portfolio Associates LLC, and Atlanta Capital Management LLC.

This material has been issued by any one or more of the following entities:


This material is for Professional Clients/Accredited Investors only.

In the EU, MSIM and Eaton Vance materials are issued by MSIM Fund Management (Ireland) Limited (“FMIL”). FMIL is regulated by the Central Bank of Ireland and is incorporated in Ireland as a private company limited by shares with company registration number 616661 and has its registered address at The Observatory, 7-11 Sir John Rogerson's Quay, Dublin 2, D02 VC42, Ireland.

Outside the EU, MSIM materials are issued by Morgan Stanley Investment Management Limited (MSIM Ltd) 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.

In Switzerland, MSIM materials are issued by Morgan Stanley & Co. International plc, London (Zurich Branch) Authorised and regulated by the Eidgenössische Finanzmarktaufsicht ("FINMA"). Registered Office: Beethovenstrasse 33, 8002 Zurich, Switzerland.

Outside the US and EU, Eaton Vance materials are issued by Eaton Vance Management (International) Limited (“EVMI”) 125 Old Broad Street, London, EC2N 1AR, UK, which is authorised and regulated in the United Kingdom by the Financial Conduct Authority. 

Italy: MSIM FMIL (Milan Branch), (Sede Secondaria di Milano) Palazzo Serbelloni Corso Venezia, 16 20121 Milano, Italy. The Netherlands: MSIM FMIL (Amsterdam Branch), Rembrandt Tower, 11th Floor Amstelplein 1 1096HA, Netherlands. France: MSIM FMIL (Paris Branch), 61 rue de Monceau 75008 Paris, France. Spain: MSIM FMIL (Madrid Branch), Calle Serrano 55, 28006, Madrid, Spain. Germany: MSIM FMIL (Ireland) Limited Frankfurt Branch, Große Gallusstraße 18, 60312 Frankfurt am Main, Germany (Gattung: Zweigniederlassung (FDI) gem. § 53b KWG). Denmark: MSIM FMIL (Copenhagen Branch), Gorrissen Federspiel, Axel Towers, Axeltorv2, 1609 Copenhagen V, Denmark.


Dubai: MSIM Ltd (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).



Latin  America (Brazil, Chile Colombia, Mexico, Peru, and Uruguay)

This material is for use with an institutional investor or a qualified investor only. All information contained herein is confidential and is for the exclusive use and review of the intended addressee, and may not be passed on to any third party. This material is provided for informational purposes only and does not constitute a public offering, solicitation or recommendation to buy or sell for any product, service, security and/or strategy. A decision to invest should only be made after reading the strategy documentation and conducting in-depth and independent due diligence.


Hong Kong: This material is disseminated 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 material 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 material shall not be issued, circulated, distributed, directed at, or made available to, the public in Hong Kong. Singapore: This material is disseminated by Morgan Stanley Investment Management Company and 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 material 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.  Calvert Research and Management, ARBN 635 157 434 is regulated by the U.S. Securities and Exchange Commission under U.S. laws which differ from Australian laws. Calvert Research and Management is exempt from the requirement to hold an Australian financial services licence in accordance with class order 03/1100 in respect of the provision of financial services to wholesale clients in Australia.


For professional investors, this material is circulated or distributed for informational purposes only. For those who are not professional investors, this material 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 material 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. 


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.

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 managers, please refer to Form ADV Part 2.

The  views and opinions and/or analysis expressed 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 without notice 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 personnel at Morgan Stanley Investment Management (MSIM) and its subsidiaries and affiliates (collectively “the Firm”), and may not be reflected in all the strategies and products that the Firm offers.

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 strategy or product the Firm offers. Future results may differ significantly depending on factors such as changes in securities or financial markets or general economic conditions.

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.

The Firm has not authorised financial intermediaries to use and to distribute this material, 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 material is appropriate for any person to whom they provide this material in view of that person’s circumstances and purpose. The Firm shall not be liable for, and accepts no liability for, the use or misuse of this material by any such financial intermediary.

This material 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 material in another language, the English version shall prevail.

The whole or any part of this material may not be directly or indirectly reproduced, copied, modified, used to create a derivative work, performed, displayed, published, posted, licensed, framed, distributed or transmitted or any of its contents disclosed to third parties without the Firm’s  express written consent. This material may not be linked to unless such hyperlink is for personal and non-commercial use. All information contained herein is proprietary and is protected under copyright and other applicable law.

CRC 4958519  Exp 9/30/2023