Morningstar starts scoring funds on carbon risk via Sustainalytics data

Ratings firm will badge funds with low carbon risk and fossil fuel exposure

Morningstar, the influential funds rating company, is to start scoring investment funds based on their carbon ‘transition risk’ via a new product called Portfolio Carbon Metrics based on Sustainalytics data, which evaluates the potential for the fund’s underlying portfolio companies to be affected by tightening regulation, consumer shifts or physical impacts such as extreme weather. The fund ratings company will also label funds that have both low carbon risk and low fossil fuel exposure with a green badge. The transition risk calculation is based on the goals of the Paris Agreement to keep the global-temperature rise below 2 degrees Celsius above preindustrial levels with an aim of limiting the rise in temperature to 1.5 degrees Celsius. The Sustainalytics research, via a new Carbon Risk Ratings product, covers more than 4,000 publicly-listed companies across 147 sub-industries. It is being rolled out for its own clients as well as underpinning the new Morningstar fund scores.
It looks at companies’ exposure to policy and legal risks across 70 carbon indicators such as rising GHG emissions pricing, increased regulation and reporting, and litigation risk. Other risk factors assessed are technology risk (shift to lower carbon products, replacement of exiting products), market risk (changing consumer behaviour, increased raw material), reputation (shifts in consumer preferences or stigmatisation), and physical risks (increased severity of weather events,rising sea levels). Sustainalytics scores the unmanaged carbon risk that it calculates remains for a company after accounting for management activities that mitigate overall carbon-risk exposure. The lower the score, the lower the risk.
Morningstar’s score is an asset-weighted version of the Sustainalytics data. Jon Hale, Head of Sustainability Research at Morningstar said that in global developed-markets and emerging-markets portfolios, it is estimated that carbon risk could be reduced by 10% without making otherwise significant changes. He said lowering carbon risk by 30% in global developed markets portfolios could result in shifts toward growth and quality and in emerging markets may result in lower overall volatility. 
Michael Jantzi, CEO at Sustainalytics, said investors wanted to better understand carbon risk exposure following the work of the Task Force on Climate-related Financial Disclosures (TCFD) and burgeoning climate change legislation worldwide. He said the scores could support investment decisions and low carbon product development and could be particularly important for investor engagement with companies on climate change.
In July last year, Morningstar took a 40% stake and a seat on the board at Sustainalytics. Link to RI story
That followed a strategic collaboration announced in August 2015 that led to the launch, in March 2016, of the Morningstar Sustainability Rating for mutual and exchange-traded funds.