Portfolio Strategies to Support Decarbonization in the Real Economy: An Overview

Why Scale Up Transition Financing in Emerging Markets? 

2024 marked the hottest year on record,¹ with average global temperatures surpassing the 1.5 degrees Celsius warming limit set in the 2015 Paris Agreement. To limit warming and achieve the ambitious goal of net zero emissions by 2050, a massive scaling up of investment is essential to support accelerating decarbonization efforts. 

Emerging markets and developing economies are expected to be the largest source of future emissions growth² due to growing energy demands driven by rapid industrialization, urbanization, and population growth.³ These markets have also historically received less investment than developed markets,⁴ and so a mobilization of unprecedented levels of capital from the private sector is required,⁵ with the International Energy Agency (IEA) estimating that clean energy spending alone in emerging economies needs to be at least tripled by 2030 (to around USD 2-3 trillion per year between 2030 and 2050).⁶ In climate-driven scenarios, the private sector will need to finance about 60% of this clean energy spending.⁷

This funding gap could be closed significantly if institutional investors were to allocate even a fraction of their funds to financing decarbonization efforts. This would also enable them to have a real-economy impact and differentiate their portfolio strategies. Additionally, investors that manage transition risks and identify the investment opportunities sooner may be better positioned in the long term to benefit from the transition potential, economic growth, and diversification in emerging markets, which will be reshaped by evolving regulatory expectations, shifting consumer preferences, and technological advancements. 

Shift From Portfolio Decarbonization to Financing Reduced Emissions in the Real Economy 

To better manage systemic climate risks and influence the transition to net zero emissions, institutional investors are increasingly adopting strategies that influence and support decarbonization in the real economy (i.e., where emissions are generated via the production and distribution of goods and services). This reflects a shift from simply decarbonizing portfolios by divesting from high-emitting assets, which can immediately impact a portfolio’s reported carbon footprint, but may not directly lead to an actual reduction in global greenhouse gas (GHG) emissions. 

Decarbonizing the real economy and addressing economy-wide systemic risks is complex and will take time, requiring a long-term view. This approach to supporting decarbonization in the real economy is being advocated for by investor-led associations such as the Paris Aligned Investment Initiative (PAII) and the Glasgow Financial Alliance for Net Zero (GFANZ), which collectively represent trillions in assets under management. 

nstitutional investors with broad market exposure might consider how they can contribute to the reduction of real-world emissions, although achieving net zero by 2050 is impossible without financing critical transition strategies to decarbonize energy intensive (i.e., hard-to-abate) sectors, such as integrated oil and gas producers, cement and steel. 

Our recently published report, Opportunities to Finance Reduced Emissions in Emerging Economies, offers strategies for investors to finance decarbonization activities in emerging and developing market, including leveraging index and transition risk data. 

Portfolio Strategies to Prioritize Decarbonization in Emerging Markets 

There are a range of portfolio strategies that aim to manage the emissions trajectory over time and could be applied to emerging markets. These include allocating capital to carbon-intensive sectors and companies through best-in-class selection, prioritizing engagement, and financing capital-intensive transition projects.

Figure1 outlines several strategies for institutional asset owners (such as sovereign wealth funds, pension funds, and endowments) managing multi-asset total portfolio strategies that seek to influence real economy decarbonization in emerging markets. These portfolio approaches, which aim to mitigate longer-term systemic climate risks, are suggested in lieu of divestment. (This is not an exhaustive list).

Figure 1. Decarbonization Strategies in Hard-to-Abate Sectors

Best-in-Class Selection: Allocating capital towards industry leaders demonstrating climate action in hard-to-abate sectors offers a significant opportunity for real-economy impact and rewards companies actively transitioning their business model towards alignment with Paris Agreement goals. 

Carbon-intensive companies can be identified by incorporating scope 3 emissions into evaluations, alongside scope 1 and 2 emissions, to assess emissions across the entire business value chain. Scope 3 emissions refer to indirect emissions that are generated upstream in the supply chain, and downstream when the company’s products are used. In some industries, scope 3 emissions can be the most material source of emissions contribution. 

Engagement: All sectors will be impacted by climate change, albeit in varying degrees. Regardless, all sectors will need to manage physical and transition risks. Rather than divest, prioritizing engagement activities as good stewards of capital is important for investors to have a real-economy impact, particularly with carbon-intensive companies that are slow to make progress or are at the early stage of their transition readiness. 

Directly Financing Transition Projects: Leaving the low-carbon transition to market mechanisms alone has not resulted in the necessary industrial shifts, at the speed needed, to drive decarbonization in carbon-intensive sectors. Barriers to progress, particularly in emerging markets, include lack of direct investment to fund scalable high-impact climate projects or implement decarbonization technologies, in addition to weak market demand for low-carbon alternatives. Direct financial support is crucial to bridge the investment gap in decarbonizing hard-to-abate sectors. Investors can consider several approaches to finance transition projects, such as: 

1. Evaluating corporate bond issuances: Prioritize bonds that finance low-carbon transitions or those issuing labelled green bonds with clear use of proceeds. 
2. Prioritizing sector-specific approaches: Rather than blanket exclusions, asset owners may consider prioritizing high-emitting sectors, like industrials or power generation, with tailored decarbonization strategies to enable or accelerate broader decarbonization efforts. 
3. Financing projects in private markets: Asset owners are increasingly allocating capital to private markets, through private equity firms, venture capital funds, blended finance structures, private debt, or direct investment as part of their broader strategies to help finance innovation in capital-intensive climate technologies and low-carbon projects. 

Index Approach – Financing Transition Strategies in Emerging Markets 

In our recent report, we highlight an index approach to explore emerging market opportunities. Index methodologies can be designed to systematically incorporate companies leading on climate action for best-in-class selection or to identify and track companies for engagement. 

We analyzed the Morningstar Emerging Markets Low Carbon Transition Leaders Index™ (EM LCTL), which is a thematic sub-set of the Morningstar Emerging Markets Target Market Exposure Index™ (EM TME). The EM LCTL Index is designed to provide diversified, broad market exposure to companies outperforming their sector peers in their commitment to climate action. Its methodology draws from Morningstar Sustainalytics’ Low Carbon Transition Ratings (LCTR).   

Using the LCTR methodology, we identified: 

• 125 unique companies (24% of 524) listed on the EM LCTL Index assessed as having strong management of low carbon transition readiness. 
• 168 companies (32% of 524) listed on the EM LCTL Index assessed as having average management; that is, companies demonstrating some activities in pursuit of reducing GHG emissions, but not yet considered in line with best practices, nor sufficient to manage their emissions trajectory towards alignment to a net zero pathway.  

In comparing the parent index (EM TME) and its thematic subset (EM LCTL), we observe that the EM LCTL Index includes nearly double the percentage of companies assessed as having strong management of low-carbon transition readiness compared to its parent (24% vs 13%). Moreover, from an index weight perspective, the exposure to strong performers increases by roughly 13% – a material improvement (see Figure 2). 

Figure 2. Comparing the EM TME Parent Index and the EM LCTL Index 

Of note, the EM LCTL Index, which launched in early 2024, outperformed its parent index by 1.54% by year end.⁸

Outperformers in Transition Readiness in Hard-to-Abate Sectors 

To take a more nuanced approach, we isolated climate action activities in the highest carbon-intensive sectors⁹ on the EM LCTL Index. Sectors are defined by the Morningstar Global Equity Classification Structure. 

By focusing on the three highest carbon-intensive sectors (materials, energy, utilities), among 11 sectors, we identified 38 unique companies (31% of 121) assessed as having strong management of low-carbon transition readiness, representing a positive active weight of 2% and roughly double the percentage of companies assessed as having strong management compared to its parent benchmark (7.3% strong performers on EM LCTL Index vs 3.2% on the EM TME Index). The 38 companies are listed in the report. 

For asset owners prioritizing carbon-intensive sectors, the EM LCTL Index is better positioned to provide greater exposure to strong performers as part of a best-in-class portfolio strategy, while also identifying opportunities for engagement. 

Best Practices in Transition Readiness 

Companies demonstrating strong performance in managing climate risks and transforming their business to reduce their emissions trajectory typically follow several best practices for climate action. Leading companies often demonstrate a higher degree of disclosure on their transition plans and on how they are aligning their own governance and operational processes to meet low-carbon transition objectives, making it easier to assess their activities.¹⁰ 

Our analysis of transition readiness in the preceding index overview is centered on standard best practices for climate action, as assessed by Morningstar Sustainalytics’ Low Carbon Transition Ratings. A summary of best practices is described in the report. For a more comprehensive overview, see The Investor’s Guide to Assessing Corporate Climate Transition Plans.   

Demonstrating Best Practices in Transition Readiness 

Using the LCTR assessment methodology and a subindustry analysis, we identified two companies listed on the EM LCTL Index operating in carbon-intensive subindustries that demonstrate best practices in transition readiness.  

See Table 3 for a summary of Enel Chile SA and TCC Group Holdings Co. Ltd. For a more comprehensive overview of the transition readiness practices of these companies, see the full report.

Table 3. Snapshot of Two Companies Listed on the Morningstar Emerging Markets Low Carbon Transition Leaders Index™ Demonstrating Best Practices in Transition Readiness

Read more about financing reduced emissions in emerging markets in our full report. 

References:  

1. The Copernicus Climate Change Service. 2024. "Copernicus: Second-warmest November globally confirms expectation for 2024 as warmest year." Press Release. December 9, 2024. https://climate.copernicus.eu/copernicus-second-warmest-november-globally-confirms-expectation-2024-warmest-year.
2. International Energy Agency and International Finance Corporation. 2023. "Scaling Up Private Finance for Clean Energy in Emerging and Developing Economies." June 2023. https://iea.blob.core.windows.net/assets/a48fd497-d479-4d21-8d76-10619ce0a982/ScalingupPrivateFinanceforCleanEnergyinEmergingandDevelopingEconomies.pdf. 
3. According to the World Economic Forum, emerging economies accounted for over 95% of the increase in greenhouse gas (GHG) emissions during the past decade. See World Economic Forum. 2022. "3 Actions to Accelerate Emerging Market Climate Transition." June 14, 2022. https://www.weforum.org/stories/2022/06/3-actions-to-accelerate-emerging-market-climate-transition. 
4. UN Trade & Development. 2023. "World Investment Report 2023." https://unctad.org/publication/world-investment-report-2023. 
5. International Energy Agency. 2023. "Scaling Up Private Finance for Clean Energy in Emerging and Developing Economies." June 2023. https://www.iea.org/reports/scaling-up-private-finance-for-clean-energy-in-emerging-and-developing-economies.  
6. Estimates exclude China. See International Energy Agency. 2021. "Financing Clean Energy Transitions in Emerging and Developing Economies."  June 2021.  
7. International Energy Agency. 2023. Scaling Up Private Finance for Clean Energy in Emerging and Developing Economies. https://www.iea.org/reports/scaling-up-private-finance-for-clean-energy-in-emerging-and-developing-economies. June 2023.  
8. Morningstar Indexes. 2025. In a Mixed Year for Sustainable Investing – Most Climate and Net Zero-Aligned Indexes Outperformed in 2024. January 28, 2025. https://indexes.morningstar.com/insights/analysis/bltb2c0f2c420d4b98d/in-a-mixed-year-for-sustainable-investing-most-climate-and-net-zero-aligned-indexes-outperformed-in-2024 
9. We selected the highest carbon-intensive sectors based on whether a sector’s scope 123 carbon intensity median was above a certain threshold (i.e. scope 123 carbon intensity of 864). This threshold was chosen based on the carbon intensity of the constituents of the parent EM TME Index and specifically based on the 75th percentile of the carbon intensity distribution across the Index. 
10. Joshi, Pustav, “Beyond 1.5 Degrees: What the LCTR Tells Us About Companies Managing Their Climate Risk.” Morningstar Sustainalytics. March 11, 2024. https://www.sustainalytics.com/esg-research/resource/investors-esg-blog/beyond-1.5-degrees--what-the-lctr-tells-us-about-companies-managing-their-climate-risk