More climate-aware investors than ever are seeing the transition to a low-carbon economy as a financial opportunity. So many people are looking to green sources that record amounts of cash are flowing into funds designed for climate-aware investors. As of December 2020, there were 400 mutual funds and exchange-traded funds globally that had climate change as a key theme, with collective assets under management of $177 billion. Global assets almost tripled in one year, according to analysts at Morningstar, Inc., a investment firm that builds financial products and services.
Chicago-based Morningstar has released a 31-page report that assesses the landscape of climate-aware investment products. They looked at last year’s findings and updated them by taking a global view of products from Europe, the US, Canada, and Asia Pacific. Climate-aware funds are those open-end funds and exchange-traded funds that have a branded, climate-related mandate. Such a list of funds spans all key asset classes, including equity, fixed income, allocation, and alternatives.
Although climate change and its negative effects have been recognized for decades, only in the past 4 years has this become a mainstream investment theme. Investors and asset managers started paying attention after the Paris Climate Agreement and the UN Sustainable Development Goals in 2015.
Because climate-aware funds represent a broad range of approaches that aim to meet varying investor needs and preferences, Morningstar applied a suite of carbon exposure metrics to test their claims.
- Each fund’s level of carbon intensity
- The exposure of climate-aware funds to fossil-fuel companies
- The exposure of climate-related funds to oil & gas production
- The exposure of climate-related funds to Thermal Coal Involvement — one of the most carbon-intensive energy sources
- How much exposure to climate solutions investors can expect from climate-aware funds
- The carbon risk embedded in each climate strategy type
The report breaks the market into 5 groups: low carbon, climate conscious, climate solutions, green bond, and clean energy/tech.
- Low carbon funds invest in companies judged to have a relatively benign carbon footprint. DNB Global Lavkarbon, Amundi IS Equity Europe Low Carbon, and TIAA-CREF Social Choice Low Carbon Equity are among the funds that fit this category.
- Climate conscious funds tilt toward companies that are better prepared for the transition to a low-carbon economy. Those include Aviva Investors Climate Transition Euro Equity, DNCA Invest Beyond Climate, and Lyxor S&P Europe Paris-Aligned Climate ETF.
- Climate Solutions funds only target companies that are contributing to the transition to a low-carbon economy. Examples are Candriam SRI Equity Climate Action and Wellington Climate Strategy.
- Green bond funds invest in debt instruments that help finance clean-energy projects. Morningstar singled out LO Funds Global Climate Bond and DPAM L Bonds Climate Trends Sustainable.
- Clean energy/tech funds concentrate most of their assets in renewable energy companies, “smart-grid” distribution networks, and storage and power management technologies. Funds include First Trust Nasdaq Clean Edge Green Energy Index and RobecoSAM Smart Energy.
Key Takeaways for Climate-Aware Investors
- Europe has the latest and most diverse universe of climate-aware funds, with 282 funds and $136 billion in assets, followed by the US, with 42 funds and $21 billion in assets. In the rest of the world, the biggest market is China, which accounts for $17.1 billion.
- The year 2020 saw major developments for climate funds, with a record 76 new launches, globally. Europe saw the launch of 9 passive Paris-aligned funds. These are index funds based on the European Union’s Climate Transition Benchmark and Paris-Aligned Benchmark.
- The climate-aware funds universe represents a broad range of approaches addressing various sustainability and investment objectives.
- Clean Energy/Tech has become the most popular category, holding a third of global assets at the end of 2020, boosted by significant inflows in the fourth quarter. Clean Energy/Tech and Climate Solutions funds represent the most attractive options for investors looking to take advantage of the opportunities created by the transition to a low-carbon economy.
- Climate-aware funds largely deliver on their promises. For example, relative to a global market benchmark, more than 90% of Low Carbon funds do provide access to companies with lower carbon intensity, while Climate Solutions and Clean Energy/Tech funds score high on carbon solutions.
- There are surprises. Many Carbon Solutions and Clean Energy/Tech funds carry some of the highest carbon risk. Alongside companies that focus on providing green solutions, these funds also invest in transitioning companies that operate in carbon-intensive sectors such as utilities, energy, and industrials and that are developing solutions to help reduce their own carbon emissions and that of others.
For those of us small investors who don’t want to subscribe to a pricey service that lists positively performing ESG and other climate-related funds, the Morningstar report also offers lists of the top companies most commonly held in Low Carbon, Climate Conscious, Climate Solutions, and Clean Energy/ Tech funds. That allows you to set up your own watchlists, picking and choosing the companies that speak to your investment ideologies most closely.
Indeed, Morningstar offers the advice that, when choosing a climate product, investors should carefully consider their green preferences and carbon risk appetite. They note that Low Carbon funds provide the greatest shield from carbon risk but will offer little in the way of carbon solutions. Conversely, Clean Energy/Tech funds offer high exposure to carbon solutions as expected but also currently hold the greatest carbon risk in the bunch. (Look at the confusion analysts have over Tesla stock right now if you want to see this in action.)
The rationale for investing in solutions is not only to profit from their potential success but also to help provide the capital and support to bring those solutions into being. If these companies are able to do so successfully, they will have sidestepped their carbon risk in the process. However, it’s important that investors do their homework. Here are some reminders of what you should do to be a truly climate-aware investor.
- Understand different funds’ investment objectives and how the portfolios are constructed.
- Ensure you are comfortable with the level of carbon exposure.
- Look at the funds’ holdings to avoid any bad surprises.
- Bear in mind that some climate change investment strategies can result in narrow and concentrated solutions, which makes them more suitable as satellite holdings than as core parts of a portfolio.
- Remember that climate-aware funds also have a relatively short history, with most launched in the past 2 to 3 years, making their long-term performance hard to assess.
Regarding the header image, see: Why Bitcoin Truly Is Bad For The Climate & Environment, And Counter To Tesla’s Mission