Globally, regulators are ratcheting up efforts to combat climate change and the investment industry is responding in kind with more disclosure and more ambitious targets. The 2021 UN Climate Change Conference (COP) will begin in November. At the summit, delegates including heads of state, climate experts and negotiators will come together to agree on coordinated action to tackle climate change.
Morningstar has been observing the reaction of investors closely and as of December 2020, there were 400 mutual funds and exchange-traded funds (ETFs) globally that had climate change as a key theme, with collective assets under management of $177 billion. Indeed, 2020 was a major year of development for the climate funds universe with a record 76 launches of climate mandated funds, globally assets almost tripled in one year.
Europe is the largest 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.
Our universe of climate-aware funds is subdivided into five mutually exclusive groups based on investment objective and policy, diversification, and sector exposure: Low Carbon, Climate Conscious, Climate Solutions, Green Bond, and Clean Energy/Tech
- Low Carbon funds seek to invest in companies with reduced carbon intensity and/or carbon footprint relative to a benchmark index.
- Climate Conscious funds select or tilt toward companies that consider climate change in their business strategy and therefore are better prepared for the transition to a low-carbon economy.
- Climate Solutions funds only target companies that are contributing to the transition to a low-carbon economy through their products and services and that will benefit from this transition. These funds are less well diversified and tilted towards industry and technology.
- Clean Energy/Tech funds invest in companies that contribute to or facilitate the clean energy transition. These funds are concentrated in industry and technology sectors.
- Green Bond funds invest in debt instruments that finance projects facilitating the transition to a green economy.
We analysed our list of funds by climate strategy type to ascertain how they compare against one another and whether they deliver what they claim to deliver.
- Carbon Intensity. We found that 54% of the funds included in our analysis with carbon intensity numbers offer an improvement on the benchmark. The majority of these are Low Carbon and Climate Conscious funds. By contrast, most Climate Solutions and Clean Energy/Tech funds exhibit higher carbon-intensity scores than the index.
- Fossil Fuel Involvement. We found that more than 80% of Climate Conscious funds and more than 70% of Climate Solutions funds have lower Fossil-Fuel Involvement than the index. However, only 52% of Clean Energy/Tech funds do.
- Oil & Gas Production Involvement. The vast majority of funds included in our analysis have lower exposure to oil & gas producers than the benchmark, and all Green Bond funds were below the benchmark.
- Thermal Coal Involvement. Low Carbon funds exhibited the lowest level of thermal coal involvement, with almost 80% of them beating the benchmark. Conversely, only 30% of Green Bond products beat this benchmark, and about half of Clean Energy/Tech funds had high exposure to thermal coal.
- Carbon Solutions Involvement. As expected, Clean Energy/Tech and Climate Solutions funds offered the highest exposure to carbon solutions, although the level of involvement varies greatly. By contrast, only about half of Low Carbon and Ex-Fossil Fuel Funds beat the global benchmark.
- Carbon Risk. Climate Conscious and Low Carbon funds have the lowest Carbon Risk Scores. On the other hand, Climate Solutions and Clean Energy/Teach funds tend to carry more carbon risk, because they tend to invest in more diversified businesses.
Which Funds are the Right Fit for Your Portfolio?
Investors concerned about climate-related risks can look to Low Carbon funds to decarbonise a portfolio. Our analysis shows that these approaches provide broad and diversified exposure to the market and are therefore suitable as part of a portfolio core allocation.
Investors who have a greater risk appetite and consider climate change an alpha-generating opportunity can look to Climate Solutions and Clean Energy/Tech strategies. In early 2021 these funds experienced a dip in valuation relative to the market’s bump, highlighting their volatility and emphasising the need to be cautious.
We expect to see more climate-aware funds launching and more conventional funds repurposing to a climate mandate in the coming months to keep pace with investment community net zero commitments. As companies are being asked to disclose more fulsome and accurate data, we can expect funds with a climate-related mandate to become clearer in their mission and more accountable to investors.
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