Funds that take climate change into account are being launched rapidly due to dramatic increases in investor demand, according to Morningstar.
Europe is leading the U.S. in creating new funds, but firms in both regions are responding to investors who want to promote the transition to a green economy, Morningstar said in its report, “Investing in Times of Climate Change - A Global View,” released Friday. The increased number of mutual funds and ETFs available gives investors more choices, but investors need to do their homework, the firm warned.
“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,” the report said. Morningstar defined these funds as ones that have creating a positive on climate change as a core mission. Global assets for these funds tripled in the past year, the firm said.
“Europe is the largest and most diverse universe of climate-aware funds with 282 funds with $136 billion in AUM, followed by the United States with 42 funds with $21 billion in assets. In the rest of the world, the biggest market is China, which accounts for $17 billion.” In particular in the U.S., large flows into First Trust Nasdaq Clean Edge Green Energy ETF and the iShares Global Clean Energy ETF provided the unprecedented spike in the investing universe, Morningstar said.
Morningstar noted that 76 new climate-aware funds launched globally in 2020 alone. The report looked at funds that Morningstar described as low carbon, climate conscious, green bond, climate solutions or clean energy/technology. The firm concluded that the funds are delivering on their missions of investing in those companies that have a positive impact on climate.
“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/technology funds score high on carbon solutions,” the research firm said.
One caveat issued by the firm was that investors have to be aware that some climate conscious funds include high-carbon companies that are transitioning to low-carbon footprints, including utilities, industrials and energy. For these, “investors must be willing to accept the potential for more carbon-investment in their portfolio” for the time being, Morningstar said.
The popularity of the funds varies, with clean energy/technology being the most popular category, holding one-third of global assets as of the end of last year. “Clean energy/technology 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,” the report said.
The dramatic increase in investor interest in these funds is partially attributable to the Paris Climate Agreement and the United Nations’ Sustainable Development Goals adopted in 2015, Morningstar concluded.
With the increased interest comes an increased need for investors and their advisors to do their research, Morningstar said.
“When choosing a climate product, investors should carefully consider their green preferences and carbon risk appetite. For instance, 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” because they include transitioning companies, Morningstar said.
“This, however, should not put investors off. 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,” the report said.
In addition, Morningstar warned, “Investors should also bear in mind that some climate change investment strategies can result in narrow and concentrated portfolios, which makes them more suitable as satellite holdings than as core parts of a portfolio. Climate-aware funds also have a relatively short history, with most launched in the past two to three years, making their performance hard to assess.”