How Can Climate-Aware Funds Fit Into Your Portfolio?
Our analysis shows how these funds stack up on specific climate-related metrics.
Our analysis shows how these funds stack up on specific climate-related metrics.
Just as governments around the world have spent the past year racing to get the coronavirus pandemic under control, we should be racing to contend with a similarly harmful global event: the threat of climate change. To be sure, a growing number of entities are doing their part. Regulators are ratcheting up efforts to combat climate change, and the investment community is offering more disclosure.
How can individual investors play a part in this effort? To start, they can familiarize themselves with climate-aware funds and fit them into their portfolios where appropriate. The funds we consider "climate-aware" represent a broad range of approaches to meeting various investor needs and preferences, such as the divestment from fossil fuels or participation in carbon solutions.
In our report "Investing in Times of Climate Change," we dig into the global landscape of climate-aware funds. We map out the products that fit into each category, explore how well funds deliver on their promises, and demonstrate how investors can assess the efficacy of these products. Morningstar Direct and Office clients can access the full report here.
We divide the landscape of climate products into five groups:
The graphic below displays the different roles that these strategies play in portfolios.
The United States has been relatively slow to adopt these types of products. We have currently identified 42 available in the U.S., as compared with Europe, where we have identified 282. Though we have sought to gather as many funds as possible, this list is not intended to be exhaustive but to be a clean selection with which to analyze the funds' efficacy.
Even so, the chart below shows that the U.S. saw a record number of climate-aware product launches in 2020, with eight. We also anticipate that the number of fund launches may continue to increase now that President Joe Biden has re-signed the Paris Accord.
Of these five categories, Clean Energy/Tech funds have constituted the bulk of U.S. climate products in recent years. The chart below shows how the assets in this category far outpace the assets in the other four categories.
The two largest funds available to U.S. investors fall into the Clean Energy/Tech group: iShares Global Clean Energy ETF (ICLN) and Invesco Solar ETF (TAN). ICLN also led the global landscape in flows in the fourth quarter of 2020 with $1.98 billion in inflows.
We also assessed how these strategies compare on specific climate-related measures and how well they deliver on their premises. We evaluated the global universe of climate-aware products against the relevant Morningstar metrics and also plotted them on the Morningstar Global Target Market Exposure Index, which we used as our benchmark.
Here's what our findings revealed for each metric:
Clearly, these five strategies reflect a broad range of approaches that aim to meet different investor needs and preferences. The choice of one type over another largely depends on an investor's investment goals, risk appetite, and preferences.
For instance:
As investors look to incorporate climate-aware funds into their portfolios, it's important that they do their homework. To avoid any unpleasant surprises, they should 1) understand the funds' investment objectives and how the portfolios are constructed, 2) ensure they are comfortable with the level of carbon exposure, and 3) look at the funds' holdings.
We anticipate that this product universe will only expand as climate-related regulation continues to roll out and investor interest continues to grow. This is an opportunity for fund managers to showcase their commitment to client service and education--and to a cleaner world.
Elizabeth Stuart does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.
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