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ESG

A Look at the Thematic Funds That Offer a Sustainable Focus

Morningstar’s thematic funds taxonomy provides a new lens for evaluating funds with a sustainable focus.

Read Time: 3 Minutes

Thematic funds aim to capitalize on emerging investment opportunities by creating portfolios that align with specific trends or themes. Instead of investing in a single stock related to a trend, investors can buy shares of a thematic fund, with the advantage of diversification.

This diversification includes not only companies directly involved in the trend but also suppliers, service providers, and other companies that benefit from the changes brought about by the trend. In addition to a potential opportunity to boost returns, thematic funds provide a distinct way to identify and reduce risk.

When it comes to identifying ways to reduce ESG risk, investors can explore funds with different kinds of sustainable focus, such as alternative energy, clean technology, and water.

Here, we take a closer look at the funds available in resource management and energy transition themes.

Leading Funds With a Sustainable Focus

Water funds and alternative energy funds account for the lion’s share of sustainable thematic funds, with about $6.51 billion in assets under management for North American water funds and $4.8 billion AUM for North American alternative energy funds as of March 31, 2024.

Other themes that make up a smaller portion of the thematic funds’ universe include clean tech, wind, rare resources, and energy transition.

The sheer length of time they’ve been around for is a driving reason for the prominence of water funds, which make up a plurality of funds under the Resource Management theme. The largest water funds in North America include:

  • Invesco Water Resources ETF (PHO), at $2.12 billion.
  • First Trust Water ETF (FIW), at $1.64 billion.
  • Invesco S&P Global Water Index ETF (CGW), at $985.2 million.
  • Virtus AllianzGI Water Fund, at $654.4 million.
  • Calvert Global Water Fund (CFWAX), at $586.9 million.

Alternative energy funds seek to facilitate the transition to a low-carbon world. Though these funds are particularly popular in Europe, they’re still a powerful presence in North America. The largest alternative energy funds in North America include:

  • iShares Global Clean Energy ETF (ICLN), at $2.42 billion.
  • First Trust NASDAQ Cln Edge GrnEngyETF (QCLN), at $789 million.
  • Fidelity Select Envir and Alt Energy portfolio, at $534.9 million.
  • Invesco Wilderhill Clean Energy ETF (PBW), at $364.5 million.
  • ALPS Clean Energy ETF, at $227.7 million.

North American leaders in thematic funds with a sustainable focus include iShares, First Trust, and Invesco.

How Funds With a Sustainable Focus Are Managing ESG Risks

The Morningstar Sustainability Rating™ evaluates a fund’s ESG risks and enables investors to directly compare funds on this front. The rating measures funds on a scale of 1 to 5 globes, with 1 globe indicating high ESG risk and 5 globes indicating low ESG risk.

A few funds from the list of thematic funds that stand out on this front include:

  • iShares Global Clean Energy ETF (ICLN), within the Alternative Energy theme, has $2.42 billion in AUM and a 4-globe rating.
  • First Trust NASDAQ Cln Edge StGidIfsETF (GRID), in the Clean Tech category, holds $995 million in AUM and has a 5-globe rating.
  • Ecofin Global Water ESG (EBLU), a water-focused fund, holds $53.6 million in AUM and has a 4-globe rating. It also holds a Morningstar Medalist Rating of Bronze.
  • First Trust Global Wind Energy ETF (FAN), under the Wind theme, has $188.3 million in AUM and a 4-globe rating.

Understanding the Nuances of Investing With a Sustainable Focus

Though thematic funds are often used with the hopes of boosting returns over the investment period, they can also help investors reduce portfolio risk—including ESG risk.

And by understanding the different ways that ESG risk can take shape according to funds’ different focuses, investors can be more intentional about where they put their money and the ESG factors that funds are prioritizing. For instance, they can replace traditional energy sector exposure with alternative energy funds.

For the full analysis of ESG thematic funds around the world, download the report.