Fund Solutions

High Risk, High Impact Funds Lead Fast-Growing Climate Market

Climate fund assets double in 12 months, but only half of funds reduce carbon intensity.    

Funds that offer high exposure to climate solutions or invest in transitioning firms in carbon-intensive sectors are now the most popular in a climate funds market which has doubled in the past year.  

New Morningstar research found ‘climate solutions’ – which invest in firms offering products and services for climate adaption or mitigation – became the largest category of climate funds in 2021, with a collective US$106 billion AUM, alongside climate conscious funds (US$105 billion AUM), which select or tilt toward firms with transition-aligned business models, many of which operate in carbon-intensive sectors.  

In 2020, the largest sub-category in the climate funds market was clean energy/tech, which slipped to third last year ahead of low carbon and green bond funds.  

Morningstar said the shifts seen in 2021 reflected growing investor interest in opportunities beyond the renewable energy sector.  

Overall the climate funds market doubled from just over US$200 billion to US$408 billion globally in 2021, consisting 860 funds. Europe represented three-quarters of the climate market, followed by China, which overtook the US, despite a 45% growth in assets in the latter’s climate funds. 

The largest two climate funds in Europe were climate solution strategies offered by Nordea and Pictet, while the biggest US funds were clean energy/tech exchange-traded funds (ETFs) issued by iShares and First Trust.  

The universe for the study was open-ended funds and ETFs with an intended climate mandate, as reflected in name or filings.  

Rising demand for innovative strategies  

Morningstar said market growth in 2021 offered investors globally a wider range of choices for managing climate-related investment risks and opportunities. In Europe, where the introduction of the Sustainable Finance Disclosure Regulation had “ratcheted up demand for innovative investment strategies”, almost half of the 151 climate fund launches in 2021 were classed as having climate conscious strategies.  

“Recent improvements in climate-related data empower asset managers to better understand and interpret the climate profile of companies and countries”, allowing for new fund solutions to better meet client preferences, said Hortense Bioy, Global Director of Sustainability Research. 

According to the study, climate funds exposed investors to differing levels climate risks across sub-categories, with climate solutions and clean energy/tech funds carrying more carbon risk, calculated via a qualitative analysis incorporating management actions on climate mitigation.  

This is partly due to some firms in these funds operating in carbon-intensive sectors in transition, such as utilities, as well as others which are delivering climate-positive products and services using carbon-intensive operational activities, including suppliers of electric vehicle batteries.  

Carbon intensity  

Morningstar found that only half of the funds for which it could calculate a carbon intensity score – based on reported Scope 1 and 2 emissions – offered an improvement on a broad global benchmark providing exposure to developed and emerging markets. Of the 575 funds for which carbon intensity was calculated, 290 offered an improvement on the benchmark.  

Most green bond, climate solutions, and clean energy/tech funds exhibited higher carbon intensity scores than the Morningstar Global Target Market Exposure Index, reflecting that many such portfolios invest in diversified companies that operate carbon-intensive businesses, the firm said.  

The study also found wide differences in the levels of exposure to fossil fuels across climate fund sub-categories. More than 80% of low carbon, climate conscious, and climate solutions funds were found to have lower fossil fuel involvement than the global benchmark index, contrasting with only 37% of green bond funds and 59% of clean energy/tech funds. 

This was due, said Morningstar, to their greater exposure to utilities companies that have built “large renewable energy operations but still operate their legacy fossil fuel businesses”. Firms in portfolios were considered involved in fossil fuels if they derived at least an aggregate 5% share of total revenue thermal coal extraction, thermal coal power generation, oil and gas production, and / or oil and gas power generation.  

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