Posted inESG

European climate funds near €60bn milestone

Investors across Europe are predominately putting their money into the most carbon risk-averse climate strategy.

Among 405 European climate funds accumulating roughly €60bn in assets, the ‘ex-fossil fuel’ strategy has been most popular among investors, Morningstar has found.

The data and research provider compiled a stocktake of European-domiciled, open-ended funds and exchange traded funds with a climate-related mandate.

It grouped the climate funds, which either seek to avoid carbon risk or promote a low-carbon transition, into six categories: ex-fossil fuel, low carbon, climate conscious, climate solutions, green bond and clean energy/tech.

Altogether, 165 funds have an ‘ex-fossil fuel’ strategy and collectively hold €16.53bn of assets under management (AUM). The second most popular strategy is climate solutions, with €13.52bn of AUM, followed by green bond, with €9.01bn (see charts below).

But only 40% of ‘ex-fossil fuel’ funds actually exclude fossil fuels despite having a strategy termed as such, Morningstar said.

It explained that this is due to the greatly varying definitions of fossil-fuel exclusions. These range from ‘no investments in companies with fossil-fuel reserves’ to ‘no involvement in any fossil-fuel-related activities’, including exploration, production and distribution.

While ex-fossil fuel funds take a negative screening approach to brown energy companies, low-carbon funds choose companies with a lower carbon footprint across the portfolio.

Marketed and non-marketed funds

The report found that 196 funds market themselves by using a name which highlights their specific climate-change mandate.

In a breakdown, Morningstar emphasised that ex-fossil fuel funds, the largest group among the categories, are the least likely to flag the exclusion in their name (see chart below).

Flows into funds that specifically market themselves as climate funds have increased in recent years, with a major uptick in 2019.

It is noticeable that climate solutions and green bond funds saw the biggest inflows among marketed funds, whereas both ex-fossil fuel and clean energy/tech saw the least inflows (see chart below).

Motivations to invest in these funds differ. While low carbon and ex-fossil fuel strategies may appeal more to risk-averse investors who want to decarbonise their portfolios, climate solutions and clean energy/tech funds could attract opportunity-affine investors who look for companies driving the low-carbon transition, Morningstar said.

No climate washing

It also found that the climate funds largely deliver on their promises: Relative to their benchmark, virtually all low-carbon funds provide access to companies with lower carbon intensity; climate solutions and clean energy/tech funds score high on carbon solutions; and low carbon and ex-fossil fuel funds have the lowest exposure to fossil-fuel companies (see charts below).

Risk vs solution?

The funds exposed to higher carbon risks are climate solutions and clean energy/tech funds, Morningstar said, as they invest in both companies providing green solutions and in more diversified businesses that are at different stages of their transition journey, including carbon-intensive sectors like industrials, utilities, energy and materials (see chart below).

This supports a common narrative that the companies trying to solve the carbon challenge are often operating in the most carbon-intensive sectors, the report notes.

Yet, it is still possible to find funds that score high on carbon solutions involvement, while keeping a lid on their carbon risk.

As examples, Morningstar pointed to Axa WF Framlington Clean Economy, Candriam SRI Equity Climate Action, and Wellington Climate Strategy Fund.

The most commonly held companies in climate solutions funds are (see chart below):

Launches

Hortense Bioy, director of passive funds and sustainability research in Europe at Morningstar, explained that asset managers have launched the climate funds as a response to the EU Action Plan on Sustainable Finance and investor demand.

In 2019, 76 new offerings came to market, following 67 launches in 2018, Morningstar said. The decarbonisation-type of strategy, including low carbon and ex-fossil fuel, has seen the highest number of launches, it added.

Asset managers have also been “tweaking existing strategies to incorporate climate-related criteria”, Bioy said.

Sustainable funds have either changed their mandate to focus on the “climate” theme or added specific climate-related criteria to their investment objective.

Elena Johansson

Senior Reporter

Part of the Bonhill Group.