Number of climate-focused funds surges 600% in the past five years

The number of climate-focused open-ended portfolios available to investors has increased by approximately 600% since 2018, according to the latest study from Morningstar.

Its fourth annual Investing in Times of Climate Change paper, which explores the progression of climate themed funds, found that as of June 2023, there were 1,407 open-ended and exchange-traded funds with a climate-related mandate. This compared with fewer than 200 portfolios five years ago.

Total assets within the funds had also surged by around 30% in the past 18 months to $534bn, partly as a result of the product development.

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Hortense Bioy, global director of sustainability research at Morningstar, said the growth of this sector since 2018 was "simply remarkable and reflects the growing awareness of the investment risks and opportunities arising from climate change".

According to the report, Europe remains the hotspot for climate themed investments, with the "largest and most diverse climate fund market", which accounts for 84% of global assets. This is followed by China and the US, with 8% and 6% market share, respectively.

The US' flow of new climate themed products was particularly stunted by the backdrop of high oil and gas prices and falling valuation of renewable energy stocks over the past 18 months, Morningstar argued, with assets in US climate funds up just 4% in the period, to $31.7bn.

There was an overall slowdown of the launch of new climate funds in the past year, which Morningstar said matched the wider market trend of fewer new products coming to market.

Morningstar defines climate funds included in the study by "intentionality" as opposed to its holdings.

"Many sustainable portfolios score well on climate metrics, but if climate issues are not the focus of these funds' investment strategies, they are not included in our universe. To identify intentionality and understand the strategies, we relied on a combination of fund names (a strong indicator of intentionality) and information found in legal filings," it stated.

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This meant it did not include funds for which the "sole climate-related mandate is to exclude fossil fuel companies", for example, or funds that had a lower carbon intensity goal but did not "provide a specific carbon reduction target", as this objective made up just a "small part" of the overall investment process.

It also excluded portfolios that "claim using investment stewardship as an approach to mitigate climate risks, unless it is the sole objective of the fund".

Morningstar said it acknowledges the "crucial role" proxy voting and engagement played in better understanding and managing climate risks within funds, but said these activities "often complement other key objectives and cannot be considered the focus of the strategy".

Of the products it did study, the report found the most popular companies held within this style of fund were not aligned with the 1.5°C Paris Agreement.

"Our analysis of these funds reveals a gloomy reality," Bioy said. "None are aligned with the goal of limiting global warming to 1.5 °C.

"We are not saying climate funds are greenwashing.

"The fact is that they are investing in a tiny pool of companies and countries on track or close to being on track to achieve net zero emissions by 2050."

Climate-themed funds still fared better from a carbon-intensity rating than a broader equity portfolio, mainly because of the "high and difficult-to-manage carbon emissions coming from the supply chain and/or customers of top companies in broad market portfolios", according to the report.

Morningstar said that funds offering exposure to ‘climate solution' companies tended to exhibit a high carbon intensity rating, as they were invested in firms in high-emitting sectors, such as utilities, energy and industrials.