Investors Need to Choose Green Funds Carefully

VIDEO: On Earth Day 2020, Morningstar's Hortense Bioy looks at how investors can make sense of sustainable funds and why they could be a good addition to your portfolio

Holly Black 22 April, 2020 | 11:33AM
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Holly Black: Welcome to Morningstar. I'm Holly Black. With me is Hortense Bioy. She is Director of Sustainability Research at Morningstar. Hello.

Hortense Bioy: Hi, Holly.

Black: So, it's Earth Day today, and investors might be thinking about how to incorporate some sustainable or ESG funds into their portfolio. But I think one of the first problems in doing this is just how much choice there is, isn't there?

Bioy: Absolutely. I mean, what we've seen in the past couple of years is asset managers launch a flurry of new climate aware funds and they've also tweaked some existing funds to incorporate some climate – investment objectives like reduced exposure to fossil fuels or low carbon footprint. So, now we have this wide array of choices for investors. And when started this project, we realized that actually they also had different outcomes. But to simplify, I think, there are really two broad types of climate aware funds. There are those that aim to reduce carbon risks. So, these are, for example, those low-carbon funds and those funds that exclude or reduce exposure to fossil fuels. And the second types are those funds that invest in climate solutions. So, for example, clean energy, clean tech, but also green bonds and climate solution funds. And these are really aiming to promote the transition to a low-carbon economy or take advantage of that transition.

Black: I think one of the concerns a lot of investors might have in this kind of environment when we get an area of investment that becomes very trendy all of a sudden is whether the funds are actually delivering on what they are promising, and in this case, there are worries about greenwashing. What are you finding in regards to that?

Bioy: Yes, you're right. I mean, greenwashing is certainly a concern for investors as well as regulators. So, the purpose of our report was really to help investors make sense of the growing space of climate aware funds but also to test the claims. So, we tested the claims using a series of carbon metrics. So, we used, for example, carbon intensity, exposure to fossil fuels, exposure to carbon solutions, carbon risks. And what we find is that almost all the funds in our studies delivered on the promises. So, for example, low-carbon funds really offer reduced exposure to carbon intensity. I think most offer between 20% and 40% reduction to carbon intensity.

Those funds that said they invest in climate solutions tend to score high on carbon solutions. So, that score the highest are obviously those climate – certainly, those clean energy, clean tech funds. But what we also found surprising is that those that really offer high exposure to climate solutions also tend to have high carbon risks. So, they are more vulnerable to the transition to a low-carbon economy. And I think this is because alongside investing in pure plays in renewable energy like First Solar or Vestas Wind Systems, they also invest in companies that are on the journey. So, they still operate carbon-intensive businesses in utilities like Iberdrola, for example, but they also provide exposure to solutions. So, again, those funds that offer climate solutions also have higher exposure to carbon risks. So, this is something to bear in mind.

Black: So, for investors who are feeling a bit baffled by all of this choice and all the different types of climate conscious funds, what would be a couple of top tips for them?

Bioy: So, I think those investors really need to carefully consider the green preferences and their appetite to risk. Because as we've seen not all climate-aware funds are created equal and they provide – I mean, they result in different outcomes in terms of carbon risk and exposure to carbon solutions. Now, they really need to feel comfortable with the type of companies they end up investing in. So, it's very important to look under hood as well as at the holdings and also to consider where these funds would fit best in the portfolios. Because there are funds like low-carbon funds and ex-fossil fuel funds that would – that are very suitable for core allocation but other funds that are more concentrated in nature like clean energy, clean tech and climate solutions, these ones are more suitable as satellite holdings.

Black: Hortense, thank you so much for your time. For Morningstar, I'm Holly Black.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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Holly Black  is Senior Editor, Morningstar.co.uk