Interest in sustainable investment is surging but it’s doing very little to keep climate change in check, a new Morningstar report says.
The number of climate-related funds globally has witnessed a sevenfold increase in the past five years, according to the fourth annual edition of Morningstar’s ‘Investing in Times of Climate Change - A Global View’ report. As of June, there are over 1,400 open-end and exchange-traded funds with a climate mandate. This is a significant jump from fewer than 200 in 2018.
In the past 18 months, assets in these climate-focused funds have seen a substantial 30 percent growth, reaching a whopping 534 billion dollars, the report said. This uptick is attributed to a combination of fresh inflows and new product developments in the sector.
None of these funds however are aligned with the global goal of limiting global warming to 1.5-degree Celsius, said Morningstar. Its report was released just as the International Energy Agency (IEA) warned that this objective will not be reached unless the world’s governments come together and agree on “more aggressive action”.
‘Tiny pool’
“The growth of climate-related funds over the past five years is simply remarkable and reflects the growing awareness of the investment risks and opportunities arising from climate change,” said Hortense Bioy (photo), global director of sustainability research at Morningstar, in a statement.
“Our analysis of these funds reveals a gloomy reality, though. None are aligned with the goal of limiting global warming to 1.5-degree Celsius. We’re not saying climate funds are greenwashing. The fact is that they’re investing in a tiny pool of companies and countries on track or close to being on track to achieve net zero emissions by 2050.”
The IEA this week said that capping global warming at 1.5 degrees Celsius is still possible, but requires steep cuts in the energy sector’s greenhouse gas emissions. “Removing carbon from the atmosphere is very costly. We must do everything possible to stop putting it there in the first place,” IEA executive director Fatih Birol said in a statement. “The pathway to 1.5°C has narrowed in the past two years, but clean energy technologies are keeping it open.”
Europe dominant
According to Morningstar, Europe stands out as the most dominant player in the climate fund market, holding a staggering 84 percent of the global assets. The strong investor interest, combined with regulatory backing, has cemented Europe’s leadership in this domain. Following Europe, China and the United States take the second and third spots with 8 percent and 6 percent of the market share, respectively.
Despite external factors such as high oil and gas prices and a dip in the valuation of renewable energy stocks, coupled with the challenges of the Inflation Reduction Act, the U.S. climate funds still managed a growth of 4 percent in the past 18 months. This brings the total assets in U.S. climate funds to 31.7 billion dollars.
Preference for transition
European investors exhibit a clear preference for climate transition funds, which represent nearly half of all the continent’s climate fund assets, Morningstar said. As other regions gradually embrace these strategies, Climate Solutions and Clean Energy/Tech funds still maintain their dominance in areas outside Europe.
However, 2023 witnessed a slowdown in the product development of climate funds, mirroring trends in the broader fund market.
Interestingly, Morningstar’s deep dive into the composition of these funds reveals a paradox. Funds that offer exposure to climate solutions often have a high carbon intensity. They predominantly invest in companies from sectors with high carbon emissions – like utilities, energy, and industrials. These are businesses that are in transition, aiming to develop strategies to curtail their own emissions and that of others.
Two new climate focused funds recently unveiled by BLI Luxembourg and Funds for Good for example each invest more than one third of their portfolio in industrial companies.
‘More misalignment’
None of the most common companies in these climate funds align with the 1.5° Celsius target set out in global climate agreements. In fact, broad market climate portfolios show more misalignment than those focusing on climate solutions, Morningstar said. They register an average Implied Temperature Rise of 3.3°C against the 2.4°C of the latter. A deeper analysis reveals that this discrepancy can be attributed to the challenging-to-manage carbon emissions emerging from the supply chain or customers of these top companies.