Ecology funds invest in companies that contribute to resolving the myriad environmental challenges facing our society. The funds in the Morningstar Equity Sector Ecology category experienced a peak in 2020 and 2021; however, subsequently, they witnessed a decline in both returns and assets under management.
Companies engaged in activities that promote a better environment are enjoying considerable momentum. In recent years, there has been a widespread recognition of the need to use our planet more judiciously and to take action to curb global warming, for example. Companies, consumers, and governments are altering their behaviour, thereby creating favourable market conditions for firms operating in sectors such as alternative energy, waste treatment, water treatment, and energy efficiency. Funds in the Morningstar Equity Sector Ecology category invest specifically in these types of companies.
These funds have caught the attention of investors and, during 2020 and 2021, they enjoyed a period of prosperity. Historically, ecology funds led a relatively marginal existence, with total assets under management consistently below 10 billion euros. Since 2017, this landscape has shifted with increasing interest and new capital inflows. In 2017, there was an inflow of 2.5 billion euros, followed by 3.1 billion euros in 2018, and 6.5 billion euros in 2019.
Impressive inflows
Explosive growth ensued in 2020. With inflows of 22.9 billion euros and robust price performance of ecology-related stocks, total assets under management rose from 25 billion euros to 55.6 billion euros. This achievement was replicated the following year, and, aided by net inflows of an impressive 33 billion euros, the assets of ecology funds soared to a record of over 107 billion euros.
Undoubtedly, the stellar stock market performance of ecology companies was a primary driver behind the growing interest in this asset class. For instance, funds in the Morningstar Equity Sector Ecology category achieved an average annual return of 30.87 per cent in 2019, followed by 21.99 per cent in 2020 and 22.63 per cent in 2021 (compared to returns for a global equity index like the Morningstar Global TME index of 28.76 per cent, 6.26 per cent, and 27.57 per cent, respectively).
However, these prosperous years have now ended, at least for the time being. From the end of 2021 to the end of March 2024, ecology funds posted an average annual loss of 3.05 per cent, while global equities fared much better with a gain of 5.85 per cent. Rising valuations likely prompted investors to take profits.
Trend reversal
Moreover, many stocks in the ecology sectors are growth-oriented and, during 2021, a style rotation among investors began, with value stocks outperforming growth stocks. During that period, the energy and financials sectors outperformed the broader equity market, sectors in which ecology funds typically do not invest. The following year, 2023, saw US large-cap technology stocks particularly dominate the market, a sector also largely unrepresented in ecology funds.
Despite still attracting nearly 11 billion euros in investor money in 2023, this trend now appears to have reversed. In 2023, almost 5 billion euros flowed out of the funds, and over the first three months of 2024, the outflows matched this amount.
Impax Environmental Leaders Fund
The Impax Environmental Leaders Fund receives an Above Average rating from Morningstar’s analysts on the People Pillar and an Average rating on the Process Pillar, resulting in a Morningstar Medalist Rating of Bronze for the X EUR Acc share class.
This strategy is managed by three managers, including the experienced Hubert Aarts, the seasoned David Winborne, and the talented Siddharth Jha. Despite Aarts’s announcement of his retirement by December 2025, Morningstar analysts remain confident in the remaining managers, who will also benefit from support from a yet-to-be-appointed successor to Aarts. This confidence is partly driven by the substantial team of 37 investors conducting equity research, comprising a mix of SRI veterans and talented analysts.
The managers employ a longstanding approach to investing in ecology markets and a thoughtful and disciplined stock selection process. Each portfolio position undergoes a detailed and structured 10-step process, where the team assesses management, competitive advantage, business model and strategy, and environmental, social, and governance factors, among others.
The focus is on companies that address significant social and environmental challenges, which can lead to considerable sector concentrations. For instance, the portfolio has a significant allocation to industrial values, typically accounting for more than 40 per cent of assets. As of the end of February 2024, Waste Management, Republic Services, and Schneider Electric are the largest holdings in this sector. The technology sector accounts for about a quarter of the portfolio and includes positions in Microsoft, Texas Instruments, and TE Connectivity, among others.
Other sectors, such as communications services, energy, financial services, and real estate, are excluded from the portfolio on sustainability grounds. Collectively, these sectors comprise about 45 per cent of a global equity index, such as the MSCI ACWI, and excluding such a large part of the global equity universe could be seen as a disadvantage. This is why the Process Pillar rating is deemed Average.
Ronald van Genderen is a senior manager research analyst at Morningstar. Morningstar analyses and rates mutual funds based on quantitative and qualitative research and is a knowledge partner of Investment Officer, providing regular insights into investment funds or providers.