How to do climate-friendly ETF investing

Its time to start positioning investment portfolios for the fight against climate change.

Investors are increasingly concerned about the impact of climate change on their investments. An alarming report by the United Nations Intergovernmental Panel on Climate Change (IPCC) projects that emissions needed to be 40% to 70% lower, if we want to avoid climate catastrophe. Companies will be forced to adapt their business models to the policy, technology and market changes needed to facilitate the transition to a low-carbon economy.

In this scenario, there will inevitably be winners and losers. And investors can start positioning their portfolios accordingly by either reducing exposure to high-carbon companies or gaining exposure to companies that will benefit from the green transition, or both. Some investors may also want to actively participate and help finance solutions to tackle climate change. These different approaches can all be implemented with ETFs.

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Low-carbon ETFs

Currently, more than a dozen ETFs in Europe offer an explicit low-carbon strategy, either pure or integrated into a broader environmental, social and governance (ESG) strategy, including Xtrackers ESG MSCI World ETF and iShares MSCI Japan ESG Enhanced ETF.

Low-carbon strategies allow investors to invest in the least polluting companies in their industries. This is the case for BNPP E Low Carbon Europe 100 ETF, which has been awarded the Morningstar Low Carbon Designation. The fund’s carbon risk score is two times lower than the market index’s and its fossil fuel involvement is close to zero.

The Xtrackers ETF replicates a series of leading Low Carbon ex-Tobacco Involvement 5% ESG indices which aim for a carbon footprint half that of their benchmark indices by eliminating companies with the highest carbon intensity and largest fossil fuel reserves.

Two ETFs offered by Ossiam adopt a similar approach without replicating an index. The Ossiam US ESG Low Carbon Equity Factors ETF and Ossiam ESG Low Carbon Shiller Barclay CAPE®US ETF follow active quantitative management, targeting a 40% reduction in total greenhouse gas emissions and carbon intensity relative to their initial indices. The Ossiam ESG Low Carbon Shiller Barclay CAPE®US Dry ETF has also received our Low Carbon Designation.

Ex-fossil fuel ETFs

Another climate-focused approach is to simply exclude or reduce fossil fuel exposure. Last month, BlackRock reduced the exposure to fossil-fuel companies in five iShares MSCI SRI ETFs. Meanwhile, BNP Paribas has launched three fixed income ETFs that exclude fossil-fuel companies completely.

We can expect more ETFs of this type to come to the market as the movement to divest portfolios of fossil-fuel exposure continues to spread.

iShares reduces fossil fuel exposure

Fund name Launch date Carbon intensity Fossil fuel (%) Fees (%)
iShares MSCI EM SRI ETF USD Acc 07/2016 239.48 8.28 0.35
iShares MSCI Europe SRI ETF EUR Acc 02/2011 96.63 10.28 0.30
iShares MSCI Japan SRI ETF 03/2017 79.62 2.10 0.30
iShares MSCI USA SRI ETF USD Acc 07/2016 106.26 7.30 0.30
iShares MSCI World SRI ETF EUR Acc 10/2017 133.46 8.79 0.30

Source: Morningstar Direct. Data as at end November 2019.

Green bond ETFs

Investors who want to help finance the transition to a low-carbon economy can turn to green bond ETFs. Three new ones have hit the shelves this year. Green bonds are issued to finance projects that contribute to climate-change solutions and deliver other environmental benefits.

The BNPP ECPI Circular Economy Leader ETF offers a more innovative approach. The fund invests in around 50 global companies selected for their active participation in an economic model based on the ‘circularity’ of goods, materials and raw materials.

Choice in the ETF space for climate-conscious investors is growing. It is important that investors do their homework. They should understand how the underlying indices are constructed and what type of stocks are excluded, and crucially, look at the fund’s holdings to avoid any bad surprises.

Green bond ETFs help finance climate-change solutions

Fund name Inception date Fossil fuel (%) Fees (%)
Franklin Liberty Euro Green Bond ETF 04/2019 6.43 0.30
Lyxor Green Bond (DR) ETF C EUR 02/2017 10.64 0.25
BNPP E ECPI Circular Economy Ldr ETF 04/2019 N/A 0.30

Source: Morningstar Direct. Data as at end September 2019.

Hortense Bioy is a director, manager research, Europe, at Morningstar.

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