Climate transition funds are gaining momentum, Morningstar, a fund data and research firm, concluded in its September 2023 report, “Investing in Times of Climate Change”. Despite Europe leading the pack, with 84% of global climate fund assets, none of the most commonly held companies in these funds are aligned with the 1.5°C global warming limit, raising critical questions about the real-world impact of these investments.

Ballooning assets in climate funds

The report identified 1,407 open-end funds and exchange-traded funds (ETFs) with a climate focus as of June 2023, collectively managing assets worth $534bn worldwide. This indicates a 30% surge in assets over the past 18 months.

In comparison, the broader open-end funds and ETF markets contracted by 5% and 8%, respectively, since December 2021. This growth in climate fund assets also outpaced the global sustainable funds market, which expanded by 11% over the past six months.

Hortense Bioy, the global director of sustainability research at Morningstar and the lead author of the report, said, “The growth of climate-related funds over the past five years is simply remarkable. This reflects the growing awareness of investment risks and opportunities arising from climate change.”

Europe takes the lead

Europe accounted for 84% of global climate fund assets, or $447bn, marking a 38% increase over the past 18 months. China and the United States lagged behind with market shares of 8% and 6%, respectively. Assets in Chinese climate funds decreased to $44bn as of June 2023, from $47bn at the end of 2021.

However, Morningstar noted that in local currency, these assets actually rose by 16%. In the US, assets in climate-focused funds grew modestly by 4% to $31.7bn over the same period, despite the implementation of the Inflation Reduction Act.

Differing regional preferences

European investors have shown a strong inclination towards climate transition funds, accounting for 45% of all climate fund assets domiciled in Europe. In contrast, climate solutions and clean energy or clean tech funds continue to dominate the landscape in China and the US, making up 31% and 46% of total climate fund assets in their respective regions. Morningstar also stated that this difference in asset allocation can be attributed to regional variations in investor preferences and regulatory landscapes.

As the transition to a low-carbon economy picked up pace, the Morningstar report warned that various investments might face challenges due to evolving regulations, technological shifts and changing consumer preferences. If global warming mitigation measures were not expedited, the report stated that these investments could become increasingly susceptible to ‘physical risks’--risks linked to vulnerabilities in a company’s supply chain, operations and assets due to more frequent extreme weather events like floods and hurricanes. Concurrently, Morningstar concluded that a growing number of investors were focusing on lucrative opportunities in the climate sector, particularly in companies that were innovating in areas such as clean energy, electric vehicles, carbon capture and storage, and flood prevention measures.

Conflicting climate goals and corporate realities

However, despite the significant growth in climate fund assets and product offerings, Morningstar concluded that none of the most commonly held companies in these funds align with the 1.5°C target.

The report also highlighted that the most popular stocks in broad market climate portfolios are more misaligned with this target, with average implied global temperature rises of 3.3°C compared to 2.4°C in portfolios focused on climate solutions. According to Morningstar Sustainalytics, 87% of the 5,000 largest public companies globally are on a pathway of at least 2.1°C.

Bioy added, “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 54-page full report is available .