Environment and climate-focused funds dominate ESG investing

From January through October, mutual funds and exchange-traded funds specializing in environmental themes attracted far more cash than those ESG funds that focus on other sustainability areas, fund-flow data from Morningstar show.

The attraction to green funds has been fueled, in part, by growing attention to climate change, an issue that gained further exposure with the COP26 global summit on climate change in Glasgow this month.

“Global media puts a lot of attention on environmental issues, and investment flows mirror that," says James Penny, chief investment officer at TAM Asset Management in London. “In COP26, every headline from here to Australia was dominated by what we are doing about climate change."

According to Morningstar, funds with the attributes “low carbon/fossil-fuel-free," and “environmental" had inflows of $28.33 billion and $13.53 billion, respectively, from January through October. (Funds may have multiple attributes in Morningstar’s analysis, so some flows of individual funds show up more than once.)

Less ‘green’ for nongreen funds

Those strong environment-themed flows contrast with the more modest popularity of funds with the attributes “community development," “other impact themes" and “gender and diversity," which attracted $7.53 billion, $5.99 billion and $5.12 billion, respectively, for the 10 months.

“At times, the singular focus on the environment comes at the expense of social and governance factors," says Jake Walko, director of ESG investing and global investment stewardship at Thornburg Investment Management. Environment-focused funds outdraw other ESG funds in part because the green-themed funds can use quantifiable metrics to guide their investments and demonstrate their focus more than funds focused on social issues or governance, which sometimes use more-subjective measures, he says.

Also, the relative lack of interest in funds focused on social issues has led to a smaller range of investment products in that sector. The three Morningstar categories of gender, other impact and community development each had far fewer than 100 available funds at the end of October, compared with 165 funds with a low carbon/fossil-fuel-free attribute.

Still, that might be a temporary shortage, at least in some sectors, as Wall Street responds to shifting interests among investors. “Gender diversity is gaining traction as an investment theme, and we are seeing more products come to market" focused on that issue, says Todd Rosenbluth, head of ETF and mutual-fund research at CFRA. In the first 10 months of the year, the number of gender-and-diversity funds grew about 9% to 50 from 46, the Morningstar data show.

Governance still a mystery to many

Funds focused on corporate governance, meanwhile, may be less popular than other ESG funds in part because governance issues aren’t as easy for many investors to understand as other ESG themes. “Governance is not an investible theme in the same way as the other areas," says Hortense Bioy, global director of sustainability research at Morningstar.

Matters of governance include how well a company is managed, the diversity and independence of the board, and the amount and manner of executive compensation. Superior governance is often an attractive feature for many stock pickers. However, it’s still not easy to invest using governance as a sole attribute, Ms. Bioy says.

Mining still popular

For comparison, natural-resource funds were included in Morningstar’s fund-flow analysis. These funds typically hold shares in fossil-fuel and mining companies. Most investors would say that is the opposite of green investing. This year through October, such funds attracted $12.80 billion of inflows.

Soaring commodities prices are part of the reason such funds remain attractive. Crude oil and copper, for instance, have staged strong rallies last year and this year as the global economy emerged from the Covid-19 pandemic lockdowns.

Also, the world still relies on the extraction of minerals to provide the materials necessary to make clean energy happen. Solar power and electric vehicles both require vast quantities of minerals to be mined, says Arthur Hogan, chief market strategist at National Securities Corp. “While all this ESG investing moves us in the right direction of trying to slow down global warming," he says, “there will be a transition and that will take a while."