Investors concerned about the impact of carbon risk on their portfolios can use the newly launched Morningstar Low Carbon designation into their fund selection process. The designation is given to funds that invest in stocks which will be least impacted by the transition to a low-carbon economy.
To demonstrate, we used the designation to screen 10 diversified equity Morningstar Categories. As a measure of overall fund quality, we also screened for Morningstar funds the analyst team have evaluated as likely to outperform their benchmark and/or category peers going forward, and have awarded a Gold, Silver or Bronze Rating.
We found that investors have 64 low-carbon top rated funds from which to choose in these 10 categories. However, the choices are not spread evenly across the categories because carbon risk is related to style and, especially, sector exposures. It's easier to earn the Low Carbon designation for a fund that has less exposure to high-carbon-risk sectors and more exposure to low-carbon-risk sectors.
The energy sector, not surprisingly, carries the greatest carbon risk, at 43.01, more than twice that of utilities, which has a score of 19.71. Materials and industrials also have higher relative scores. On the low end of the range are technology, which weighs in at 2.91, and healthcare, which has an ultralow score of 1.19.
Large-Growth Funds
More than half of the low-carbon top-rated funds in the Europe, US, and global large-cap equity categories are growth funds. Why? Because growth funds tend not to invest in companies in the three sectors with the most carbon risk; energy, utilities, and materials, while having significant investments in technology companies, which carry very little carbon risk.
Among all global large-growth funds, 55% receive the Low Carbon designation. Among the group of global large-growth top-rated funds, 74% receive the Low Carbon designation. Among Europe and US large-growth funds, it’s even easier to find a good low-carbon large-growth fund as 92% and 90% of the Europe and US large-growth top-rated funds, respectively, receive the Low Carbon designation.
Large-Value Funds
It’s significantly harder to find a good low-carbon fund on the value side, especially in the Europe large value category where no top-rated funds receive the Low Carbon designation. To find additional lower-carbon options in the large-value categories, use the Carbon Risk Score rather than the Low Carbon designation and search for funds with scores in the category’s lowest quartile.
That’s a weaker screen than the Low Carbon designation because it doesn’t include an explicit fossil fuel exposure component, but it is a measure of carbon risk that can be compared with other funds. Using the Carbon Risk Score turns up an additional seven top-rated funds, including DNCA Value Europe, which earns a Morningstar Analyst Rating of Bronze.
In the US and global large-value categories, only one and three top-rated funds, respectively, receive the Low Carbon designation. Europe large-value funds, on average, devote nearly 22% of assets to companies in the higher-carbon risk energy, utilities, and materials sectors and only less than 5% to tech companies. US and global large-value funds, on average, are more balanced in terms of how much they allocate to higher-carbon risk and lower-carbon-risk sectors.
Large-Blend Funds
In the global large-blend categories, where 19% of funds receive the Low Carbon designation, we found 11 low-carbon top-rated funds, including Gold-rated Dodge & Cox Worldwide Global Stock and Fundsmith Equity. In the Europe large-blend category, where 15% of funds receive the Low Carbon designation, we found only eight low-carbon top-rated funds, including Silver-rated M&G Pan European Select and Jupiter European Opportunities.
Just under 13% of funds in the US large-blend category receive the Low Carbon designation. Only four are low-carbon top-rated funds, including two Bronze-rated ETFs: UBS ETF Factor MSCI USA Quality (UC99) and UBS ETF MSCI USA Select Factor Mix (USFM).
Diversified Emerging-Markets
Fewer emerging-markets funds receive the Low Carbon designation. Emerging-markets managers generally must choose among companies with higher carbon risk compared with developed-markets managers. In the automobile industry, for example, emerging-markets firms have an average Carbon Risk Score of 41.2, in the High risk range, while developed-markets firms have a much lower average score of 26.3, in the Medium risk range.
Only three diversified emerging-markets top-rated fund funds also receive the Low Carbon designation: Comgest Growth Emerging Markets and Magellan. Both are rated Gold. Vontobel Emerging Markets Equity is rated Bronze.
To find additional options, we used the Carbon Risk Score rather than the Low Carbon designation, as we did for Europe large-value, and searched for funds with scores in the lowest quartile. That turns up an additional eight top-rated funds, including Silver-rated T. Rowe Price Emerging Markets Equity and Stewart Investors Global EM Leaders.
