The Takeaway
For climate investors, the surest way to decarbonize a portfolio is to explicitly consider emissions in investment selection, as opposed to excluding fossil fuels, minimizing ESG risk, or targeting climate-related solutions, technologies, and impact.
Conversely, an analysis of Morningstar Indexes' climate benchmarks reveals that investing in renewable energy, climate solutions, and targeting climate impact can come at the expense of current emissions and risk related to environmental, social, and governance factors.
From a performance perspective, portfolios focused on decarbonization can deliver market-like returns, while narrower climate focused investments diverge more dramatically. The former group have performed well in the tech-driven market of 2023, but they suffered in 2022. By contrast, climate-opportunity-oriented investments have lagged in 2023 but had a good 2022.
"Climate is clearly king when it comes to ESG," concluded the qualitative phase of Morningstar's 2023 Voice of the Asset Owner Survey. "But how is the dialogue, scope and investment approach around climate broadening and deepening as asset owners become more sophisticated and nuanced?"
Pension plans, endowments, foundations, and sovereign wealth funds increasingly view climate change as financially material. How that translates into an investment strategy, however, is highly dependent. Managing climate-related investment risk can prompt a far different approach to investing in opportunities stemming from the low-carbon transition. Some climate investors prioritize portfolio decarbonization, while others might focus on green technologies. Incorporating impact goals is another point of divergence.
Sustainable investing has never been monolithic. Environmental, social, and governance-based investment approaches have long varied in their motivation and implementation. "Low carbon, "net zero," "energy transition," "green technology," and "climate solutions," are among the many terms applied to climate-focused strategies. What do they mean for investors? How do they differ in terms of ESG-related outcomes? What are their implications for risk and return?
Morningstar Indexes’ range of climate-related investment solutions can help answer these questions.
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