Demand for climate funds, particularly those focused on climate solutions, clean energy and technology, is waning, according to a new report from Morningstar.
While global climate funds experienced $345 billion in inflows over the past four years, these funds are on track for their first annual outflow in 2024. Outflows from these funds totaled nearly $24 billion in the first nine months of this year , according to the Report “Investing in the Time of Climate Change”.
Morningstar analysts attribute the exits to high funding costs and a concern that companies involved in these funds could be penalized for switching to new energy sources faster than the rest of the world. However, since the transition to new energy sources will have to happen sooner or later, some investors may see this as an opportune time to buy those funds on the cheap, analysts said.
Funds reviewed by Morningstar included open-end funds and ETFs that feature investment strategies related to the topic of climate change. The US market share of $572 billion in such funds globally currently stands at 5%.
Overall, assets in US-based climate funds fell by just 0.9%, to $31.5 billion, between September 2023 and September 2024. However, this year marked the first time that inflows into US climate funds were negative , falling by $1.66 billion in the first nine months of 2024.
Funds focused on clean energy and technology experienced the highest redemption volume at $1.5 billion, while funds tracking climate solutions saw $340 million in outflows and those tracking low carbon emissions saw $230 million in outflows. In total, assets in funds focused on clean energy and technology fell 27% to $6.4 billion. Over the past three years, these types of funds have experienced a contraction of nearly 66% due to a higher interest rate environment and inflationary pressure.
On the positive side, funds focused on climate transition strategies experienced inflows of $370 million. Their assets rose 25% in the first nine months of 2024 to $10.7 billion, helped by new product launches and market price appreciation.
Launches of new US climate funds have also fallen since peaking at over 30 in 2021. This year only six funds were launched to pursue climate strategies.
However, these trends are likely to be temporary, according to Hortense Bioy, head of sustainable investment research with Morningstar and one of the report's authors. For example, just a few years ago, US investors preferred funds that focused on clean energy, clean technology and climate solutions because these are opportunities that generate alpha, she said.
What changed was that greater inflationary pressures and a higher interest rate environment brought funding costs to the companies involved in those funds, and their stocks have underperformed over the past two to three years. And while the U.S. Federal Reserve cut its key interest rate twice this fall, those moves aren't nearly enough to change the financial picture for these types of companies, Bioy said.
At the same time, she pointed to the fact that funds focused on climate transition, which are better suited to more risk-averse investors, have seen a small increase in inflows year-on-year. These types of funds focus on companies that are decarbonizing and not on the production of new technologies, which require more upfront investment. The latter are “growth stocks, and growth stocks are very sensitive to a high interest rate environment because they have very high upfront costs,” she said. With clean energy and cleantech stocks, in particular, there is limited opportunity for them to pass on these costs.
Another issue is that the world is decarbonizing at a slow pace, and funds that invest in companies that are further along in their transition than the rest of the market may be seen by investors as riskier, Bioy added. “I think that's a dilemma for investors—they might want to include those companies in their portfolios, but they might think 'Do we want to take the risk if they decarbonize faster than the rest of the market, will penalized? '”
However, given that in the long term decarbonisation is here to stay, this moment when energy and climate technology stocks have been hit hard could be seen by some investors as an opportune time to invest, she said. “The world has to transition, so those companies at the end of the day will do well.”