Demand for climate funds, particularly those focusing 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 last four years, these funds are on track for their first annual outflow on record in 2024. Outflows from these funds reached nearly $24 billion in the first nine months of this year, according to the “Investing in Times of Climate Change” report.
Morningstar analysts attribute the outflows to high financing costs and a concern the companies included in these funds might be penalized for transitioning to new sources of energy faster than the rest of the world. However, since the transition to new sources of energy will have to happen sooner or later, some investors might see this as an opportune time to buy into those funds on the cheap, analysts said.
The funds Morningstar examined included open-end funds and ETFs featuring investment strategies related to the theme of climate change. The U.S. market share of the $572 billion in such funds globally currently stands at 5%.
Overall, assets in U.S.-based climate funds declined by just 0.9%, to $31.5 billion, between September 2023 and September 2024. However, this year marked the first time that inflows into U.S. climate funds were negative, dropping 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 pursuing climate solutions saw $340 million in outflows and those pursuing low carbon emissions saw $230 million in outflows. In total, assets in funds focusing on clean energy and technology declined by 27% to $6.4 billion. Over the past three years, these types of funds experienced a contraction of almost 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 by 25% in the first nine months of 2024, to $10.7 billion, helped by new product launches and market price appreciation.
New climate fund launches in the U.S. have also declined since a high of over 30 in 2021. This year saw only six funds launched pursuing climate strategies.
However, these trends are likely temporary, according to Hortense Bioy, head of sustainable investing research with Morningstar and one of the report’s authors. For example, just a few years ago, U.S. investors preferred funds that focused on clean energy, clean technology and climate solutions because these are alpha-generating opportunities, she said.
What changed was that greater inflationary pressures and a higher interest rate environment brought up financing costs for the companies included in those funds and their stocks have been doing poorly over the past two to three years. And while the U.S. Federal Reserve did cut its key interest rate twice this fall, those moves are not nearly enough to reverse the financial picture for those types of companies, Bioy said.
At the same time, she pointed to the fact that funds focused on climate transition, which are a better fit for more risk-averse investors, have seen a small uptick in inflows year-to-date. These types of funds focus on companies that are decarbonizing rather than producing 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 clean technology stocks, in particular, there is limited ability for them to pass on those costs.
Another issue is that the world is decarbonizing at a slow rate and funds that invest in companies that are further down in their transition than the rest of the market might be viewed by investors as riskier, Bioy added. “I think that’s a dilemma for investors—they may 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, are they going to be penalized?’”
However, given that in the long-term decarbonization is here to stay, this moment when climate energy and technology stocks have been badly battered might 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, they will do well.”
