The ETFs you can use to help combat climate change

Kenneth Lamont highlights the current crop of ETFs with a climate focus.

The transition towards a low-carbon future is a risk for any investor’s portfolio. ETFs can be used to help mitigate this risk. In this article, we examine the current crop of ETFs with a climate focus that are listed on the London Stock Exchange. 

Broad ESG with climate twist

iShares and Xtrackers both offer a range of broad equity ESG (environmental, social and governance) ETFs, with an additional focus on climate.

Starting with the largest, iShares MSCI USA SRI ETF USD Acc (LSE:SUAS) applies additional fossil fuel screens to its popular SRI ETF range. The funds exclude any holding with fossil-fuel exposure through extraction and production activities, power generation activities or reserves ownership.

Xtrackers’ flagship range of ESG equity ETFs, such as Xtrackers MSCI USA ESG ETF 1C GBP (LSE:XESU), go further, employing MSCI’s Low Carbon Leader methodology. Beyond the best-in class ESG selection process, this approach excludes the top quintile of holdings based on carbon emissions intensity across sectors. It also excludes the largest owners of reserves per dollar of market capitalisation, representing 50% of the reserves in the parent index.

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‘Paris aligned’ ETFs

As the popularity of climate investing grows, so do the accusations of ‘greenwashing’. To address this, a number of index providers have worked with the European Commission to ensure that their strategies are aligned with the Paris Climate Agreement goal to limit the increase in global average temperatures to below 2°C above pre-industrial levels.

This goal-focused approach and the stamp of approval from such a respected third party will please many investors. For UK fund-buyers, Franklin Templeton has launched the Franklin S&P 500 Paris Aligned Climate ETF (LSE:USPA).

Comparing the options

With so many different approaches, it is easy to get overwhelmed. To help, we have grouped climate-aware ETFs into two exhibits: US and Global. 

By comparing both Morningstar Carbon Risk and Morningstar Carbon Intensity scores we can see how successful each strategy has been in improving its climate risk and emissions profile respectively.

USA-focused equity ETFs with climate focus

The good news is that all the climate-aware ETFs show improvements in both Morningstar Carbon Risk and Morningstar Carbon Intensity scores versus the broader market.

The Xtrackers ETFs perform well in both markets, cutting Carbon Risk by more than one third and Carbon Intensity by almost three-quarters in each case.

World-focused equity ETFs with climate focus

iShares’ range also scores well, although sometimes unevenly so. For example, in both groups funds see some of the largest improvements to Carbon Intensity scores but the lowest improvements in Carbon Risk.

This highlights why each fund should be evaluated by the metric most appropriate for each investor. For example, an investor targeting improved risk and return metrics would likely concentrate on Carbon Risk, while an investor more concerned with their carbon footprint should place more emphasis on the importance of Carbon Intensity metrics.

Trade-off between impact and tracking 

As with other ESG offerings, there is a general trade-off between the strength of the sustainable impact being made and how closely the fund tracks the broader market.

While the iShares and Xtrackers funds can boost their carbon (and ESG) metrics by excluding large portions of the underlying universe, fund performance can be expected to deviate from the broader market, particularly over longer periods.

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This approach may suit the most environmentally conscious investors, but others may prefer a more measured approach.

Other climate-aware ETFs

Those looking to profit from the structural shift towards renewable energy might use the thematic iShares Global Clean Energy ETF (LSE: INRG), which invests in 30 of the largest players in solar and wind power and has been the best-performing ETF in Europe year to date. The narrow focus of the fund means that it’s not suitable as a direct replacement for a core holding but may fit snuggly with existing ex-energy funds.

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There is currently only one single climate-aware fixed income ETF listed on the London Stock Exchange; the Lyxor Green Bond (DR) ETF C EUR GBP (LSE:CLIM), which tracks the market for green bonds. These are defined as fixed-income securities that back environmental projects.

Kenneth Lamont is a senior analyst focused on manager research and passive strategies at Morningstar.