Once upon a time, saving the planet meant recycling the glass and cardboard you used and running your car on unleaded petrol. Then things began to change. Before long, your neighbour was boasting about the solar panel on his roof, and a few years later, he was showing off his battery-powered car. You could argue little has changed―and that impulse to improve the air and harvest natural energy has always occurred. It’s just that now it’s occurring on a bigger and more dramatic scale. The semantics of the investing “landscape” have changed too. ETHI, ERTH, ESGI: the acronyms alone of today’s environmentally focused funds are as good an indication as any of a growing trend among investors to channel their money to causes they believe in (renewable energy) and away from things they don’t (tobacco, fossil fuels, firearms). Today’s investor is increasingly guided by a new type of climate iconography: catastrophic warnings about the unaddressed rise in greenhouse gas emissions and the stark images of associated natural disasters (bushfires, floods, brittle icebergs, coal pits). 

Of course, today’s investor is no different to his predecessor. He wants to make money but not if it means inadvertently funding companies that break the law, mistreat their staff, and foul the air. To that end, companies are no longer rewarded merely for generating profit. They must also leave their surroundings―i.e. their workers, the community, in short, the planet―in a better state than they found them. Hence the new catch-all rating term ESG, which aims to measure a company on its environmental, social and governance credentials. 

Asset managers are alive to the change in attitudes and the number of sustainable investing funds are consequently proliferating. Eleven sustainable investing funds were launched in Australia last year―the fifth straight year of double-digit fund launches. There are now 126, notes Grant Kennaway, a director of manager research at Morningstar. And if you wondered whether they’re profitable, you’re in for a pleasant surprise. More on that later.

In the first part of this two-part feature, we examine why asset managers foresee a “golden age” in renewables, and why 2020 accelerated attitudes around sustainability and ESG, in particular. In part two, we examine ways in which investors can gain exposure, be it through superannuation, managed funds, stocks or exchange-traded funds.

‘A golden age in renewables’

“Renewable energy has historically been perceived as expensive, impractical and unprofitable but all that is quickly changing,” says Noriko Honda Chen, an equity portfolio manager at Capital Group. “I believe we’ll see a dramatic shift towards renewable energy over the next decade. We are in the early stages of the transition to an electrification of the grid and green energy, and there are strong tailwinds that could drive growth through 2030 and beyond. Automation and artificial intelligence are setting the stage for a golden age in renewables, pushing costs down while boosting productivity and efficiency.”

The change is palpable. Some traditional utilities are already generating more than 30 per cent of their business from renewables and are reaching an inflection point where they are being recognised more as growth companies rather than just staid, old-economy power generators and grid operators, Chen says. Take Europe, where governments have set high decarbonisation targets. The Renewable Energy Directive stipulates that a minimum of 32 per cent of energy in the European Union should come from renewable resources by 2030.

Themes such as sustainability and renewable energy are obviously politically charged topics, particularly because many companies receive government help. As Don Stammer, a former director of Deutsche Bank, says, “keen environmentalists say renewable energy is now cheaper, cleaner and profitable but the substantial subsidies from government are a reminder it’s still not easy being a green investor.” And remember “thematic” investments that seek to tap new trends can be a risk for long-term investors. Thematic funds are often launched in the final years of a bull market, says Morningstar's analyst Daniel Sotiroff, who covers the US ETF industry. As such they are likely to hold stocks with strong recent performance, which sets them up for poor future performance. And not every stock within an ETF is necessarily a pure-play in sustainability, ESG or renewable energy.

The purpose of this article is not to debate the science, as the expression goes, but to identify investment trends and explain where asset managers see opportunities. “Forward-thinking investors should consider whether their portfolio has sufficient exposure to this trend,” says nabtrade’s Gemma Dale, director, SMSF and investor behaviour, “as one thing is for sure. It isn’t going away.”

Why now?

But before we unfurl the list of stocks picks, it may help to answer the question “why now?”. What’s behind the momentum? For Arian Neiron, managing director at VanEck, an ETF provider, 2020 was a watershed. “2020 was unquestionably a defining year in history,” Neiron says, “characterised by disruption, adaptation (or lack thereof) and acceleration. It will also likely be pinpointed as the year where the groundswell of public demand, technological advancements and economic pressures culminated to reshape the global energy supply paradigm.”

The onset of covid-19 may have altered the way we live and think about the environment. But don’t forget what immediately preceded it. Remember when Sydney Harbour disappeared under a shroud of bushfire smoke? Even the South Americans could see it. “2020 tied for the hottest year on record,” Neiron notes, with NASA figures at the ready, “matching 2016”. Mainstream media called it another wake-up call for action on repairing the climate and averting future damage. There were macroeconomic changes too. US oil prices turned negative for the first time on record in 2020 and later in the year, major oil producers announced the world had now passed “peak oil” demand. 

Averting damage of course means investment―and lots of it. The Energy Transitions Committee, a global organisation of energy producers, financial institutions and environmental groups, believes it is possible to create a prosperous net-zero-emissions economy by mid-century, in which case global warming would be limited to the lower bounds of the Paris Agreement’s target range. By the ETC’s reckoning, the extra investment needed to achieve a zero carbon-emissions economy by 2050 will be in the order of US$1-2 trillion a year. Similarly, the US Energy Information Administration forecasts that power generation from renewable sources such as wind, solar, hydro and geothermal, should provide the bulk of the world’s needs by 2050.

The renewable energy industry has grown over the past decade, rising from about 10 per cent of all energy produced in 2010 to 22 per cent as of November 2020 in the US, notes Phillip Brzenk, senior director, Strategy Indices at S&P Dow Jones Indices. But more is needed if signatories to the Paris Agreement hope to achieve their stated aim: keep the increase in global average temperature to well below 2C above pre-industrial levels, and a “climate neutral” world in three decades’ time. “The need for increased renewable production and efficiency is perhaps evident,” Brzenk says. “But more investment into equipment is needed as well to further support increased production and efficiency.”

a picture of emission from a coal-fired power station

By the Energy Transitions Committee's reckoning, the extra investment needed to achieve a zero carbon-emissions economy by 2050 will be in the order of US$1-2 trillion a year

Investment must be renewable too

Investment in renewable energy is of course happening. And 2020 was again a milestone on that front. In Europe, new solar and wind projects resulted in renewables generating more electricity than fossil fuels. In Britain, renewable energy made up almost half of Britain’s electricity generation for the first three months of the year. And in the US, April 2020 was the first month ever that renewables generated more electricity than thermal coal in the US every single day. The covid shutdown helped, but some, like VanEck’s Neiron, foresee a “clean energy revolution”. And the flow of investment money in the major economies supports his claims. In 2020, the world invested an unprecedented $500 billion in decarbonisation. In the UK, Boris Johnson committed £12 billion ($21 billion) to create a “green industrial revolution” in the kingdom; Germany allocated €9 billion ($14 billion) to end its reliance; the new Democrat government of Joe Biden earmarked US$2 trillion ($2.6 trillion) for clean energy projects. And not to be outdone, China, the world’s largest emitter, has committed to carbon neutrality by 2060, with other developed nations pledging to achieve this target by 2050.

‘Karma delivers dividends’

If you had any doubt investors still regarded sustainable investing as expensive, impractical and unprofitable, Morningstar’s Kennaway is ready to disavow you of that notion. And again, 2020 was a banner year in which sustainable funds hit $25 billion. “Retail assets invested in Australasian sustainable investments grew 35 per cent to $25 billion compared with the previous year,” says Kennaway. “Given the volatility of global markets during the pandemic, it seems investors are increasingly committed to sustainable approaches, with over $4 billion of inflows over the past months.”

Estimated net flows and aggregate fund size of Australasian sustainable investments (AUD, Mil)

a graph showing Estimated net flows and aggregate fund size of Australasian sustainable investments (AUD, Mil)

Source: Morningstar Direct. Data as of 31 Dec. 2021. Excludes fund of funds.

And investors in these funds aren’t just banking on warm feelings and a sense of virtue; they’re seeing a return too. “Sixty-three per cent of sustainable funds placed in the top half of their respective Morningstar category peer groups during the 12 months to 31 December 202,” Kennaway says, “which suggests investing sustainably does not necessarily mean sacrificing returns.” Or as Australian Ethical, a leader in ethical managed funds and superannuation, likes to say, “karma delivers dividends”.

Sustainable funds bloom

Compared with Europe and the US, the sustainable fund market is still relatively small, says Kennaway. “Through Morningstar’s sustainable attribute framework, we have identified 11 additional funds that have been launched in the year to 31 December, bringing the total number of individual sustainable strategies available to Australasian retail investors to a revised 126. The momentum of sustainable fund launches has soared since 2015. This is the fifth consecutive year of double-digit fund launches.”

Australasia-domiciled sustainable fund and ETF launches (by year)

a graph showing Australasia-domiciled sustainable fund and ETF luanches (by year)

Source: Morningstar Direct. Data as of 31 Dec. 2021 

The record amount of money going into such funds has been roughly evenly split between active ($2.2 billion) and passive ($1.9 billion) strategies. This latter category includes exchange-traded funds, a type of security that tracks a market index, sector, commodity, or other asset, but which can be bought and sold on a stock exchange just like a regular share. Read further on for a selection.

In part two of this article, we examine ways in which investors can gain exposure to sustainability, renewable energy and ESG-related funds, stocks, and exchange-traded funds.

Read part 2.

Morningstar's Global Best Ideas list is out now. Morningstar Premium subscribers can view the list here.

See also Morningstar Guide to International Investing.