Climate Action

How green funds help protect investors from climate change risks

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Major private investment is needed to meet 2050 climate goals. Image:

Steffen Kern
Chief Economist and Head of Risk Analysis, European Securities and Markets Authority, ESMA
Adrien Amzallag
Economist, European Securities and Markets Authority
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Private Investors

  • Investment funds in Europe are more exposed to climate-sensitive economic sectors than banks, insurers and pension funds.
  • However, few investment fund climate-related financial risk assessments have been conducted.
  • We've examined the portfolios of more than 23,000 EU investment funds and reveal some relative long-term benefits of green funds.

Getting to carbon neutrality is immensely expensive. In the EU alone, reaching zero emissions by 2050 is estimated to cost $300 billion per year for the foreseeable future. Taxpayers will play a role in this, but a major part of the financing, nearly two-thirds, will need to come from private investments.

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So, what is the role of investment funds in moving the planet towards carbon neutrality? After all, funds around the world manage more than $60 trillion of assets, around one-third of which are European. Indeed, many fund managers are doing what they can to respond to growing investor demand that environmental and other sustainability risks and challenges be reflected in their portfolio selection. Assets in European ESG investment funds have been booming to over $1.7 trillion today.

The bad news is that this is only a drop in the ocean, given the scale of what needs to shift. The good news is that there is plenty of upward potential – new fund investments in environmental sustainability will not only help tackle climate change, they will also benefit individual investors as well as the financial system as a whole, as a network analysis of the EU fund industry suggests.

Green funds offer less vulnerable portfolios: portfolio overlaps among EU investment fund portfolios, measured as the number of common investments between two investment funds. Colours indicate average portfolio emissions, from dark green (cleanest) to dark brown.
Green funds offer less vulnerable portfolios: portfolio overlaps among EU investment fund portfolios, measured as the number of common investments between two investment funds. Colours indicate average portfolio emissions, from dark green (cleanest) to dark brown. Image: A. Amzallag (2021), 'Fund portfolio networks: a climate risk perspective', ESMA Report on Trends, Risks, and Vulnerabilities No. 1 2021, pp. 73-86.

We have examined the portfolios of more than 23,000 EU investment funds, which include equity and bond investments in 21,000 corporates. We also checked the greenhouse gas emissions of these corporates. The insights are profound:

1. More fund greening is needed

Fund portfolios are still by and large underweight on green firms and overweight on brown firms. The average share of portfolio holdings in green firms is only 11%, while the share of exposures to brown firms tends to be about 53%. The funds with the most polluting portfolios, and thus with the greatest scope for improving their portfolio carbon footprint, are also the largest.

2. Investors benefit from green fund resilience

Green fund portfolios are more diversified relative to other funds. In other words, green fund portfolios “herd” less than brown fund portfolios, which are much more similar to each other. Climate-related financial shocks will therefore disproportionately affect brown funds in a coordinated way. Our analysis suggests that, in such a scenario, investors in brown funds could lose two to three times more than those in green funds.

3. Green funds bring lower systemic financial risk

Because their portfolios are more similar, brown funds are more interconnected with each other, compared to green funds. Thus, brown funds have greater systemic impact: they contribute more to total system-wide losses than green funds.

These are three pressing reasons for investors to review their portfolios and consider the long-term benefits of green fund investments. Governments can support this rebalancing, as the EU does through its European Green Deal.

Investors need to assess investment funds not only in terms of their pure financial performance, but also with respect to their vulnerability to climate-related risks. Greater transparency of ESG fund strategies, more detail on fund exposures to climate-sensitive sectors, and higher quality emissions-related disclosures by downstream firms are all necessary if we want to enable well meaning investors to take the right decisions for our planet.

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