As is being widely documented, carbon-free investing is garnering plenty of attention these days.
Advisors with carbon-sensitive and sustainability attuned clients frequently turn to active and passive funds for climate-related allocations, but it's crucial to note that just because a group of funds extol the virtues of carbon avoidance in their titles, that doesn't make these products twins. It doesn't even make them cousins.
That is to say, particularly with index funds, methodologies and structures differ from issuer to issuer. For example, some funds will focus on criteria such as environmental efficiency, emissions momentum and lower overall emissions in an effort to cobble together a portfolio of companies that appear to be environmentally.
That can lead to indexes and portfolios featuring a variety of sector exposures, ranging from technology to healthcare to banks and, in some cases, fossil fuels producers.
Getting to the Heart of the Matter
Advisors probably get this a lot from clients: “What's XYZ bank doing in my supposedly ESG fund?” “Why's Chevron in my low carbon fund?”
Relevant questions to be sure and those inquiries speak to fluidity in environmental scoring, which can be onerous for advisors to keep up with. I'll save the topic of greenwashing for another day because it really is a standalone article, but the fact is, for many clients, dedicated renewable energy strategies may be the way to go. That's true because broad equity approaches to low carbon investing may and often do miss out on clean tech companies.
“It is important to look under the hood of clean energy and low carbon portfolios to understand their true makeup,” according to VanEck research. “A balanced approach including established alternative power producers and wholesalers, along with emerging low carbon energy technologies, may provide the potential stability associated with utilities exposure that could help offset the volatility accompanying high growth, low carbon transition technologies.”
Consider the case of the VanEck Vectors Low Carbon Energy ETF (SMOG). As a pure renewable energy ETF, SMOG is obviously levered to the low carbon theme and not just because “low carbon” is in its name. SMOG allocating 61% of its weight to wind, solar and renewable power providers cements its low carbon status.
The interesting tidbits don't stop there. SMOG shares just five holdings with the widely followed MSCI USA Extended ESG Focus Index and the overlap by weight between the VanEck fund and that index is just 2%.
Translation: There's a true low carbon option in that pair and one that may leave clients wanting less carbon. It's clear which one is which.
Diversification + Purity = Winning Combination
One way of enhancing carbon purity – one that clients are likely aware of – is to zone in on specific concepts, such as solar and wind. That's fine in a discretionary account, but it's likely too risky for many clients. Rather, diversification should carry the day when making renewable energy allocations.
“This broad, low carbon energy ecosystem includes allocation to electric vehicles, alternative energy producers and wholesalers, as well as low carbon energy supporting technologies,” notes VanEck.
Interestingly, by achieving that level of diversity, clients gain something: A higher level of carbon avoidance than is found with many of the prosaic funds in this category.
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