Ecology Funds That Could Outperform in a More Cynical World

Lukas Strobl: ESG strategies have had a bumpy ride. Political criticism is ramping up, especially in the U.S., and an unexpected war in Europe is raising new questions about investors' priorities. Here to talk with me about ecology funds, a big part of the E in ESG, is Morningstar's Ronald Van Genderen.

Ronald, ESG investing is a broad church. What exactly are ecology funds?

Ronald Van Genderen: Yeah. So, these are funds that primarily invest in companies whose products or services actively promote a cleaner environment. Most of them invest in a range of companies, including alternative energy, pollution control, water treatment and energy efficiency companies. And although most funds invest in a range of industries, there are also some funds that concentrate on just one industry segment. Either way, given the focus on environmental markets, ecology funds are considerably more concentrated on the sector level compared to a broad global equity index such as the MSCI World Index.

Strobl: Now, what are some ecology funds that you expect to do well from here?

Van Genderen: So, we cover several different funds in the ecology space. Among them are Impax Environmental Markets and Pictet Global Environmental Opportunities. Due to strong investor demand in recent years, these are soft closed, meaning that new investors cannot access these funds or at least access for new investors is limited. Therefore, I would like to mention today three positively rated funds that are still open. And these are BNP Paribas Climate Impact, which has a Morningstar Analyst Rating of Silver; Impax Environmental Leaders, which has a Silver rating; and Vontobel Clean Technology, rated Bronze.

So, the BNP Paribas fund is supervised by Impax. So, it is managed by the same team and following a similar process as the Impax Fund. And these two funds also share the same positive attributes. They are managed by Impax's listed equity team, which is a sizable 28-member team. They are not fully dedicated to this strategy as they are managing all listed Impax strategies. But in our view, it is a very well-resourced team and altogether they cover around 500 stocks, warranting depth of research and it's resulted in a very manageable workload for the team. The strategies are using an established and well thought through process that is thorough and benefits from the company's in-depth knowledge of environmental markets. And finally, the process is very structured and executed with discipline.

So, finally, the Vontobel Clean Technology Fund is managed by a long tenured and seasoned manager who receives well experienced support from a dedicated deputy manager and an investment analyst, and the three of them have been working together over the past six to seven years, making stability a positive attribute. The team is relatively compact, but they have a strong knowledge of the stocks in the universe, and they apply a holistic, structured and repeatable investment process based on in-depth thematic and company research with a medium to long-term mindset.

Strobl: So, rather specialist themes. What would you say are the main risks that these funds are facing?

Van Genderen: So, the first one I would like to mention is a possible continuation of the style rotation that we have observed in the market since the end of 2021. Investors have been preferring value over growth stocks, and as ecology stocks tend to have growth characteristics, this rotation in the market has hurt the performance of ecology funds. And a continuation of that trend can put relative performance of ecology funds under continued pressure.

Also, related to that, I should mention sector risk as well. The preference for value stocks also comes with an outperformance for more cyclical value sectors such as basic materials, energy, financials, areas where ecology funds have no or hardly any exposure, and this can also negatively influence relative performance. And then, finally, sustainable funds have experienced some strong interest from investors in recent years, but this is especially true for ecology funds. For example, since the end of 2019, total assets under management in ecology funds have quadrupled, and this can lead to several different risks, such as the risk of overcrowding for the entire ecology space or liquidity risk on a strategy level.

Strobl: Beware the crowds. Thanks for this, Ronald. For Morningstar, I'm Lukas Strobl.