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What are we looking for?

Low-carbon, low-ESG-risk equity funds.

The screen

This past Tuesday, U.S. President Joe Biden signed the Inflation Reduction Act, which, among other things, is focused on reducing the country’s carbon emissions and increasing its use of green energy. With our southern neighbour officially on the low-carbon bandwagon, a complement to Canada’s 2030 Emissions Reduction Plan, investors may be looking to position their portfolios to benefit from this theme.

For savvy ESG-oriented investors however, a portfolio with a low-carbon focus may not shield them from broader ESG risks. These risks include consideration of not just environmental risks, but also social and governance risks. To guide investors dedicated to an overall ESG-friendly and low-carbon portfolio, I used Morningstar Direct to screen 144 equity funds that exhibit metrics mitigating ESG and carbon-related risks using the following criteria:

• Earns Morningstar’s Low Carbon Designation, which is an overall designation based on two of Morningstar’s metrics: Portfolio Carbon Risk Score and Portfolio Fossil Fuel Involvement. To receive the Low Carbon Designation, funds must have a 12-month average Portfolio Carbon Risk Score below 10 and a 12-month average Fossil Fuel Involvement Score of less than 7 per cent of assets

• A Morningstar Sustainability Rating of “high,” indicating ESG risk is managed very well at the fund level relative to its peer group

• A Morningstar Quantitative Rating of bronze, silver or gold, indicating a forward-looking view of the fund’s ability to outperform its peer group and/or its relevant benchmark on a risk-adjusted basis over a full market cycle

• A Morningstar Overall Rating (informally known as the “star” rating) of four stars or better. The star rating is an objective look back at a fund’s after-fee, risk-adjusted returns relative to the category to which the fund belongs. Though the measure is backward-looking, Morningstar’s research shows that over time and on an aggregate basis, five-star funds continue to outperform four-star funds, three-star funds and so on, after receiving the rating

What we found

Low-carbon, low-ESG-risk equity funds

NameMER (%)Low Carbon Designation™Morningstar Quantitative RatingMorningstar Sustainability Rating™Morningstar Rating OverallTotal Ret 1 Mo (Mo-End) CADTotal Ret 3 Mo (Mo-End) CADTotal Ret 1 Yr (Mo-End) CADTotal Ret Annlzd 3 Yr (Mo-End) CADTotal Ret Annlzd 5 Yr (Mo-End) CAD
BMO MSCI USA High Quality ETF0.34YesBronzeHigh58.15-0.39-9.0311.5014.64
Fidelity Greater Canada Sr F1.15YesSilverHigh58.43-2.17-9.3121.2817.08
Horizons Global Sustainability Ldrs ETF0.54YesSilverHigh58.40-2.21-14.4414.22N/A
Lazard Global Compounders F1.05YesBronzeHigh58.640.92-10.149.8910.86
Sun Life MFS US Growth F1.05YesBronzeHigh510.021.30-15.709.2813.88
RBC Life Science & Technology Fund F0.94YesGoldHigh58.42-0.21-10.8513.8315.87
Fidelity Intl Growth Sr F1.14YesSilverHigh58.86-0.74-16.514.796.52
RBC U.S. Mid-Cap Growth Equity Fund F0.93YesGoldHigh59.57-1.06-7.588.3313.19
BMO Concentrated Global Equity F0.93YesGoldHigh45.39-2.88-9.417.55N/A
Canoe Defensive U.S. Equity Port Cl F1.25YesSilverHigh44.451.09-2.8511.5211.79
North Growth US Equity Advisor Ser F0.70YesBronzeHigh412.890.87-14.709.1311.49
RBC Emerging Markets Equity Fund F1.00YesGoldHigh4-1.60-5.27-16.08-1.311.96
Manulife US Dividend Income F1.10YesGoldHigh47.581.92-6.3210.8612.40
Scotia US Equity F1.28YesSilverHigh411.071.50-5.1114.6816.83
Guardian Fundamental Global Equity WF0.77YesGoldHighN/A5.21-2.80-9.41N/AN/A

Source: Morningstar Canada

It is not uncommon for developed markets to be strongly represented in a screen such as this, given the greater availability of data in those markets. The screen’s output includes eight U.S. equity funds, five global or international equity funds, one Canadian equity fund and one emerging markets fund.

Interestingly, just two of the funds above self-identify as a sustainable product by prospectus. This means that they are the only funds on the list explicitly managing ESG and low-carbon risks to obtain a objective.

The others, although they meet the screen’s criteria, do so implicitly. From a performance perspective, we note the funds have been challenged over short-term time periods, with top-quartile (and in some cases, top-decile) category ranks noted over longer-term time periods. This aligns with the long-term nature of ESG and carbon-related risks, which may require investors to remain patient as the benefits materialize.

Note that the management expense ratios (MERs) listed here reflect the oldest fund class. In the table, F-class funds exclude the cost of advice and are held in fee-based accounts in which the adviser charges separately for advice.

This article does not constitute financial advice. Investors are encouraged to conduct their own independent research before purchasing any of the investments listed here.

Danielle LeClair, MFin, is director of manager research, Canada, for Morningstar Research Inc.

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