Don’t get burned by a drought fund

Droughts, wildfires and flooding are occurring at an increasing rate. As the number of investments products relating to these events soars, it’s essential that investors understand the underlying structure of these investments.

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  1. Lynn Hutchinson

Droughts, wildfires and flooding are occurring at an increasing rate as changes in the world’s climate result in more extreme-weather events. As the number of investments products relating to these events soars, Lynn Hutchinson, Charles Stanley’s ETF expert, argues that it’s essential that investors understand the underlying structure of these investments.

There has been a major shift in the way Environmental, Social and Governance (ESG) matters are discussed in the City over the last decade. Talk has moved from limited conversations on environmental concerns to real action. Individual investors of all age groups, pension funds and governments worldwide are pressuring companies to make changes for the common good, ensuring ESG factors are now routinely considered at board level in businesses big and small.

Extreme weather events are contributing to the interest in climate-fund products – in 2019 investors added roughly $21bn into ETFs that apply environmental, social and governance principles, in 2020 the flows more than doubled to add a further $51bn of net new money from investors. By the end of May 2021, total assets invested in global ESG ETFs reached a record $246bn.

In 2020, the world watched as dry conditions resulted in an increasing incidence of dangerous wildfires in the US – and recent record-breaking temperatures in Canada have also highlighted the impact of changing weather patterns. Jacobabad, in Pakistan, recently recorded the world’s highest recorded temperatures of 52 degrees Celsius – creating conditions that were hotter and more humid than the human body can tolerate.

Climate-change products

The days are past when governments could only encourage the adoption of clean energy through heavy subsidies – solar and wind energy is now mainstream as the costs continue to fall. Global governments are also working on action plans that they will present in November this year at COP26, which will crystalise the commitments made in 2015 at COP21 in Paris to limit global warming by 2050. There are a growing number of clean-energy related ETFs – and not all are tracking the same companies.

Water technology funds are becoming increasingly popular as many countries have scarce water resources and not enough technology to increase the water sources available – South Africa has already experienced a water supply crisis. At the start of June, a report by the World Health Organisation and UNICEF showed that, when the Covid-19 crisis began, three in 10 people worldwide could not wash their hands with soap and water at home. The report warned that the world was on track to miss Sustainable Development Goals covering access to water services.

As well as understanding the products underlying investments, it is important to understand whether the fund is covering your ESG requirements. Solar and wind might be the better-known clean energy sources, but others are becoming increasingly viable from economic and efficiency perspectives. This list includes biofuels and biomass, thermal, hydro, wave and tidal-generated power. Green hydrogen, which is currently in its very early stages of development, may also become an important part of the global solution, especially in shipping and other long-haul industries. These sectors are driven by technology and new technologies are emerging rapidly.

The heightened interest in ESG means the fund providers have responded by launching a stream of products. Most are doing similar selections criteria within their products – excluding tobacco, controversial weapons and other companies, alongside their corporate governance selections.

Many investors have difficulty choosing a product. With so many available it has become increasingly difficult to decide what fits your investment criteria and what doesn’t. The truth is that this market has become saturated and many of these products are likely to close over the next five years as they fail to compete. There will undoubtedly be winners as government policy and investor expectations focus on ESG matters, particularly relating to climate change. But with too many products available, selecting the right fund should be done with care.

Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.

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