So, You’re Looking for a Fossil-Fuel-Free Fund. How to Tell Them Apart
A look at the largest fossil-fuel-free funds in the US and globally.
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Fossil-fuel-free funds have emerged as a way for investors to contribute to climate action. But the term “fossil-fuel-free” can mean different things to different people. So, how to differentiate one from the other? Below, we assess the largest fossil-fuel-free funds in the US and globally. Using an array of Morningstar climate analysis tools, we looked for which funds come closest to fully excluding fossil fuels from their portfolios.
The exhibits below list the 20 largest global and US fossil-fuel-exclusion funds by assets under management. Most earn medals under the Morningstar Medalist Rating. The Morningstar Medalist Rating leverages both qualitative insights and quantitative measures to indicate a strategy’s likelihood of outperforming its respective Morningstar Category index and/or peers. Most of these funds focus on large-cap stocks in the US, with a few exceptions offering diversified, global exposure (for example, Northern Trust ESG Equity Index Fund and HSBC Global Aggregate Bond ETF). Our list also includes a few fixed-income funds. As of August 2024, these largest fossil-fuel-exclusion funds generally lagged the Morningstar Global Markets Large-Mid Cap Index except for DWS Concept Kaldemorgen.
Exhibit 1a Top 20 Global Fossil-Fuel-Exclusion Funds by AUM
Seven of the largest global fossil-fuel-exclusion strategies have been categorized Sustainable Investment, as they have explicit sustainability criteria as binding factors in their security-selection and portfolio-construction process in addition to fossil fuel sector exclusion. All the sustainable funds earned more than 3 globes under the Morningstar Sustainability Rating, suggesting the overall environmental, social, and governance risks of these portfolios are either on par with or lower than their peers within the Morningstar Global Category.
As for the largest US fossil-fuel-exclusion strategies, the majority of the group earned Above Average (4 globes) or High (5 globes) Sustainability Ratings or are categorized as Sustainable Investment under the Morningstar Sustainability Attributes. Returns by Parnassus Value Equity Fund PARWX and Xtrackers MSCI USA Climate Action Equity ETF USCA beat the Morningstar Global Markets Large-Mid Cap Index by 220 and 1,080 basis points, respectively, whereas DFA International Sustainability Core 1 Portfolio DFSPX and Impax Global Environmental Markets Fund PGRNX stayed marginally below the benchmark.
Exhibit 1b Top 20 US Fossil-Fuel-Exclusion Funds by AUM
What’s a Fossil-Fuel-Free Fund? Depends on Who You Ask
Definitions of “fossil fuel free” often vary. For example, three State Street ETFs feature “Fossil Fuel Reserves Free” in their names but track two different indexes applying different exclusion or screening criteria. One index defines “fossil fuel reserves” as proved and probable reserves for coal, proved reserves for oil, and proved reserves for natural gas used for energy purposes, while the other adopts a more comprehensive exclusion range of fossil-fuel-related assets.
From Morningstar’s perspective, fossil fuel involvement is defined more broadly as a portfolio’s percentage exposure to companies that derive at least 5% of their revenue from thermal-coal extraction, thermal-coal power generation, oil and gas production, or oil and gas power generation, or 50% of their revenue from oil and gas products and services.
The varying definitions adopted by portfolios inevitably give rise to mixed exposures to fossil fuel assets. Below, we showcase the fossil-fuel-related involvement across different Morningstar Sustainability Ratings, which are expressed as globes, with the highest rating having 5 globes and the lowest, 1 globe. Under our own definition of fossil fuel involvement, for those strategies with 5 globes, 31% have less than 1% of assets in fossil fuels. Meanwhile, more than half the funds with only a 1-globe rating have more than 10% in fossil-fuel-related companies.
Exhibit 2 Fossil Fuel Involvement Across Morningstar Sustainability Ratings
A similar picture is found where high (above 5%) exposure to thermal coal power generation accounts for just 8% of fossil-fuel-free funds that earn a 5-globe rating.
Exhibit 3 Thermal Coal Power Generation Across Morningstar Sustainability Ratings
Of funds receiving 5 globes, more than 50% have less than 1% of assets in oil and gas power generation. Only 7% have involvement of over 10%. Overall, we see a greater chance of avoidance of high-level fossil fuel involvement among the funds earning the High and Above Average Sustainability Ratings.
Exhibit 4 Oil and Gas Power Generation Across Morningstar Sustainability Ratings
The varying exposures to fossil fuel assets in part explains the different levels of Implied Temperature Rise across the Sustainability Rating. The Morningstar Sustainalytics Low Carbon Transition Rating, expressed as ITR, indicates how close a company is to operating within its net zero (1.5 degrees Celsius) budget. It also signifies the expected level of global warming if the global economy had the same proportion of emissions misaligned to the net zero budget of the company. The portfolio ITR is then calculated as the asset-weighted average of the ones of the underlying holdings. A portfolio with a lower ITR is positioned to fare better in the transition to a low-carbon economy than is a portfolio with a higher ITR.
As shown below, fossil-fuel-exclusion strategies earning the High (5 globes) Sustainability Rating showcase not only a lower ITR average (2.3 degrees Celsius) than those that receive 2- (2.4 degrees Celsius) or 1-globe ratings (2.5 degrees Celsius), but also a shorter upper tail dragged high ITR outliers.
Exhibit 5 Implied Temperature Rise by Morningstar Sustainalytics Across Morningstar Sustainability Ratings
Portfolios earning the top Sustainability Rating of High (5 globes) are also associated with higher LCTR Emission Management Scores, suggesting stronger emission management capacities of their underlying holdings. As of August 2024, fossil-fuel-exclusion strategies with 5-globe ratings on average score 57 in emission management, compared with less than 51 found among the funds with 1 globe.
Exhibit 6 LCTR Emission Management Scores by Morningstar Sustainalytics Across Morningstar Sustainability Ratings
Lower levels of fossil fuel involvement, combined with stronger emission management capacities, translate into smaller potential investment losses. Using the LCTR Value at Risk Percent of Covered Holding metric, we find that fossil-fuel-exclusion strategies with 5-globe ratings show on average 4% of VaR, compared with the over 10% seen among the funds receiving a 1-globe rating under the Inevitable Policy Response Net Zero pathway.
Exhibit 7 Value at Risk Across Morningstar Sustainability Ratings
However, it is possible that some companies have a relatively low VaR and a high ITR. A company with high misalignment but low emissions may have a lower VaR due to fewer excess emissions. The regions in which an underlying company operates are crucial, as some areas have stricter pricing schemes. Additionally, companies with strong financials might face less risk as they can better absorb the costs associated with policy changes.
The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar’s editorial policies.
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