Responsible investment funds review – opportunities in a changing energy mix?

The past six months have been a challenging time for investors around the world. Skyrocketing inflation, a cost-of-living crisis, and the repercussions of Russia’s invasion of Ukraine have created an environment of uncertainty and volatility.

Environmental and social concerns have slipped down the agenda for some investors, but they’re still as important as ever. From severe flooding in Pakistan to wildfires in Europe and the US, the world has experienced first-hand the catastrophic consequences of a changing climate.

In this sector review, we look at the headlines and trends dominating the responsible investing world, the latest analysis from our research team and how our Wealth Shortlist picks have performed.

This article isn’t personal advice. If you’re not sure whether an investment is right for you, ask for financial advice. Investments can fall as well as rise in value, so you could get back less than you put in.

COP out?

The annual Conference of Parties (COP) to discuss the world’s collective climate goals has established itself as one of the biggest events in the sustainability calendar. The 27th annual COP took place in November. There was no shortage of rhetoric, but what counts is firm political action and commitments, and this was sadly lacking.

The headline commitment was the creation of a ‘loss and damage’ fund. Almost 200 countries agreed to set up a fund to cover the costs that vulnerable nations are experiencing because of climate change.

There were also some country-specific announcements. India, for example, gave more detail on how it would achieve its net zero by 2070 commitment. In the UK, Rishi Sunak announced commitments to triple funding for climate adaption, roll out additional funding for green technology innovation and accelerate clean energy investments with Kenya and Egypt.

The conference didn’t achieve much success on carbon reduction though. The longer the world waits to launch a proportionate response to the climate crisis, the more forceful government actions will need to be in order to avoid the worst impacts. This political and regulatory scrutiny will impact some companies more than others.

On top of increased regulation, those companies not seen to be doing enough could face a customer backlash, negative press, and reputational damage. That’s why it’s more important than ever to consider sustainability issues when you invest.

Renewables and the changing energy mix – opportunity ahead?

There’s been a lot of progress for renewables of late as well – they now make up over a fifth of the European Union’s energy mix. Wind and solar power were responsible for 22% of the EU’s electricity in 2022, helped by a surge in renewable energy capacity and a drop in overall electricity demand. It meant renewables pulled ahead of fossil gas for the first time.

Russia’s invasion of Ukraine fuelled speculation that Europe would make a large-scale return to coal. But while the proportion of electricity produced using coal rose 1.5 percentage points to 16%, coal power has been in structural decline in the EU for the past decade. Even with the rise in 2022, coal generation was still 37% below 2015 levels.

To meet the EU’s net-zero commitments, the proportion of energy generated from coal will need to fall to zero over the coming years. The number of wind and solar power farms will also need to increase substantially. This could provide both risks and opportunities for investors.

3 responsible investment funds for your ISA

What has our research team been up to?

We recently added the Legal & General Future World ESG UK Index to the Wealth Shortllist of funds chosen by our analysts for their long-term performance potential.

Its benchmark, the Solactive L&G Enhanced ESG UK Index, is made up of around 320 companies spread across the UK stock market. The index invests more in companies that score well on a variety of ESG criteria – from the level of carbon emissions generated, to the number of women on the board and the quality of disclosure on executive pay. It also reduces how much it invests in companies that score poorly on these measures.

The fund has a small amount of exposure to smaller companies. They have the potential to do well over the long term, but they’re higher risk.

READ MORE ABOUT LEGAL & GENERAL FUTURE WORLD ESG UK INDEX, INCLUDING CHARGES

LEGAL & GENERAL FUTURE WORLD ESG UK INDEX KEY INVESTOR INFORMATON

We also met with the managers of several responsible investment funds in recent months. This included the team behind the BNY Mellon Sustainable Real Return fund, following the tragic news that Suzanne Hutchins, who led the real return team, had passed away.

Suzanne had been a key member of the team since 2010 and in addition to her investment responsibilities, she took on people management at the start of 2018. She was also an important member of the wider investment business at BNY Mellon.

We’re currently in the process of understanding the implications for the funds she was involved with. We’ll continue to monitor the funds and will provide a further update when we can.

READ MORE ABOUT BNY MELLON SUSTAINABLE REAL RETURN, INCLUDING CHARGES

BNY MELLON SUSTAINABLE REAL RETURN KEY INVESTOR INFORMATON

How have our Wealth Shortlist funds performed?

There are currently six funds in the responsible investment sector of the Wealth Shortllist, and several other responsible funds that sit in other sectors. We look at the top and bottom performers below.

Remember, investing in funds isn't right for everyone. You should only invest if the fund's objectives are aligned with your own, and there's a specific need for the type of investment being made. Investors should understand the specific risks of a fund before they invest, and make sure any new investment forms part of a diversified portfolio.

For more details on each fund and its risks, use the links to their online factsheets and key investor information below. Past performance isn’t a guide to the future. Investments and any income they produce can fall as well as rise in value, so you could get back less than you put in.

Stewart Investors Indian Subcontinent Sustainability was the best performing responsible fund on the Wealth Shortlist over the year to 31 January 2023.

Sashi Reddy and co-manager David Gait invest in quality companies they believe can benefit from and contribute to the sustainable development of the countries they’re based in. They like cash-generative businesses, which are in good financial health and could withstand periods of economic volatility.

The managers also put emphasis on businesses’ people and culture. They only invest in companies they believe are run by management teams with integrity.

India has excellent long-term growth potential, but a fund focused on a single emerging country is a high-risk option. It should only form a small portion of an adventurous investment portfolio. The fund also invests in smaller companies, which adds risk.

Past performance isn’t a guide to the future. Source: Lipper IM, to 31/01/2023.

FIND OUT MORE ABOUT STEWART INVESTORS INDIAN SUBCONTINENT SUSTAINABILITY, INCLUDING CHARGES

STEWART INVESTORS INDIAN SUBCONTINENT SUSTAINABILITY KEY INVESTOR INFORMATION

Fidelity Sustainable MoneyBuilder Income was a weaker performer.

The managers had very little invested in government bonds or quasi sovereign bonds (those issued by companies that are part owned by governments or have significant revenue from government contracts). As the market performed poorly, these bonds typically didn’t lose as much value because of government backing, meaning they’re less likely to default on future payments.

It was recently announced that Sajiv Vaid, the fund’s lead manager, will step down in September, remaining at Fidelity until the end of 2023 in an advisory capacity. Co-manager Kris Atkinson will be promoted to lead manager. We’re monitoring the transition closely and will update investors when we can.

The managers’ flexibility to invest in derivatives adds risk.

Past performance isn’t a guide to the future. Source: Lipper IM, to 31/01/2023.

FIND OUT MORE ABOUT FIDELITY SUSTAINABLE MONEYBUILDER INCOME, INCLUDING CHARGES

FIDELITY SUSTAINABLE MONEYBUILDER INCOME KEY INVESTOR INFORMATION

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Our fund research is for investors who understand the risks of investing and that investing in funds isn't right for everyone. Investors should only invest if the fund's objectives are aligned with their own, and there's a specific need for the type of investment being made. Investors should understand the specific risks of a fund before they invest, and make sure any new investment forms part of a diversified portfolio.