Navigating Carbon Exposure

Ian Tam outlines how to identify funds involved in the fossil fuel business and champions of the Morningstar Low Carbon Designation

Ian Tam, CFA 12 January, 2021 | 4:48AM
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Ian Tam: Last year, the Canadians who invested in energy were hit particularly hard as the price of oil tanked, mainly because of the pandemic led demand slump, and it has yet to recover.

Here's a chart of the S&P/TSX Composite Total Return Index as well as an ETF that tracks the price of crude oil. You can see here that although the S&P/TSX Composite has finally recovered to its pre-pandemic highs in November, oil has yet to do so. This recent performance slump has caused you to rethink your exposure to the energy sector. There are a couple of ways that Morningstar can help in selecting funds and ETFs. The first is our sustainable attributes framework through which you can find funds that explicitly mention in their prospectuses that they seek to invest in low carbon or fossil fuel free companies. Through this framework, you can separate funds that intentionally invest in this manner from those that just don't happen to own any energy companies at the moment. For example, a technology fund will unlikely have very much exposure to fossil fuels, but it's not the intent of the manager to do so.

The second is to look for funds that have received the Morningstar Low Carbon Designation. To get this designation a fund must fulfil two criteria. Number one, the individual holdings must have low levels of carbon risk, which is defined as the degree to which a company's economic value is at risk as the world transitions to a low carbon economy. Second, companies must have low exposure to fossil fuels defined by the percentage of revenue derived from the company's involvement in activities like thermal coal extraction and oil and gas production. Funds that fit both requirements and have received a Morningstar rating of four or five stars are listed in the table accompanying a transcript to this video.

For more information about the Morningstar Low Carbon Designation, click the link below the transcript to read the full methodology paper.

From Morningstar, I'm Ian Tam.

Morningstar Low Carbon Designation methodology

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About Author

Ian Tam, CFA  is Investment Specialist at Morningstar Canada. 


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