Climate change concerns meet return‐chasing: Evidence from energy exchange‐traded funds

• Published date: 01 May 2022
• Author: Viktoriya Lantushenko,Carolin Schellhorn,Gulnara R. Zaynutdinova
• Date: 01 May 2022
• DOI: http://doi.org/10.1111/fire.12291

DOI: 10.1111/fire.12291

ORIGINAL ARTICLE

Climate change concerns meet return-chasing:

Evidence from energy exchange-traded funds

Viktoriya Lantushenko1Carolin Schellhorn1

Gulnara R. Zaynutdinova2

1Department of Finance, Saint Joseph’s

University, Philadelphia, Pennsylvania,USA

2Department of Finance, WestVirginia

University, Morgantown, WestVirginia, USA

Correspondence

ViktoriyaLantushenko, Department of

Finance,Saint Joseph’s University, 5600

CityAvenue, Mandeville 239, Haub School

ofBusiness, Philadelphia, PA 19131, USA.

Email:vlantush@sju.edu

Abstract

Decarbonizing the global economy is a challenge requir-

ing massive funding and coordination across all economic

sectors. Energy ETFs play an important role in this transi-

tion. We find that investment flows into alternative energy

ETFs (A-ETFs) increase with climate change risk. After the

Paris Agreement, A-ETFs experience significantly stronger

net flows than traditional energy ETFs (T-ETFs): A one-

standard-deviation increase in fund return results in about

8–12% higher net flows per year to A-ETFs compared with

T-ETFs. Return-sensitive investorsappear to have joined the

early climate-concerned investors after the global invest-

ment community made public its determination to take cli-

mate action post 2015.

KEYWORDS

climate change, energy, ETFs, performance-flow sensitivity

JEL CLASSIFICATION

G11, G23

“Awarenessis rapidly changing, and I believe we are onthe edge of a fundamental reshaping of finance. . .

The evidence on climate risk is compelling investors to reassess core assumptions about modern

finance.. . In the near future – and sooner than most anticipate – there will be a significant reallocation of

capital....Everygovernment,company,andshareholdermustconfrontclimatechange.”

BlackRock C.E.O.,Laurence Fink (Fink, 2020)

Financial Review. 2022;57:247–272. wileyonlinelibrary.com/journal/fire ©2021 The Eastern Finance Association 247

248 LANTUSHENKO ET AL.

1INTRODUCTION

Ever since the release of the Stern Review on the “Economics of Climate Change” in 2006 (Stern, 2006), economists

havedebated the appropriate strategies and policies to address the risks from this global threat (e.g., Aldy et al., 2010;

W. D.Nordhaus, 2007;W.Nordhaus,2019; Stern, 2008). The urgency of the issue has also gained momentum in the

finance literature (e.g.,Brown, 2016; Hong et al., 2020; Litterman, 2011). Today,it is well understood that appropriate

financial instruments and mechanisms are vital components of efforts to decarbonize the economy (E. Choi & Seiger,

2020). The magnitude of this challenge requires prompt action by all market participants. Leiserowitz et al. (2020)

document an increase over time in the public’s climate change awareness and its sensitivity to the associated risks.

Although climate change concerns have been spreading, investment fund reallocations have remained far below the

required amounts.

To better understand investmentflows in support of the low-carbon transition, a recent line of research focuses

on investor perceptions and beliefs regarding climate change risk.1However,to the best of our knowledge, the liter-

ature lacks an analysis of the motivations that drive investment flows into low-carbon energy,which are essential for

a successful economy-wide transition. The purpose of this study is to fill this void by focusing on flows into energy

exchange-tradedfunds (ETFs).

We analyze the determinants of flows and the performance-flow relation2of alternative energy ETFs (A-ETFs) rel-

ative to traditional energy ETFs (T-ETFs) from 2009 through 2019.3Energy ETFs are the focus of this study because

the energy sector contributes the largest share of greenhouse gases (GHG) to total emissions, and it powers all other

economic sectors. Financial support for programs and projects, which enable cleaner energy production, is critical for

success with GHG emission abatement throughout the economy(Center for Climate and Energy Solutions, n.d.). Along

with mutual funds (Ceccarelli et al., 2020), ETFs are important investment vehicles in this effort, because they allow

a large number of investors to participate while offering many other advantages such as liquidity and tax efficiency

(Mercado, 2016; Sherrill et al., 2016). Tolimit the increase in global average temperatures to less than 2◦C, the transi-

tion to a net-zero carbon economy must gather speedquickly and, according to the International Energy Agency (IEA),

will require $3.5 trillion in annual energy sector investmentsuntil 2050 (IEA, 2017). According to the Investment Com-

pany Institute (ICI), at the end of 2019, environmentally focused mutual funds and ETFs represented only $11 billion

in assets under management out of $321 billion for all Environmental, Social, and Governance (ESG) funds (Fig. 2.16,

ICI, 2020).4Clearly,a significant acceleration of growth in alternative energy investments is necessary to achieve the

global decarbonization objectives within the required time frame.

To better understand the motivations of investors in energy ETFs, we include both financial and non-financial

determinants of net fund flow. The financial metrics include fund performance and expense ratio. The non-financial

measures include climate-related metrics: the cumulative global temperature anomaly and the number of new ESG

mutual funds launched. Cumulative global temperature anomaly represents the underlying physical consequences of

human-induced greenhouse gas emissions, while the number of new ESG funds reflects the intensity of market partic-

ipants’ resolve to address economic externalitiesmore generally. All energy ETFs in our sample are institutional funds.

Consistent with Krueger et al. (2020), the focus on institutional investors is appropriate because long-term and large

investorsare most likely to have been among the earliest adopters of the emerging clean energy investment strategies.

1Forexample, Krueger et al. (2020) survey institutional investors and document their concern regarding risks associated with climate change and its impact

ontheir portfolios’ risks and returns. Although concerned, most institutional investors deploy only minimal instruments for mitigating climate risks. Long-term

andlarge investors make more pro-active investment decisions to move towards a low-carbon economy.However, the authors conclude that “the industryas

a whole is still at early stages of incorporatingthese [climate] risks into their [investors] investment processes” (page 1105). D. Choi, Gao, et al. (2020) show

thatindividual, not institutional investors, sell stocks with a high carbon footprint as a result of increased attention following abnormal weather events.

2Throughoutthe paper, the “performance-flow” refers to the relation between performance at time t-1 and fund flow in the subsequent period, at time t.

3Theyear 2009 is used as a starting point in this study in order to focus on the time after the financial crisis. With the first A-ETF appearing in 2005, there are

justa handful of such funds during the 2005-2008 period.

4ICIdefines funds with an “environment focus” based on whether they include the following keywords in their principal investment strategiesor fund names:

“alternativeenergy,” “climate change,” “cleanenergy,” “environmental solutions,” or “low carbon.”