Olive Is the New Black: The Rise of Transition Funds

Investors worldwide are increasingly looking to capitalize on the shift to a low-carbon economy. This involves investing in companies committed to decarbonization, funding climate solutions and replacing high-emission assets, all while closely monitoring carbon footprints. While pure-play “green” investments tend to focus on renewables, transition investments extend further to capture less-clean, emissions-intensive industries that may not have clean alternatives today, are transitioning or stand poised to benefit from the transition. Funds in these categories have been referred to as “olive” investments. Understanding the current state of this slice of the fund market can help investors as they form their own strategies and analyze climate-related issues, such as the potential “greenium” from renewables and the state of decarbonization in real estate.

The landscape of transition funds

In recent years, despite the lack of globally standardized definitions, transition-labeled funds have become the fastest-growing category of climate funds. Globally, 139 such funds now manage collective assets of just over USD 50 billion, with almost 70% of the funds launched in the last four years.^[1] All are designed to capitalize on the shift to a low-carbon economy, focusing on companies that are actively reducing their carbon emissions, adopting sustainable practices or offering products and services that support the transition. Over 70% of transition funds are active equity strategies and are primarily domiciled in Europe.

A growing number of transition funds

What’s inside these olives?

Given that the majority of transition funds are active strategies, each with its own interpretation of "transition," identifying clear patterns in stock selection is challenging. Additionally, several funds target not just the energy transition but also social and broad environmental transitions, leading to inconsistent definitions and approaches across strategies. As a result, composition and portfolio size varies widely, as well, ranging from small, high-conviction strategies with fewer than 50 holdings, to large, globally diversified portfolios with more than 1,000.

At the sub-industry level, the most common allocations were in specialty chemicals, semiconductors, electrical components and diversified metals and mining. The top three most-common holdings across these funds were Schneider Electric SE, Albemarle Corporation and Atlas Copco AB. Notably, the lowest allocations were in energy and real estate, two key hard-to-abate sectors. Although the majority of these funds were domiciled in Europe, over 70% of fund assets were allocated to U.S.-based companies, and just under 10% allocated to emerging markets.

Top holdings by sector and company

How green is your olive?

Nearly 80% of transition funds were aligned with an implied temperature rise of less than 2.5°C, while just under a third were on track for a 1.5°C rise. Regarding net-zero commitments, one-fifth of these funds had over 50% of their market value invested in companies with long-term net-zero targets set for 2051 or earlier, and near-term targets approved by the Science Based Targets initiative (SBTi) to be achieved by 2030. At the company level, just under half of the companies across transition funds had SBTi-approved emissions-reduction targets, in line with the global investable universe of companies, as measured by the MSCI ACWI Index. The more-concentrated transition funds exhibited higher revenue exposure to alternative energy, energy efficiency, green buildings, pollution prevention and sustainable water versus their peers.

Climate ambitions and attributes

Fund performance has been a mixed batch

Most transition funds had positive calendar-year returns for 2023, with 48% beating their benchmark (or parent index), while the reverse was the case in 2022. In 2023, the best-performing transition funds had returns in excess of 25%, while the worst returned close to -30%. Year to date through July 31, 2024, most transition funds have performed positively.

Tracking performance over time

Looking ahead — regulations and growth

Although the definition of transition investments remains fluid, EU regulations have begun to set some boundaries on what transition-labeled funds can and cannot invest in. According to ESMA’s guidelines on funds' names using ESG or sustainability-related terms, funds that include transition-related terms in their name must meet specific criteria, such as adhering to exclusions based on the EU Climate Transition Benchmark and demonstrating a clear, measurable path to transition.^[3] The development of transition taxonomies and increased reporting of activity-based data could help establish more consistent definitions globally.

Additionally, market dynamics have evolved to favor a more opportunity-oriented view of climate transition, driven by innovations and supportive policies, such as the U.S. Inflation Reduction Act, which have lowered the costs of transition technologies.

While no one can say for sure whether these transition funds are indeed the next “big thing,” understanding the market helps investors determine the best way forward, and how they can work to stand out. And, indeed, the convergence of expanding market opportunities and a supportive policy environment suggests that the growth of transition funds may continue as the global economy continues to shift toward sustainable practices.

The authors thank Lauren Yeung for her contributions to this post.