We construct a novel carbon risk measure for mutual funds based on stock holding data and explore how carbon risk affects mutual funds’ performance, risk, and flows. We find that funds with higher carbon risk exposure have lower performance and higher unexplained risk in factor models. Furthermore, carbon risk is not fully captured in traditional Environmental, Social, and Governance (ESG) measures. We also find that institutional investors take carbon risk more seriously than retail investors do. Institutional funds with higher carbon risk exposure experience a negative flow shock in the subsequent period and their flow–performance relation is more sensitive. Moreover, when there is more news coverage on climate change, carbon risk exposure affects fund flows more negatively. These findings do not apply to retail funds.