Pivotal year for green investments

Newly inaugurated US president, Joe Biden’s decision to re-join the Paris Agreement on day one of his new term has followed a series of high profile net zero pledges from multi-national companies and governments around the world over recent months – all setting the stage for the UN climate change conference (COP26) in November, which this year is being hosted by the UK.

But with the steps businesses are taking to combat climate change increasingly under the microscope, what is the investment case for shifting capital to companies doing more to prepare for the transition to the green economy? And how do those managing their own money, perhaps via stocks and shares ISAs or their own pension fund allocations, gain exposure to this growing sector?

Renewed political momentum in the US, the largest national economy and significant contributor to CO2 emissions, is likely to act as a strong tailwind for further growth in investments that take into account both climate risks and opportunities.

This could mean taking action on a company’s exposure to the physical risks of climate change such as sea level rises, or the economic cost of transitioning operations away from carbon intensive activities. Yet, it could also mean taking advantage of opportunities created by climate change such as renewable energy.

Reaching market consensus on defining and quantifying these risks and opportunities and how companies report this information will be key and regulators are looking at how to implement industry standards.

The UK Government has mandated that starting with the largest companies listed on London Stock Exchange, UK firms must disclose climate performance metrics such as carbon emissions. While in Europe, new disclosure rules for fund managers will bring greater transparency to the often-hidden sustainability risks that could have a material impact to the financial performance of a fund.

These risks are becoming increasingly integrated into the decision-making process by professional investors and are already incorporated into credit rating companies’ assessments.

But what about the investment opportunity? Recent data from global index provider, FTSE Russell, found that the green economy is currently represented by more than 3,000 global listed companies, a US$4 trillion market cap opportunity ‒ equivalent of over 5 per cent of the total listed equity market.

While it must continue growing substantially to keep global warming within 2 degrees by 2050, it is encouraging that companies with strong green credentials have demonstrated real resilience through the pandemic.

For example, the FTSE Global All-Cap index delivered returns of 81.8 per cent over the five years to 31 December 2020, whereas the FTSE Environmental Opportunities, delivered 135.3 per cent over the same period.

This puts pay to the mantra that sustainability benefits can only be achieved at the expense of financial performance.

This hasn’t gone unnoticed by professional investors, many of which are using their shareholdings in companies to campaign for change. A 2020 survey conducted by FTSE Russell which included 139 pension and sovereign wealth funds showed that over 70 per cent have either already implemented, or were evaluating, ESG factors into their investment strategies.

As a result, there has been an explosion of investment products with varying levels of exposure to the green economy. Half of new exchange traded products, known as ETFs, listing on London Stock Exchange in 2020 were focused on delivering environmental, social and governance (ESG) benefits for investors. These ETF’s are made up of a ‘basket’ of stocks or bonds and trade like a single stock on an exchange.

To achieve certain climate or ESG investment objectives, an index is typically rebalanced to give a greater weighting to green companies and away from higher carbon emitting sectors.

Organisations such as The Transition Pathway Initiative, which is backed by large investors and FTSE Russell are at the leading edge of these innovations. But most crucially for individual investors, these products can be bought as part of a stocks and shares ISA.

While the investment case for climate themed investing remains long-term, 2021 is set to be a defining year for climate action in the private sector.