Climate change investments: the opportunities

What is climate change investment?

It’s no secret that the far-reaching effects of global climate change aren’t just affecting the environment and the natural world: they’re affecting every sphere of human involvement from politics to education, and from the food we source to regional and international travel. But how is climate change impacting investing and investments?

Climate change investing and investments can refer to a couple of related approaches and their respective activities, and the distinctions between them are important.

First, climate change investing can refer to investment by both government and private sector bodies into reducing carbon emissions, decreasing reliance on fossil fuels and their accompanying technologies, and innovating new technologies for renewable energy generation.

These activities are essentially preparatory; they prepare for a future that will look quite different, and will require years, even decades of concerted effort to shift priorities and build reliable and sustainable infrastructure. The opportunities here for ordinary investors in both public markets and private sector investment are numerous and lucrative.

Climate change investing also refers to ways in which preparatory adjustments are much smaller-scale and concern funds and portfolios. They seek to preempt changes that will occur in companies as they change their goals and vision, shift energy sources, and position themselves for a carbon-neutral world.

Investors are rebalancing their portfolios not only with these changes in mind, but also to protect their assets from the harmful effects of natural disasters of increasing magnitude, ensuing food shortages and other scarcities, and demographic changes that will affect how companies do business and with whom, especially as populations are displaced as a result of climate change.

These investors’ activities are essentially preventative: through adjusting risk profiles and locating vulnerabilities, investors are able to anticipate and respond to potential harm to their investments.

The investment opportunities which follow are mostly based on the first approach, though they contain elements of the second approach as well. Investors should take note of how intertwined both approaches are, for even as new products, technologies, and infrastructure shape alternative modes of living, old companies and assets must be updated or lose their effectiveness. Climate change investment is as much about preservation and renovation as it is about innovation.

ESG investing

Environmental, Social and (corporate) Governance (ESG) are a series of factors related to sustainability, social welfare and ethical business practices that are used to determine a company or investment’s merits in terms of how beneficial it is to the planet, society and human beings generally.

These factors measure everything from pollution to human rights and to how the parties involved interact with political entities. In short, it has become a catch-all for “ethical” investing, and climate change investing is a huge part of this. Investors attracted to ESG investing usually aren’t just seeking good, sustainable returns. They also want to invest in the sorts of companies and funds that are conscientious of their environmental impact and want to negate their carbon footprint.

ESG funds like the Vanguard FTSE Social Index Fund (VFTAX) and the Parnassus Core Equity Investor Fund (PRBLX) are general ESG funds that invest in a variety of companies, some of which support and invest in renewable energies. The 5-year and 10-year returns on these funds are not exactly impressive (averaging 15-20% for both timelines), which highlights that green, sustainable energy and infrastructure requires massive investment for returns that exist only in the very long-term.

Energy

Dedicated clean energy companies and funds are one of the most direct ways to invest in a future free of fossil fuels, and also to prepare one’s own portfolio for a greater degree of alignment with the curbing of carbon emissions. The largest markets for clean, renewable energy are first China, then Europe, then the U.S. in a distant third place, with solar being the dominant energy investment, closely followed by wind.

Historically, Chinese solar companies have been able to corner this subsection of the energy market by undercutting the competition, leading to miserable returns for many investors. This is quickly changing, however. Companies like the American First Solar and the American Sunpower Corp. have achieved tremendous growth recently, with net profit margins of 13.4% and 24.34% respectively. And wind companies like the Danish Vestas Wind Systems A/S and the Canadian Transalta Renewables have quickly acquired high P/E ratios as investors have piled into them, attracted by their growth prospects.

Corporate bonds (U.S., Europe)

Oftentimes, high-yield corporate bonds can be risky to invest in because they can have low credit ratings and high investment minimums, sometimes between around 700£ and 3.500£. Various exchange-traded funds (ETF), however, can offer exposure to U.S. and European corporate bonds without the need for company selection and with a greater degree of diversification. These bond funds can be filtered by company sector and region, bond maturity dates and creditworthiness, among others, and prospective yields vary according to risk levels.

Real Estate

Real estate might not seem like the most relevant investment in relation to climate change, but that may be because it’s not its virtues that are at play, but its vices. Grace O’Donnell writes that, “Globally, buildings are culpable for 38% of carbon emissions”, while at least in the U.S., only contributing less than half of that percentage to GDP. The need for sustainable, energy-efficient housing and new buildings is enormous, made only more difficult by the fact that such buildings are much costlier than otherwise. As of Q4 2021, there are not a lot of “green building” investment funds either: only in 2021 has the first green building ETF, Invesco MSCI Green Building ETF come online, pledging to invest 90% of its funds in the MSCI Global Green Building Index

Agriculture

The Western world’s push for organic products goes hand in hand with solutions for sustainable agriculture that keeps carbon trapped in the soil while using renewable fuels to power its equipment. A further concern is biodiversity, on which much of the world’s food systems and ecosystems are dependent. One fund, the Ossiam Food for Biodiversity ETF, lists on the German exchange Xetra and consists of companies upholding biodiversity while lowering their carbon footprint.

Another fund, the Rize Sustainable Future of Food UCITS ETF (FOOD) is similar in focus while prioritizing sustainably feeding the world’s growing population as growth edges towards the 10 billion persons mark.

Investors interested in climate change investing for returns, ethical reasons or portfolio protections should be prepared to invest for long time horizons and with the expectation that some of these investments will be false starts, or at least not linear in their journeys to profitability.

Fortunately, the pressure for companies and governments to address, prepare for and mitigate climate change is mounting, and the number of climate change investment opportunities is only set to multiply in the coming years.

Invest in sustainable and resilient agriculture and water infrastructure or carefully evaluate companies with operations tied to parts of the world where food or water could be scarce and avoid them if the risks are too great.