Institutional investors are more willing to make large allocations to the fast-growing green economy, but challenges around identifying appropriate investments and a continuing focus on risk rather than opportunity are hindering progress, according to leading investors and advisers.
“We’ve started forecasting the expected returns you might get from green infrastructure versus high-carbon infrastructure, or climate solutions equities versus standard equities,” Craig Mackenzie, head of strategic asset allocation at Aberdeen Standard Investments, told a London Stock Exchange Group/Principles for Responsible Investment webinar on investing in the green economy. The webinar was the third in the series focusing on investor action on climate change ahead of the major COP26 Climate Conference that the UK hosts in 2021.
“We've found that if you do that, it's relatively easy to make quite a compelling case to an investment committee to make very large allocations based on a rigorous expected return perspective. So we're seeing large clients moving portfolios in a way that, until a few years ago, they wouldn't have even considered.”
Regulators, too, are increasingly recognizing the potential for shifting capital towards the green economy. Commissioner Rostin Behnam of the US Commodity Futures Trading Commission (CFTC) noted that the CFTC’s recent landmark report on the climate risk faced by the US financial system included a chapter on financing the net-zero transition.
“There’s an opportunity to reshape our economy, [and] an opportunity to use the power of capital markets and financial markets to allocate capital in the right places and transition to a net-zero economy,” he told the webinar.
But progress among investors is not fast enough, said Nigel Topping, the UK government’s High-Level Champion for Climate Action for the COP26 climate talks. “If this is a race, the investor community is losing. Businesses and cities are way ahead,” he said in conversation with Sanda Ojiambo, CEO of the UN Global Compact.
Part of the reason is that the investment community is predominantly looking at climate change from a risk perspective, explained Mackenzie, whereas the corporate sector was looking at the opportunity presented by a shift to net-zero emissions. Investors need to “set goals to decarbonize their portfolio and shift allocations to the green economy, and there aren’t many large investors who have started to systematically do that.”
However, the green economy is becoming an increasingly compelling investment opportunity, said Arne Staal, global head of research & product management, FTSE Russell, presenting updated figures from FTSE Russell’s Green Revenue Classification System (GRCS).
“The green economy now represents a market value of around $4 trillion in listed equity, which is around 6% of the global market,” he said. “To put that in perspective, that is around double the size of the oil and gas industry, which is just over 3% of public equity markets today.”
The GRCS covering over 130 green micro-sectors is based on analysis of 16,000 listed companies to identify which of those generate revenues from a wide range of green economy activities, ranging from renewable energy to water and food and agriculture. It finds around 3,000 companies which produce green goods or services. The system—dubbed GRCS 2.0—represents the evolution of a classification system first developed in 2008, said Lee Clements, Head of Sustainable Investment Solutions at FTSE Russell.
There are considerable challenges in pulling together such a classification, noted Lily Dai, Senior Research Analyst, Sustainable Investment, at FTSE Russell. “Conventional Industry classification frameworks rarely distinguish environmentally friendly products and services, and the definition of the green economy can be quite broad,” she said.
To address this problem, a number of jurisdictions have been developing green taxonomies, notably the EU’s Sustainable Finance taxonomy, and with analogous efforts underway in China and Canada, among other countries. These taxonomies identify which types of economic activity can be deemed to be climate or environmentally friendly.
However, Joy Williams of Mantle314, former chair of the New York State Common Retirement Fund Decarbonization Panel, noted that these taxonomies are “no silver bullet,” requiring considerable work from investors in to understand the assumptions they make and the degree of alignment that might exist between their investments and taxonomy-aligned activities.
Participants also discussed other challenges faced by institutional investors in grasping opportunities presented by the green economy. Herman Bril, director of Office of Investment Management, United Nations Joint Staff Pension Fund, argued that institutional investors tend to have a conservative corporate culture: “Pension funds are very long-term, traditional investors. They are not, by nature, change agents.”
The webinar also included a preview of work carried out by Vivid Economics for the Principle for Responsible Investment’s Inevitable Policy Response project, which is examining the investment implications of a rapid ratcheting up of climate change policy. Jason Eis, an executive director at Vivid, presented findings from a report that looked at the potential for negative emissions technologies, such as nature-based carbon offsets and bioenergy crops paired with carbon capture and storage.
“The nature-based solutions market... is set to ramp up... by a couple of orders of magnitude over a decade or so,” he said, reaching hundreds of billions of dollars of revenues each year. That will lead to “the market valuation of assets that are similar in scale to the current oil and gas majors.”
Concluding the webinar, Faith Ward, chief responsible investment officer at Brunel Pensions Partnerships, said that “we’ve got a lot of the tools and techniques we need, and initiatives like the Inevitable Policy Response are giving us a good framing in terms of understanding what the consequences of inaction are.
“But things are not going to happen unless we take conscious and positive action... As investors, we have a really pivotal role.”
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