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Climate neutral investing: reduce, transform and remove

19 November 2020
4 Minute Read
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WHAT YOU NEED TO KNOW
  • Joe Biden’s US presidential victory is likely to be supportive for sustainability and sustainable investing, and could potentially boost the value of firms providing climate solutions.
  • We introduce a simple, yet effective, lifestyle and investment framework in pursuit of climate neutrality called ‘reduce, transform and remove’.
  • We believe the investment industry has a large role to play in funding the firms and technologies working towards climate neutrality. Our work highlights investment opportunities in low-carbon equities and green bonds, as well as the value of verified emission certificates.
US ELECTIONS

With Democratic nominee Joe Biden set to assume the US presidency in January, many supporters of sustainable investing and climate action have rejoiced. Biden has pledged to bring the US back into the Paris Agreement, re-joining almost 200 other countries. He has also outlined an ambitious green investment agenda that aims for the US to achieve a 100% clean energy economy and reach net-zero emissions no later than 2050. While this seems the direction of travel, how much he’ll be able to achieve – and how fast – will depend on how a likely ‘divided blue’ government manages to muster broader congressional support.

Companies aligned to a sustainable future and sustainable investing as an investment discipline are likely to benefit. We take this timely opportunity to outline a simple, yet effective, lifestyle and investment framework in pursuit of climate neutrality. Our work highlights investment opportunities in low-carbon equities and green bonds, as well as the value of verified emission certificates.

REDUCE, TRANSFORM AND REMOVE

In recent years a raft of high-profile climate-related organisations and initiatives have been developed, including the Task Force on Climate-Related Financial Disclosures, the Paris Agreement and the forthcoming EU sustainable finance regulation. We think there are three strategies that individuals and investors can employ to reduce their emissions and support climate neutrality – reduce, transform and remove.

     
Consume fewer resources, create less waste and substitute products and services Innovate by adopting and funding new sources of energy, supporting new technologies and re-engineering supply chains through a circular economy Actively remove CO2 from the earth’s atmosphere by ecological or engineering methods
REDUCE

Reducing greenhouse gas (GHG) emissions is a simple and effective concept. Consuming fewer resources, creating less waste, and making substitutions all contribute to reduced emissions.

As individuals, in terms of lifestyle, major CO2 contributions include our choice of ground transportation, propensity to utilise air travel and dietary habits.

From an investment perspective we can measure the carbon emissions from corporations and then compute an investors’ share of, or ‘responsibility’ for, them. Figures depend on the breadth of activities examined and are categorised with ‘scopes’ by the GHG Protocol Corporate Standard.

Scope 1 emissions are emissions from sources owned or controlled by the company, typically direct combustion of fuel in a furnace or vehicle. Scope 2 emissions are broader and include those caused by the generation of electricity purchased by the company. Scope 3 emissions are broader still and include an array of indirect emissions from activities such as business travel, distribution of products by third parties, and downstream use of a company’s products (i.e. by customers and ‘end-of-life’/disposal activities). The investment industry often utilises Scope 1 and Scope 2 for its analysis.

Carbon calculations can contextualise emissions (as measured by tons of CO2) by comparing absolute figures to revenue – often called intensity – or by comparing absolute figures to the value of the firm (either market capitalisation or enterprise value) to ascertain the share of emissions that the investor is ‘responsible’ for (Figure 1).

Low-emission investment strategies draw on these methodologies and can be either unconstrained or optimised. Unconstrained strategies underweight high-emission industries without regard for the resulting sector and style biases. They posit that high-emission industries will underperform low-emission industries. Optimised strategies use quantitative techniques to limit sector and style biases, ensuring that a low-emission strategy can deliver comparable returns to conventional strategies while being “responsible” for significantly lower emissions. The popular MSCI Low Carbon Target family of indexes follows an optimised approach and has, historically, consistently delivered comparable returns to conventional strategies with a 60% reduction in Scope 1 and 2 CO2 emissions (Figures 2 and 3).

Figure 1: Calculating impact

An illustrative example of an investor’s ‘responsibility’ for carbon emissions


Source: Quintet

TRANSFORM

The path to climate neutrality requires our society and economy to transform. It’s essential to innovate with new sources of energy, fund new technologies and re-engineer supply chains through a circular economy.

As individuals, in terms of lifestyle, we can transform our economy through our choice of domestic energy source, our adoption of travel alternatives, such as video conferences, and support for business strategies, such as remote working.

From an investment perspective, we can fund transformative projects and technologies that are facilitating a low-emission future. Potential investments span the asset class spectrum, from venture capital to private equity and debt, as well as public markets.

Within the public markets, green bonds are an effective and transparent dedicated asset to finance transformation (Figure 4). Green bonds are debt instruments where the proceeds are exclusively used to fund green projects. Each entity issuing a green bond produces a report detailing how the money is spent and what solutions and impacts are. According to the climate bond initiative, the current size of the green bond market is almost USD1 trillion.

We believe that the green bond market is now deep enough to run a full investment grade credit portfolio, with suitable diversification across sectors and tenors. This is an important step in mainstreaming sustainable investing.

Figure 2: Moving in synchrony

Optimised low-carbon indices typically deliver conventional performance (net performance, rebased to 100)

Source: Quintet, MSCI

Past performance is not a reliable indicator of future returns.

Figure 3: The power to change the world

Investing can make a difference when it’s targeted

USD 1 million invested in low-carbon equities produces circa 22t CO2/year

That is 57% less than conventional global diversifies equities

Source: MSCI Scope 1 and 2 emissions

Figure 4: New green bonds issuance by year (USD millions)

Green bonds are one of the most efficient ways to invest sustainably

Source: Quintet, Climate Bonds Initiative

REMOVE

The emerging frontier in pursuit of climate neutrality is carbon removal. For individuals, the most accessible carbon removal technology is tree growing. During photosynthesis, trees absorb CO2 from the atmosphere, and use it to build new materials – such as trunks, stems and roots.

From an investment perspective a range of opportunities exist, predominantly in the private markets. They include carbon capture and storage (CCS), which seeks to capture carbon from large point sources, such as a cement factory or biomass power station, to the emerging direct air capture (DAC) technology that seeks to “suck” carbon out of ambient air.

At present the most scalable removal techniques are voluntary emission reductions (VERs), commonly called carbon credits. VERs represent a ton of carbon that is either removed from the atmosphere – for example, by tree planting – or avoided – for example, by funding more fuel-efficient wood-burning stoves. VERs operate within a robust system of project development and specification, independent verification and certification.

According to Forest Trends, the size of the VER market is more than USD320 million a year. University of Oxford research has strongly endorsed VERs that evidence additionality – removals that would not have occurred without the purchase of the VER – instead of VERs that rely on carbon avoided metrics and counterfactual analysis – such as funding stoves or paying to prevent or slow deforestation.

We believe using credible VERs is a valuable part of a climate neutral strategy.

CONCLUSION

We believe the investment industry has a large role to play in funding the firms and technologies that will reduce, transform and remove. With Democratic nominee Joe Biden seemingly set to assume the US presidency, sustainability and sustainable investing could potentially receive another welcome boost.

For those clients who have access to My Brown Shipley you can check your portfolio valuation online. If you have any questions, please contact your usual Brown Shipley adviser.

Authors

James Purcell
Group Head of ESG, Sustainable and Impact Investing

Daniele Antonucci
Chief Economist & Macro Strategist

Bill Street
Group Chief Investment Officer

 

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This article contains general information only and is not intended to constitute financial or other professional advice or a recommendation that any recipient of this information should make any particular investment decision. Always consult a suitably qualified financial advisor on any specific financial matter or problem that you have.

 

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