The world is failing to reach the Paris Agreement temperature targets, and low carbon investing alone is unlikely to change this. The magnitude of the crisis requires bold action. That’s why we believe a low carbon investment strategy needs to be combined with an environmental solutions strategy. And the good news is that environmental solutions could be our generation’s biggest investment opportunity.
Investors are seeking portfolios that impact the world in a positive way, have superior environmental credentials, advance decarbonisation and align with net zero ambitions. The most common investment strategies to achieve these objectives are:
Low carbon. Companies with emissions below the benchmark and peers and are aligned with achieving a net zero goal.
Improvers. Companies that are currently not low carbon but have a firm commitment to become so.
Sinners. Companies with poor environmental profiles to encourage improvement.
Environmental solutions. Companies that are producing the goods, services and systems that will enable the planet to reduce greenhouse gas emissions and improve biodiversity.
Of these, by far the most popular strategy is low carbon. However, this approach ignores decarbonisation and biodiversity and can be harmful when overemployed. That’s why supplementing a low carbon portfolio with an environmental solutions strategy can make good environmental sense, directing capital to solve our climate problems. And it’s also a big source of alpha, generating impressive long-term returns for your client portfolios.
The limitation of low carbon investing
If we’re to limit global warming to 1.5°C above pre-industrial levels, there’s a finite carbon budget remaining. The most recent Intergovernmental Panel on Climate Change report estimates that this budget is 440 billion tonnes. Since we’re currently emitting 35 billion tonnes of carbon each year, and this number continues to grow, time’s running out. As with any other finite resource, financial markets should assess which companies are most deserving of this remaining budget and allocate capital accordingly. So how do companies currently qualify for inclusion in a typical low carbon portfolio?
1. They have an asset-light business model
Many low carbon portfolios are made up of companies whose business models are naturally not carbon intensive. This favours financials, software companies and experiential businesses. And while these companies might have low carbon footprints now, this doesn’t mean they’re improving. Further, these companies tend to be concentrated in the US and can have marketing that’s actively hostile to the environment by encouraging excess consumption.
2. They buy emission offsets
There’s a bias towards profitable companies with large balance sheets that can pay the penalty for polluting. Yet, offsetting at scale harms food production, forest quality and biodiversity.
3. They promise to improve
Companies can also be included if they’ve demonstrated a commitment to reducing their carbon intensity. Yet this often means promises as opposed to tangible improvements that have already been achieved.
Using capital to solve our biggest climate challenges
Given the planet’s limited remaining carbon budget, the optimal allocation of this budget is to companies that are using carbon to build the products, services and systems that we’ll need to live in a more sustainable way.
Consider carbon return on carbon employed
If the challenge is to build a sustainable world with our remaining carbon budget then carbon emissions alone are a one-dimensional way of looking at the problem. In finance we’re used to the notion that spending capital has a cost. So, if we choose to deploy it, we need to generate the highest possible return. We need to think this way about carbon: it’s vital to get the biggest ‘bang for our buck’ in terms of building the green infrastructure of the future. Importantly, environmental solutions companies typically have far higher ‘carbon returns on carbon employed’ than simple low carbon companies. Because environmental solutions companies are investing in technologies that are likely to rapidly grow over the next two decades, having a higher carbon return on carbon employed should go hand-in-hand with having a higher return on capital.
Support biodiversity
The current extinction rate is running at between 1,000-10,000x the baseline level of extinction throughout human history, with devastating consequences for the world. Because carbon emissions and biodiversity are inextricably linked, we need holistic solutions to the one overarching problem: the way we treat the environment. A focus on emissions alone could solve the world’s clean energy problems and still destroy the planet.
Fund critical technologies
The technologies that’ll drive the green transition need capital to develop and scale. They include electrolysers, EVs and solar panels as well as wind turbines, fuel cells and recycling facilities.
Environmental solutions offer long-term outperformance
Because environmental solutions represents one of the biggest alpha generation opportunity of the next two decades, a holistic approach to environmental investing is required. The TT Global Environmental Impact Fund combines both low carbon and environmental solutions strategies in one fund, making it easy for clients to access this growing area of opportunity.
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