Climate investing: Why we’re getting it wrong (and how to get it right)

By Deirdre Cooper, Portfolio Manager, Global Environment, Ninety One

With the UN declaring its latest climate report¹ a “code red for humanity”, we must all act quickly to tackle global warming. But one group is at risk of failing to play its part: investors.

It’s not for want of trying. Assets in funds labelled ‘clean energy, climate aware, climate solutions or low-carbon’ have more than doubled in a year, albeit from a low base². But while investors appear keen to use their capital to address climate change, the tools available to them may not be up to the job.

Specifically, by focusing on divesting from high-carbon companies and countries, many of today’s supposedly climate-friendly funds may actually be working against our collective net-zero ambition, driving capital away from where it is most needed.

The root of the problem is the widespread misapprehension that a low-carbon portfolio is per se beneficial. It isn’t. You could reduce the Scope 1 & 2 carbon-intensity of a global equity

index by 7% just by doubling the weighting in big-tech stocks (which are, by nature, relatively low-carbon). That will do nothing to effect the vast changes to energy, transport, industry and agriculture required to decarbonise the economy.

Similarly, you could cut your portfolio’s Scope 1 & 2 carbon footprint by selling out of emerging markets, where energy systems tend to be more reliant on coal. Yet starving developing-world businesses of capital would not only hamper emerging markets’ clean-energy transitions, but imperil countless jobs and strain already disadvantaged communities.

A failed transition in emerging markets will ultimately harm everyone. The developing world accounts for more than half of global emissions and 90% of emissions growth. Without a huge increase in funding for emerging market decarbonisation, there will be no net zero at all.

What’s to be done?

The first step is to accept that monitoring portfolio-level carbon emissions is a wholly inadequate way of assessing net-zero alignment. Instead, we need metrics that track real-world progress along the pathway to carbon neutrality.

Fortunately such measures are now available, such as the Net Zero Sovereign Index, a benchmark created by WWF and Ninety One to analyse where countries are in their net-zero journeys, and which accounts for each nation’s starting point, including its level of wealth.

The next step is simply to acknowledge that to invest in net zero is above all to invest in change. To illustrate the point, BMW has figured out that to stop manufacturing emissions rising as it switches to electric vehicles, it needs to reinvent everything: from the tools in production lines, to the materials it uses, to the way components are fixed together, to the (paint-free) finish³. Getting to net zero demands that level of innovation in design, production and distribution in almost every industry, everywhere.

So rather than low-carbon portfolios, we need investments that catalyse real-world decarbonisation, in both developed and emerging economies.

Such actively managed funds not only offer the chance to make a positive impact, but also to ride the wave of structural growth being unleashed as the global economy re-orients towards a low-carbon model. We believe that has the potential to be good for returns as well as the planet.

Are investors ready to abandon the idea that a low-carbon portfolio is intrinsically virtuous? Our experience is that the answer is overwhelmingly ‘yes’.

Flows into active global environment strategies – which invest in companies across industries that make a measurable contribution to decarbonisation – suggest investors are strongly motivated to allocate to solution-providers to global warming, rather than funds that merely make their own portfolios lower-carbon. It’s now up to the asset management industry to create investment products that enable them to do so.

To invest in net zero is above all to invest in change.

IPCC, Sixth Assessment Report, Climate Change 2021: The Physical Science Basis, August 2021
FT, Climate change ETFs found to be undermining war on global warming, September 2021
BMW, ‘The BMW i Vision Circular’ press release, September 2021

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