Climate investing – What are the options?

Climate investing involves using the power of capital to contribute towards tackling the issue of climate change. But how can investors integrate climate issues in their investment process? In this article, we look at three of the available options in more detail.

Low-carbon investing

One form of climate investing is low-carbon investing. This involves focusing on companies that are aligned with a low-carbon economy, for example by screening for those with low carbon emissions or low carbon intensities (carbon intensity is usually measured as the volume of carbon emissions per unit produced). While these companies can be found across many sectors, low-carbon portfolios will often be skewed towards particular low-emissions industries, such as technology and finance, while avoiding higher carbon-emitting areas such as manufacturing and construction.

With enough investors doing this, this approach can collectively make financing more difficult for high emitters. However, while solely focusing on low-emitting companies will lead to a portfolio with good carbon credentials on paper, investors can do more when it comes to tackling the real-world issue of climate change.

Climate transition investing

Another option is for investors to focus on companies that are progressively transitioning to a low-carbon economy. One way to do this is to seek out companies that have implemented emission reduction targets in line with the goals of the Paris Agreement on climate change. Here, investors usually purchase companies with high emissions and work with them to reduce their emissions. Investors could also engage with companies on climate issues, to hold them accountable to their targets and accelerate their transition (see below). 

Climate solutions investing

Investors can also look for companies providing solutions to the climate challenge. Their products and services may have a transformational effect on the environment, or they could provide the tools for others to make a positive environmental impact, or spearhead a positive climate impact in their respective industries. 

By their nature, climate solutions companies should make a net-positive climate contribution. In other words, the carbon emissions avoided/saved through the use of their products and services should outweigh those emitted in providing these products and services. Climate solutions companies typically provide the tools and services for those companies considered to be in a ‘climate transition’ to decarbonise. 

Climate solutions companies are found across a wide variety of industries. However, we can broadly split them into three categories:

• Clean energy – renewable energy producers, such as solar, wind and hydroelectric power companies, as well as those that provide critical components for the production of renewable energy.
• Green technology – companies focusing on batteries and electrification, efficient buildings, clean transportation, products that promote sustainable agriculture and plant-based foods.
• Circular economy – businesses focusing on the ‘reduce, re-use, recycle’ model, utilising products already in the economic system and reducing new production.

The importance of measurement

Measurement is essential in all climate investing approaches. Investors must track the carbon emissions produced by investee companies, to understand their environmental impact and how this changes over time. They may also look at other metrics, such as carbon intensity, water usage and the amount of waste produced, to gauge the company’s overall environmental impact. Usually, this data is reported by companies on an annual basis.

Measurability is particularly important for climate solutions investors, as they are concerned with investee companies’ net environmental impact. A climate solutions company may generate a significant amount of carbon emissions, particularly if they manufacture large structures, such as wind turbines. However, their products and services may help to offset an even larger amount of emissions. It is important that the amount of emissions avoided or saved can be measured, as this allows investors to get a clear picture of the company’s overall impact.

Engagement is a powerful tool

Engagement can be a significant feature of any climate investing approach, and it is one the most powerful tools for driving positive change that investors have. Climate engagement involves working with investee companies, either directly or collectively with other investors, to find out more about how they are tackling climate issues or to ask for more action.

For example, investors could encourage companies to expand their environmental disclosures to cover Scope 3 emissions (emissions from the company’s activities, but which occur from sources that it doesn’t control, such as its suppliers or customers). They could also encourage senior management to link their compensation packages to sustainability metrics.

Another option is to encourage investee companies to set stricter greenhouse gas emission reduction targets. For example, investors could push the company to set a target date for achieving net zero emissions, or to set science based targets for emission reductions. Targets are considered ‘science based’ if they are in line with emission reduction levels required to keep the temperature increase below 1.5°C compared to pre-industrial temperatures (the aim of the Paris Agreement). 

Investing towards a better future

At M&G we believe the investment industry needs to evolve. Rather than short-termism and quick wins, we believe investing requires forward thinking, a long-term outlook and active engagement with companies, helping them to adapt and make a more meaningful and lasting impact on our world. 

When it comes to the world’s most pressing issues, there’s no quick fix. But by investing sustainably in a pragmatic and measured way, we can work towards a future that’s better for everyone, delivering positive returns for both investors and the planet.