Portfolio Investing for Climate Change

What Is Climate Investing?

Rising sea levels, summer heatwaves, widespread droughts, storms, wildfires, and disastrous floods: These are all dramatic effects of human-induced climate change. Some investors may overlook climate change in their portfolios, but for those on top of the world’s environmental changes, green technology and renewable energy may provide profitable investment opportunities.

Climate investments fall within the realm of environmental, social, and governance (ESG) investing, a field that seeks to accomplish positive social benefits as well as profits. Institutional asset managers have been carving out a broader niche for investors seeking more ethical ways to grow their wealth in recent years. These activities include investing for the good of the planet.

Understanding Climate Change Investments

Climate change is a complex, multi-dimensional process that will affect the global environment in many ways. Largely driven by carbon dioxide and other greenhouse gases produced by agriculture and industry, it poses an existential threat to human society. Many governments across the globe have announced plans to curb greenhouse gas emissions and reduce their climate footprints.

These plans provide an economic opportunity for companies that can replace carbon-intensive production processes with those less harmful to the environment. As regulators increase the cost of using fossil fuels, many entrepreneurs are seeking to profit from environmentally-friendly technologies. At the same time, there are many mutual funds and institutional investors seeking to profit from the potential gains in these sectors.

The Risks of Climate Change

The United Nations is one of the leading providers of climate change research. The 2021 Sixth Assessment Report, published by the UN's Intergovernmental Panel on Climate Change, warned of "irreversible" changes to the ocean and atmosphere due to climate change. Based on the IPCC's forecast, it is a virtual certainty that global temperatures will continue to rise, increasing by at least two degrees Celsius by the year 2100. A more serious climate disaster can only be averted by capping cumulative greenhouse gas emissions as soon as possible.

In the United States, the National Climate Assessment, mandated every four years by the Global Change Research Act of 1990, is one of the most authoritative pieces of research. The 2018 report covers the effects of climate change on the economy, predicting severe consequences in areas such as agriculture, water access, infrastructure, and human health.

While these two research pieces are extensive, they can be great sources of information for those looking to groom a portfolio for climate change. If climate change can be averted, the technology to do so will require great investments of resources, and offer potentially great profits.

Trends in Climate Change Investing

Investors looking to create a thematic portfolio around climate change have several different options. Two of the most well-known routes include renewable energy investments and corporations with green initiatives.

Solar, a Top Choice

Renewable energy is key to eliminating the use of fossil fuels. Natural energy sources such as the wind and sun can provide inexpensive electricity without harmful pollution or carbon dioxide. Many companies are exploring new ways to improve and scale these technologies.

If you’re willing to jump in the market, solar technology remains an up-and-coming area in the alternative energy sector. Purchasing stocks in solar panel manufacturers is an easy way to invest in renewable energy. In addition to buying individual stocks, the Market Vectors Solar Energy ETF (KWT) and Guggenheim Solar Fund (TAN) are both globally diversified choices in managed funds.

On the institutional front, there are also several managers taking big bets on the returns of the renewable energy sectors. Many traditional asset managers, including BlackRock and Fidelity, have created funds that target the renewable energy sector.

Global Opportunities

Across the globe, green tech investing has been important for many nations of the world. The Global Trends in Renewable Energy Investment 2020 report, jointly published by the Frankfurt School and the U.N. Environmental Program, lays out investments across the last decade by type of technology and country.

China has by far outpaced the rest of the world with its renewable energy investments. From 2010 through 2019 China reported $818 billion in renewable energy investments, beating out all of Europe at $719 billion and nearly doubling the United States in the second-place ranking at $392 billion.

Green Initiatives

Companies with green energy initiatives can also be a great place to invest in for a climate change-targeted portfolio. These are companies with strong investments in carbon offsets, sustainable materials, meat substitutes, electric vehicles, or other low-carbon alternatives to existing technologies.

Investing in green initiatives has long been seen as a risky proposition: The high capital investment and complex infrastructure requirements mean that expenditures often outweigh profits, especially in the short term. However, many companies see long-term benefits to these investments and have taken steps to set themselves and the environment up for a better future.

The STOXX Global Climate Change Leaders Index was developed to recognize the top global companies on the A-list for green initiatives. Heavyweights in the STOXX Index include Best Buy, Ford Motor Co., Microsoft, and Toyota.

For many investors, a climate change-focused portfolio can also mean avoiding companies with high levels of emissions—such as oil, gas, and chemical companies that rely on petroleum or other hydrocarbons for their production.

Returns From Climate Investments

Broadly, investors in renewables should take a long view and cast a wide net. These investments have a tough yardstick: Returns on green-sector companies have historically often been lower than those in the traditional industries that they seek to replace, largely because of the additional costs of upholding ESG criteria.

However, more recent research and the development of more data-driven yardsticks indicate the gap is closing fast. Still, renewable and green tech investments can take years to pay off, leaving investors to expect long-term rather than immediate results.

Special Considerations

Beyond basic portfolio investing, climate-conscious investors should also consider the impact of environmental changes on more traditional assets as well. For example, climate change has already caused significant disruption to real estate and insurance markets due to wildfires and flooding.

Climate-related disasters would likely be accompanied by inflation, shortages, and utility failure, as was the case during Hurricane Katrina. A cautious investor should consider stockpiling cash and necessities in preparation for this kind of emergency.

The Bottom Line

There are many factors to consider when preparing a portfolio for climate change. Although the world economy cannot eliminate hydrocarbons overnight, even a partial reduction could pay dividends in the long term. Moreover, the companies that develop these technologies could be highly profitable if they are successful. Investing in green energy and industries could offer high returns while also accomplishing an environmental benefit.