April 22 marked the 50th anniversary of Earth Day, a day dedicated to the protection of the planet. This year’s theme was climate action—i.e., taking steps towards restoring the planet. In honor of Earth Day, we highlight a number of environmentally friendly investment themes, including clean energy, low carbon, and fossil fuel free.
All values in Canadian dollars and priced as of April 21, 2020 market close, unless otherwise noted. Produced: Apr 27, 2020 12:05ET; Disseminated: Apr 27, 2020 12:30ET. For distribution in Canada only; for important disclosures and author’s contact information see page 3. By the end of 2019, climate change emerged as a megatrend in investments, as major weather-related events increased in frequency and severity causing US$630 billion in economic damages worldwide. According to a Morgan Stanley survey, 78% of U.S. individual investors have taken notice and are interested in addressing climate change through their investments.
One way to invest in environmentally friendly securities is through the clean energy lens. Clean Energy Canada defines clean energy as ‘the technologies and services that increase renewable energy supply, enhance energy efficiency, improve the infrastructure and systems that transmit, store, and use energy, and deliver key energy services while reducing carbon emissions’. This includes companies that produce energy from renewable resources such as solar and wind. By nature, the clean energy sector tends to be heavily skewed towards Utilities and Industrials companies. Clean energy is synonymous with alternative energy, renewable energy, and green technology.
As per the U.S. Environmental Protection Agency, greenhouse gases trap heat in the atmosphere. This primarily refers to carbon dioxide, but also includes methane, nitrous oxide, and fluorinated gases. Given the extent of carbon dioxide in the greenhouse gas pool, many investments in this category monitor carbon emissions. These strategies will either invest in companies that are the most carbon efficient, or will target a certain carbon efficiency relative to the benchmark. Often these investment solutions also pair the low-carbon mandate with a negative screen (i.e., excluding companies with business involvement in tobacco, weapons, or nuclear, etc.).
One method companies are embracing in an effort to keep their footprint low is carbon offsetting, a practice that gives businesses, individuals, and governments the opportunity to neutralize emissions they put into the environment. In its Climate Blueprint, Royal Bank of Canada outlined the goal of achieving net-zero carbon emissions in global operations annually, by committing to reducing greenhouse gas emissions by 2.5% each year, with a target of 15% by 2023, and increasing its sourcing of electricity from renewable and non-carbon emitting sources to 90% by 2023. This practice may result in some surprising companies (that could include Microsoft, Apple, and Johnson & Johnson) being large holdings in low-carbon investment strategies.
Fossil fuel free
In the context of investing, fossil fuel free generally refers to companies that do not own fossil fuel reserves or those without high fossil fuel usage. Fossil fuel reserves in many cases refer to economically and technically recoverable sources of crude oil, natural gas, and coal. Note that some mandates do not consider metallurgical or coking coal (used in connection with steel production) to be fossil fuel reserves. Solutions that use a fossil fuel free strategy employ negative screening, where they exclude companies that fall under this umbrella.
Climate change implementation
There are a few options investors should consider when trying to make their portfolios more climate-friendly. Mutual funds and/or exchange-traded funds offer a way to get pooled exposure to one of the above themes.
Many of these solutions use different approaches: some are managed actively, while others use a rules-based strategy; and some aim to maintain a target tracking error compared to their parent index while others are benchmark agnostic. As such, it is important to take a look under the hood and understand each product’s methodology. Alternatively, when considering the addition of individual stocks or bonds to a portfolio, investors can weigh the company’s commitment to one of the above themes as an additional evaluation criteria. On the fixed income side, investors can also take a look at green and transition bonds.
A green bond can be issued by governments and businesses, is differentiated from a conventional bond based on the use of proceeds, and accounts for 77% of all sustainable debt issued. Issuers are mandated to disclose how they plan to use the proceeds, which gives investors the opportunity to decipher if the project is in line with their socially responsible investing goals. Issuers can use tools and frameworks developed by the Climate Bond Initiative (CBI) to determine appropriate uses of funds. Common and acceptable green bondfunded projects, according to the CBI taxonomy, would be ones that use renewable energy, reduce water usage, and create “green buildings”.
A transition bond aims to turn “brown” into “green”, as the bonds are tied to decarbonizing goals, and present a way for industries that are not traditionally “green” to reduce their carbon footprint. The proceeds are mandated to be put towards activities related to climate transition. These bonds are different from green bonds, as the focus is on the issuer’s commitment to becoming greener, whereas proceeds from green bonds are directed towards an environmentally-friendly project. For an economy that is heavily supported by natural resources, such as Canada’s, these bonds provide funding for companies to operate, while reducing greenhouse gas emissions.
Open the toolbox
Given the variety of investment solutions available within clean energy, low carbon, and fossil fuel free themes, we believe investors have access to the tools necessary to position their portfolio to celebrate Earth Day all year round.
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