“Green” Investing
As the new administration in Washington prepares to deal with monumental economic challenges, both domestic and global, a bright spot can be seen on the horizon that is most likely the illumination from a solar panel.
The Obama administration has pledged to invest $150 billion over the next ten years in alternative, renewable, “green” energy sources. Additionally, investors are becoming more interested in environmental, social, and governance (ESG) investing or socially responsible investing (SRI) – a concept that dates back to the 18th century. Green investing is just another variation on ESG or SRI investing. So how do investors take advantage of this not-so-new investment theme?
The case for green investing is compelling. Green investing is a powerful global investment theme that, regardless of sector or geography, is expected to create opportunities and enhanced returns for some companies, while creating risks and increased costs for others. Governments around the world are enacting significant regulatory changes to reduce greenhouse gases and halt the deterioration of the environment. In addition, consumers and corporations are changing their spending and purchasing practices. The green investing theme is particularly compelling because of the sheer size of the potential growth opportunity, and the significant, direct catalysts that are driving it.
Growth in the green investing sector could result in an industrial transformation that will create both opportunities and threats.
Growth in the green investing sector could result in an industrial transformation that will create both opportunities and threats. Green investing is not a fad, is not limited to alternative energy, and does not eliminate companies based solely on carbon footprint. Green investing is generally considered investment in companies with environmentally sustainable business models, strong environmental profiles or a plan to capitalize on the emerging green technology economy. It is a specific thematic investment approach. However, because environmental solutions are provided across sectors, it is likely that some areas will be more overvalued than others. As a result, it is important to select investment managers that conduct rigorous fundamental research and have a proven competitive edge in exploiting alpha opportunities in the various sectors.
Public Policy, Corporate and Consumer Behavior Changes
Significant global public policy changes and shifting behaviors on the part of consumers and corporations serve as catalysts that help to drive green sector growth opportunities and to contribute to their risks. These public policy and spending trends have led to a strong interest in green investing from individual and institutional investors. As a result, the investment management community has rolled out a wide array of green investment strategies. Unfortunately, this has also led to some confusion as no two investment strategies are alike. Not only do investment managers define green differently, but they also target different types of companies and employ unique investment philosophies and processes.
Portfolio Construction and Monitoring
When considering going green from an investment perspective, investors may consider specialty managers that focus on specific climate change themes such as water or alternative energy. Because many of these specialty funds carry high minimum investments, investors may be overexposed to certain themes. In an effort to try to capture the full set of environmental investment opportunities, enhance returns, and reduce risk, diversification across a number of green investment themes is prudent. Where there is commonality among managers, the types of companies they target may vary significantly. It is prudent to diversify across the four major green investment themes: energy production, energy efficiency, water, and acclimatization. Investment managers ideally would be permitted to construct the portfolio with pure bottom-up stock selections that present the greatest opportunities.
The need for ongoing monitoring is equally critical. Because the green theme is quite broad and affects all companies across sectors and geographies, the portfolio should be structured globally and benchmarked against the MSCI World Index. As such, green allocations would likely come from the global equity portion of a broader portfolio or by reducing U.S. and non-U.S. equities as appropriate.
Conclusion
Green investing represents a significant global investment theme that may create sector growth opportunities as well as increased risks for all companies, regardless of sector or geography. Helping to serve as a catalyst for this potential industrial transformation is increased regulation, changing behavior on the part of consumers and corporations, and a more active investment management community. A diversified green portfolio, if properly structured, can adequately capture this sector growth trend. Paramount to this is the selection of investment managers that have an edge in combining independent and proprietary fundamental research with unique insights into environmental investment trends.
