The G7 summit of global leaders in Cornwall ended with some impressive sounding commitments on tackling climate change. And this November the UK will host the next UN Climate Change Conference in Glasgow. These global deals will play a vital role in preventing catastrophic climate change, but most people are still struggling to work out what these high-level aspirations mean for them personally.
The chances are that you’ve already made some efforts to reduce your impact on the environment, maybe by switching to a renewables-based electricity supplier, taking fewer flights or eating less meat. But the companies owned in your pension or stocks and shares ISA have a far more meaningful impact on the environment. And yet most of us haven’t incorporated sustainability into our financial decisions.
If you want to change this you need to confront two important questions. First, do you risk giving up investment returns by trying to invest sustainably? It’s natural to want to use your savings to help save the planet, but many people would think twice if that’s going to result in a lower quality of life in retirement. Second, are you just going to avoid owning polluting companies or might there be a better way to change a company’s behaviour?
Happily the evidence shows that investing sustainably can lead to better risk-adjusted returns over time. And a new consensus is emerging that it’s not just what you own that matters for the environment, but how you own it.
Consider investment returns first. Investors increasingly accept that climate risk is investment risk. This idea has moved from novelty to mainstream in just a few years, accelerated by three important changes in particular: record damages from extreme weather events in 2020; the global shift in regulation towards a net zero economy; and the rapidly falling cost of greener energy production thanks to innovation. Together these have produced a fourth crucial change — investors are increasingly looking to buy sustainable assets, with ongoing inflows of money likely to continue raising the prices of those assets at the expense of polluting assets.
All of these changes mean that investing sustainably is more likely to result in higher returns and lower risks — it’s a win-win. Of course it won’t always be a smooth process. For example the new appetite for renewable assets like wind farms, combined with Joe Biden’s election victory, led to a huge rally in the prices of those assets, which has then partially unwound over the first half of this year. But as we make the transition to a net zero world those investments are still likely to outperform.
What about the other side of the coin — should you exclude polluting companies from your savings? For some investors and campaigners the simplest approach is to sell out of all fossil fuel companies. The argument is that this is the clearest signal that certain sectors need reform in order to regain their social licence to operate. You could build a portfolio with zero emissions today by excluding the worst emitting sectors such as energy. On the surface this might make you feel good, but this approach isn’t actually consistent with the global Paris Agreement which seeks to limit temperature increases to less than two degrees above pre-industrial levels.
Aligning a portfolio with this transition to a “net zero” global economy by 2050 doesn’t mean building a zero emissions portfolio today. Instead the spirit behind the Paris Agreement, and new European regulations resulting from it, lies in encouraging these sectors to shift to lower carbon intensity. After all, if you don’t own these companies then someone else will, and they may care a lot less about continuing with old, polluting practices.
This approach means continuing to invest in companies that have a credible plan for the net zero transition and using shareholder power to force those that don’t to change course. Increasingly it looks like this muscular approach can yield real results. Just in the last month several global fossil fuel companies have been forced by their shareholders to start changing their business models and align themselves with the low carbon economy.
The bottom line is this: if you want to help save the planet, how you invest your savings might be one of the most important decisions you make.
Rupert Harrison is a former chair of the Council of Economic Advisers and a multi-asset portfolio manager at BlackRock
Are you taking steps to invest sustainably? Let us know in the comments below.