Investing in climate solutions will prove vital in averting a climate catastrophe

The second step in Redington’s 7-point climate action plan is climate solutions: continuing to seek out attractive investment opportunities and helping our clients invest directly in the infrastructure that is needed to address the climate crisis. Here’s how we plan to do this:

The recent Intergovernmental Panel on Climate Change (IPCC) ‘code red’ report made it clear that net zero by 2050 is the objective for governments, corporates, investors and individuals to get behind if we’re to avert a climate catastrophe. Even before this report was released we’d seen thousands of net-zero commitments being announced, including many in the investment sector from asset owners, asset managers and consultants alike. Having made a commitment, the next step is to make a plan, and to consider the decarbonisation solutions available. There are a raft of solutions available to investors now, as well as many coming down the track.

Investors have a decision to make – along with decarbonising their own portfolio, should they be allocating capital to assets that aim to make a real-world impact as well?

When it comes to portfolio decarbonisation, our preference is to work with existing asset managers to decarbonise their portfolios in-line with the goals of the Paris Agreement (i.e. achieving net zero by 2050 with a 50% reduction in emissions by 2030). Although it’s technically possible to build a relatively well-diversified portfolio that would fit this 50% reduction objective today, this would involve divesting from companies that need to transition. Instead, investors need to engage with companies to encourage them to decarbonise, not shun them and force them to go private.

To do this, investors must ask their asset managers if they have made a net-zero commitment and whether the strategy they’re invested in is on a decarbonisation path. If the answer’s yes, the next question should be ‘what milestones are being targeted and how are they going to be measured?’ Assessing progress and taking action accordingly is crucial; investors need to ensure that their asset managers are not only making promises, but that they’re delivering on them too.

In our latest Sustainable Investment Survey, only 29% of strategies said that they had set a decarbonisation objective; asset owners and investment consultants need to engage with asset managers to stress the importance of doing so.

After taking steps to decarbonise their own portfolio, investors need to decide whether to invest in the impact strategies that help to fund the economy’s green transition. The IIGCC’s Net Zero Investment Framework recommends that investors do so, with Step 7 of the framework stating that investors should “Assess assets based on current and forward-looking alignment criteria, and investment in climate solutions”.

But what do climate solutions look like today?

There are various options available to suit a spectrum of risk profiles and liquidity budgets:

The most impactful solutions are found in relatively illiquid areas, these include:

• Renewable infrastructure: direct investment into projects that focus on the generation of heat or power from sources of energy such as wind, solar, biomass and hydro. There are also opportunities to invest in renewable-enabling infrastructure such as battery storage, flexible generation and energy-efficiency technology that aims to reduce energy consumption.
• Natural capital: investing in assets, such as forestry and farmland, that seek to generate both a financial return and a nature-based solution to climate change and biodiversity loss. Natural resources (such as trees and soil ecosystems) are expected to play a fundamental role in the path to net zero, given they’re currently the only scalable carbon sinks that exist.
• Impact private equity: investing in the equity of private companies around the world with a dual objective of delivering appropriate risk-adjusted returns as well as having a positive impact. Positive impact, in this case, means creating social and environment outcomes which are intentional, measurable and additional.
• Impact private debt: lending to projects or corporates whose assets or revenues positively contribute to specific and defined environmental or social objectives. Loans in these strategies may be backed by corporate cashflows or real assets. The impact in this strategy can be magnified by additional engagement with borrowers, for example to improve environmental disclosures.

But recognising that not all investors have an illiquidity budget, there are some relatively liquid alternatives too:

• Impact listed equity: funds that invest in companies whose products and services deliver real-world solutions to meet climate objectives.
• Climate-focused credit: in the credit space, managers can invest in impact bonds such as green bonds, social bonds or sustainability-linked bonds. Through these innovative structures, investors can promote the growth of climate solutions and of company-wide climate action.

When we talk about impact, we like to remain wary of the nuances. We’ve outlined some of the different ways in which asset owners can generate impact below.

For private assets:

• An asset owner can generate direct impact through engagement. By raising issues with management and challenging current practices, it’s possible to promote better approaches to addressing environmental and social issues within the companies they own.
• An asset owner can support an impactful company or project by providing primary capital. The company or project in scope will generate impact through their products or services and through the way it is managed, while the asset owner provides capital. This is possible when investing in illiquid assets such as private equity or real assets.

For public assets:

• The direct impact of the asset owner is less evident, but research suggests that investors can sometimes influence an issuer’s cost of capital. When investing in listed equity, asset owners can choose to be exposed to impactful companies by investing through impact-oriented managers who have identified the key solution providers and innovators.

So what?

Averting the climate catastrophe we’re currently facing requires asset owners, asset managers, consultants and governments to work together. It’s not enough for investors to divest from high-emitting industries to decarbonise their own portfolios. We have a global commitment to net zero which will only be achieved in collaboration, and investors have a vital role to play in providing capital to and engaging with those companies that are critical to the real-world transition to a low-carbon future.

Our team at Redington have researched the universe of climate solutions and are able to advise on attractive investment opportunities that suit a variety of risks profiles and liquidity budgets. If you’d like to discuss this further, please get in touch: nick.samuels@redington.co.uk