- Climate change, or global warming from greenhouse gas (GHG) emissions caused primarily by human activity, poses a substantial danger to businesses and economies, human health, and the natural environment.1
- We also see a significant near- and long-term investment opportunity and portfolio risk mitigation potential as global markets and investors allocate capital and resources to innovative research and development efforts and companies catalyzing change.
- A growing urgency about the need to invest is creating economies of scale as renewable energy technologies come into the mainstream.
- Progress is likely to continue beyond our investable lifetimes, creating a long-duration thematic trend, in our view.
Greenhouse gas (GHG) emissions produced by human activity have caused the world's atmosphere to warm in the years since the industrial revolution.2 The effects already seen include more violent and unpredictable weather patterns, challenges to the global food and water supply, and forced human migration that is contributing to social unrest and upheaval.
A recent report estimated $69 trillion of negative economic impact directly related to global warming.3 In our view, the steps to blunt the impact of climate change and successfully navigate its effects will be one of the single largest economic drivers of this century.
But we see both near- and long-term investment opportunity and potential to manage portfolio risk as people, companies, and governments worldwide take action. The modern economy remains a fossil-fuel-driven economy, driving roughly 85% of global primary energy, yet investments to reduce or eliminate GHGs are growing and this shift presents an exciting investment opportunity.
Investing implications of climate change
Climate change is a global issue that will affect every country, industry, sector, and business. In our view, this green transition is in the nascent stages but is likely an investing megatrend where economic progress over the next century may be defined by climate investments. For investors who want to align their portfolios with their values, many companies are changing or even reinventing their business models, with positive potential implications for both their stock values and bond issuance.
Both stock and bond investors are benefiting from 3 types of companies that have been early movers to help drive the private sector to net zero (see Early-mover companies in climate impact initiatives below). Net zero represents carbon neutrality, or the point at which carbon emissions by human activity are at a level where they can be absorbed naturally into the environment. These early movers include "innovators" who are developing new business models and industries; "mitigators" with technology, products, or processes to help offset the impact of climate change; and "good actors" from higher-emitting industries with strong commitments to carbon neutrality in their corporate strategy or mission statements.
Innovator companies are inventing the business models and industries of the future. They are working to "green the grid" to help remove fossil fuels from the power grid, a critical component of getting to net zero.
They are also part of a broad move toward electrification—everything from industries and supply chains, cars and public transportation, and residential and commercial real estate. In addition, innovators include companies pursuing efforts to generally help customers lower or eliminate both noncarbon and carbon GHG emissions.
Methane gas, for example, has more than 80 times the heating potential of carbon dioxide over the first 20 years it is in the atmosphere. One significant global source of methane has been from cattle used in the agriculture industry. Each year, a single cow will produce about 220 pounds of methane.4 One company developed a feed additive (non-harmful, non-toxic) that reduces emissions significantly for both dairy and beef cattle.
The United Nations' Intergovernmental Panel on Climate Change (IPCC) released a report recently that focused extensively on climate tipping points that many scientists believe could result in vastly increased physical climate change impacts than those already anticipated.5 One stark example was the potential loss of the world's rainforests, which would eliminate a powerful "carbon sink" that lowers the concentration of carbon dioxide in the environment. If the world loses rainforest to a savannah environment where the trees no longer provide a canopy of green, it could mean mass extinction of species and ripple-effect damages to local and broader economies, among other dramatic changes to our way of life.
Another tipping point could be accelerated warming brought about by melting permafrost, which could increase methane emissions and resurrect diseases. The report underscored an urgent need in investment in reducing the impact of climate change, which is a focus of mitigator companies.
We see significant potential in companies that have been providing technology, services, or tools to help companies adapt to the impacts of global warming. They are helping businesses to mitigate emission leaks from their industrial productions, or helping to remediate spills into the soil or groundwater. Other firms are providing guidance on how to navigate severe weather and its impact on business lines. Engineering and consulting firms are helping companies address the implication of sea level increases, drinking water scarcity, and water contamination.
The third type of early mover to net zero emissions are the higher emitters from traditional industries that are rapidly adapting their business models to the new realities of today's environment. These good actors will, for the most part, continue to provide goods and services that are critical building blocks of society.
For example, the cement industry, which is a necessary material for urbanization and economic development around the world, also produces 8% of GHG emissions.6 The world today does not have a lower-carbon replacement to building materials like cement and steel, in the same way that we have cheaper, cleaner renewable sources to power our electric grids. We therefore look for cement companies with an emissions profile that is improving rapidly through near-term production efficiencies, and research and development.
Heightened engagement, lower renewable costs
Several trends are helping to create a conducive market backdrop for climate-aware companies (both their equity and fixed income). First, government and corporate engagement has been rising dramatically, as seen at the COP26 Climate Change Conference in Glasgow in November.
On the government side, popular opinion is driving them to commit to ambitious emission targets, engendering large spending packages not only for research and development but traditional "shovel-ready" jobs. Many companies have been driven by a sense of mission as well, stepping up with emissions targets of their own. Committed companies have been taking action for years; they have the ability to move fast and drive significant impact.
Warming estimates and how countries are responding
As it stands today, even generous corporate and governmental pledges on GHG reductions will not do enough to limit global warming to the levels needed to maintain our current quality of life.
The chart below outlines possible scenarios based on the current level of pledges and commitments, calculated by Climate Action Tracker, a global consortium of scientists and policymakers (see Emissions and expected warming based on pledges and policies chart). Global warming projections based on current policy suggest temperature increases of up to 2.9°C above pre-industrial levels, a progressive global crisis.
Under current commitments, warming could rise by as much as 2.9°C above pre-industrial levels, which would result in a devastating impact to the world. New pledges made in Glasgow would reduce the temperature increase to 2.4°C, the data shows (see Governments and corporations have established net zero pledges below). The warming projections and commitments in Glasgow underscore the importance of climate change as a business imperative and investment opportunity.
Costs for green/renewable energy have also declined substantially, and wind and solar are now on par with traditional fossil fuel sources before accounting for externalities. For example, one wind turbine company saw a sharp decline in onshore levelized costs of electricity (LCOE); wind power costs fell below the costs for traditional thermal power in 2019.7
Growth of the sustainable debt market
Many of these early-mover companies are financing climate change initiatives through bond issuance, resulting in dramatic growth in the sustainable bond market. Sustainable debt totaled $1.7 trillion as of September 2021, including green, sustainability, and sustainability-linked bonds (see Total corporate and government sustainable debt has soared chart).
Green and sustainability bonds pay for new or existing projects with environmental or social benefits. Sustainability-linked bonds have an embedded feature in which a company must meet certain emissions targets or pay a higher coupon—signaling a strong commitment to the markets. We see significant value in this interwoven connection between traditional credit analysis and ESG analysis to help build actively managed, environmentally oriented bond portfolios to help fund the green transition. About 30% of total issuance is denominated in US dollars.
Sustainable bonds span the credit quality spectrum, with opportunities in core investment-grade bonds and beyond. The bonds span most major sectors, with especially strong growth in utilities and real estate (see Sustainable debt issuance by sector shows strong growth in utilities and real estate chart).
ESG research—a differentiating factor
One of the major challenges in investing for climate impact has historically been the availability, consistency, and quality of data on carbon emissions. But data measurement to assess companies' carbon footprints continues to evolve. We can now evaluate a company's footprint across multiple dimensions, including direct and indirect emissions, emissions intensity (relative emissions), and company targets.
For example, in addition to tracking absolute emissions, there is also value in tracking a more nuanced metric—the reduction of emissions intensity. Emissions intensity is the output relative to a given production measure (e.g., emissions per barrel of oil, or per air passenger mile). While absolute emissions are key to a net zero world, relative emissions are also important, especially in hard to decarbonize sectors such as heavy industry, transportation, energy, and utilities.
Evaluating emissions intensity, especially as a function of production, can give us insight into the near-term efforts that companies in these industries are making to greatly improve their efficiency. Such a nuanced measure matters as we think about reducing lifecycle emissions in fossil fuels, and incremental improvements in energy efficiency.
Incorporating targets to assess progress
For all companies, the path toward decreasing their climate footprint is as important as their current climate footprint. We look to have a clear line of sight to the short-, medium-, and long-term strategies for a company to decarbonize—what investments are being made in clean energy, research and development efforts for hard to decarbonize sectors, and transition plans and risk assessments, if applicable. All of this should be analyzed alongside the backdrop of management accountability and incorporate executive compensation, board oversight, and executive-level ownership.
Many companies have articulated long-term, net zero ambitions, but lack the strategies to accomplish those goals. We closely evaluate a company's targets against their specific strategies for achieving emissions reductions. We look at management's ability to articulate a strategy, and the level of transparency into investments and research and development focused on clean (or cleaner) energy solutions. Ideally, these targets cover all scopes of emissions and time periods from near-term (1–5 years), medium-term (5–10 years) and long-term (>10 years). We focus on companies that are supporting emissions targets based on the SBTI, or Science-Based Targets initiative, a framework for financial institutions to align targets with the Paris Agreement.
The world at large is getting hotter, with more pollutants in the air, more violent weather, and our fragile global water supply and broader ecosystem is at risk. Investors, shareholders, and customers increasingly want to ensure their portfolios are aligned with their core values, including their beliefs about the need to support companies working to reduce or eliminate climate change. But we also see significant investment opportunities and risk mitigation potential today and for decades to come—a megatrend that we think will only grow stronger over time.