Environmental investing

A big reason why sustainable investing has exploded in popularity in recent years is the growing demand among many investors for investments that produce renewable and sustainable energy, enhance energy efficiency, source raw materials using eco-safe methods, use little or no hazardous chemicals in their production process, limit waste, prioritize recycling, consider animal welfare, and manage land and water use, among other factors. Based on numerous surveys, this is particularly the case for younger investors. With some estimates forecasting that $30 trillion in wealth may be transferred from baby boomers to millennials over the next decade, this could be a trend that has long legs.

If you currently incorporate environmental principles into your investment plan or you are thinking about doing so, here's a roadmap for how to navigate this pillar of ESG investing.

A greener world?

An investor who wants to direct some percentage of their portfolio based on environmental principles can have a variety of reasons for doing so. For instance, some investors may be interested in investing in companies that are working to increase access to water, while others may want to invest in companies that are working to reduce pollution. 

Of all environmental concerns, perhaps the most common is climate change. The potentially ubiquitous impact of climate change is related to exponential growth in the world's population and its demand for energy. Earth's population is estimated to reach just under 11 billion around the turn of the century, up from nearly 8 billion now, according to the United Nations Population Division. Currently, about 15% of global energy comes from green sources, but to limit global warming below an increase of 1.5°C annually, which would be the threshold many scientists predict would produce irreversible environmental change, that percentage would need to be closer to 30% by 2030 and 60% by 2050.¹

A Bank of America estimate from February 2021 notes that $2 trillion to $4 trillion in global investment is needed to reach net zero emissions annually, and this level of spending would lead to more than $100 billion in annual research and development in clean technologies. Across many geographies, wind and solar power are already cheaper than fossil fuels, so there appears to be some alignment between economic and environmental incentives over the next decade.

Indeed, green energy appears poised to play a big role in meeting the earth's surging energy needs. Research firm Bloomberg New Energy Finance predicts worldwide energy demand is predicted to increase 9% between 2019 and 2050. During that time, the share of the world's energy derived from solar, wind, and other renewable sources will rise from 4% today to 14%. In total, zero-emission power sources, including nuclear and bioenergy, are forecasted to provide 27% of the world's primary energy, up from 17% today.

Powerful support behind the eco trend

A big part of the reason why environmental investing opportunities, and renewables in particular, have become an increasingly large part of the solution to addressing climate change (and other environmental concerns) is governmental support. This includes executive policies and global legislation designed to address climate change, in addition to subsidizing the growth of such technologies to help bring down costs.

These efforts have helped bring costs for renewable energy down dramatically. For example, the US Energy Information Administration estimates that the cost of solar power has declined by 82% from 2010 to January 2021, and that the cost of wind power has declined by 43% over the same time frame. Lower costs for items like solar panels, battery technology, wind turbines, and other eco-friendly initiatives is a critical factor in the adoption of green energy technologies.

Exploring the environmental investing world

If you are not familiar with environmentally friendly investments, you might look at the composition of benchmark indexes. Some of the most popular benchmarks in the green energy space, for example, are the S&P Global Clean Energy Index (SPGTCLEN), NASDAQ Clean Edge Green Energy Index (CELS), or World Alternative Energy Index (WAEXPDC). You could also look at the composition of environmentally focused ESG ETFs and mutual funds. Additionally, there are green bonds—fixed income investments issued to fund environmentally-friendly projects.

It's worth noting that many individual investors do not have the expertise or experience needed to determine if an investment aligns with desired environmental principles. For example, one way to assess a company's environmental impact is via emissions data based on both their carbon intensity and absolute emissions. For toxic emissions, data on environmental compliance, including infractions, violations, and fines incurred for breaching certain regulations, adjusted for company size, can be useful. Access to this data, and the ability to interpret it, can require time, skill, and experience. 

With that said, there are tools that can help you find investments that align with your environmental principles. ESG reports and ratings, for example, are one such tool. ESG ratings from providers can provide an assessment of how well a fund and its constituents align with ESG factors—including environmental principles. It should be noted that a provider's ratings methodology may not be fully disclosed to investors, making transparency a potential issue. And even when utilizing ESG ratings, you should dig deeper into the investment that you are considering to determine if it aligns with your principles and overall investing objectives.

More importantly, there are risks that accompany investing in emerging industries—in addition to the risks that any investment entails—where expectations may be unreasonable, earnings unpredictable, and markets are not the only forces determining success or failure. For instance, while solar and wind may now compete on cost with gas and oil (whose production is also heavily subsidized), continued reliance on subsidies makes the long-term profit potential of these companies harder to assess as the industry matures and competition increases.

With that said, if investing using environmental principles is important to you, there are more ways to achieve this objective than ever before.