Resilience Dispatch #13: Is Net Zero Investing the Next Frontier?

A Net Zero Economy on the Horizon

Dear Friends,

Forest Trends’ core mission is to move the world to an economy that works for a healthy planet, rather than at its expense.

In 2020, the world – and in particular the financial sector – moved in that direction, despite a pandemic that upended the global economy and delayed climate negotiations. Environmentally and socially consciously investing accelerated last year. Actors with “net zero” emissions commitments now represent a remarkable 25% of global emissions and over 50% of global GDP. (“Net zero” means after reducing emissions as much as possible, any remaining emissions are balanced out through natural or technological carbon removal, with the end goal of meeting Paris Agreement targets.)

This January, BlackRock chief Larry Fink’s annual letter stepped up the pressure even more, calling on business leaders to “disclose a plan for how their business model will be compatible with a net-zero economy.”

In this Dispatch, we ask Rupert Edwards, Forest Trends’ resident expert on sustainable finance, what a net zero investment portfolio would actually look like. His answers are enlightening, especially his argument that Paris target-aligned investing is well within reach for the average individual, not just major institutional investors like BlackRock. Last week’s GameStop short squeeze showed us that for better or worse, retail investors have a lot of power when they work together. Food for thought.

What does this have to do with forests? As Edwards explains, a net zero financial sector would reinforce the demand signal for climate mitigation from protecting tropical forests – a signal we’re working with partners to send through the Green Gigaton Challenge.

A big focus in 2021 for Forest Trends will also be helping investors and companies deliver on their net zero commitments, through market intelligence and strategic advice. We need them to succeed. We’re ramping up our voluntary carbon markets data offerings, and reporting on progress in efforts to grow these markets quickly while maintaining quality.

Regards,

Michael

Is Net Zero the Next Big Thing in SRI?

A Q&A on going beyond “low carbon” in socially responsible investing with Rupert Edwards, our Senior Advisor on Carbon & Finance, and Genevieve Bennett, our Director of Communications.

Genevieve Bennett: We saw BlackRock chief Larry Fink’s annual client letter this month calling the climate transition a “historic investment opportunity” and asking companies to disclose how they’re planning to move their business models to compatibility with a net-zero emissions economy. BlackRock is the biggest asset manager in the world, so their recent pressure on climate exposure has gotten a lot of attention. But they are really the tip of the iceberg in terms of a shift we’ve seen recently in institutional investors assessing climate risks in their portfolios.

Your new paper looks at retail investment as the next frontier – this idea that nonprofessional investors also want net zero carbon investment options, and what those financial products could look like.

Rupert Edwards: Right. There’ve been some major shifts underway in the last few years. The huge growth in Socially Responsible Investment; the rapid evolution of climate risk metrics and lower investment carbon strategies, which you’ve alluded to, driven partly by SRI trends, but also by regulators and central banks. And, in the real economy, the corporate focus on transitioning to net-zero under pressure from policy, regulators, and market forces.

The logical next step is that many retail investors will seek to go beyond modest shifts in the carbon intensity of their savings portfolios and look to achieve net zero, by using offsets as a supplement to lower carbon investments.

Investment managers and investment platforms could start to offer savers opportunities to offset the carbon footprint of their portfolios. But, even if they are slow to do so, we are starting to see the emergence of consumer-friendly financial technology platforms that will make it relatively easy for retail investors quantify their carbon impacts.

Rupert Edwards: There are great low-carbon product offerings available. However, it is not really appropriate from a risk perspective for ordinary savers to be overly concentrated in specialist clean technology funds, for example.

Another problem is that low carbon equities could become overvalued as investors move more and more into these funds. There’s some evidence that is already happening. Another reason that low carbon investments could struggle to outperform is if policy is insufficiently ambitious to support the trend. At that point, investment managers with fiduciary responsibilities to maximize returns would be obliged to sell. So, there will be times when it could make sense to hold standard products and offset their carbon impact, instead of holding equities that could underperform.

More to the point, the fact is that none of the mainstream index-based low carbon strategies are actually decarbonizing fast enough to be truly aligned with Paris Agreement goal of holding global warming below to 2°C. They are lower carbon, but they are not carbon neutral.

Genevieve Bennett:  So, the idea is that that offsetting gets you that last mile?

Rupert Edwards: Yes. It also gives you flexibility to switch between strategies while maintaining low carbon exposure. For example, an investor could switch out of a passive fund tracking the MSCI Low Carbon Leaders index and into one tracking the standard MSCI ACWI index and pay approximately and additional 20 basis points to remain net zero. I’ve written previously about willingness to pay for climate mitigation among private savers; I think the appetite is there.