- The transition to net zero is “the greatest commercial opportunity of our age"
- UK consumer spending on ethical products and services has risen almost fourfold versus two decades ago
As climate change has rocketed up the agenda, it has sparked a green investment boom this year. The iShares Global Clean Energy ETF (US:ICLN) – which tracks major renewable energy companies around the world – has surged from around $8 at its ‘Corona crunch’ low to over $23 now. Investors looking to capitalise on the transition to a low-carbon economy are increasingly realising that they can align their portfolios with their values without sacrificing financial returns.
We’ve picked out some key ethical trends that are worth befriending as we head into the new year.
1. The race to net zero
The transition to net zero is “the greatest commercial opportunity of our age,” says former Bank of England governor Mark Carney. As capital is reallocated towards companies helping to address this crisis, we could see a huge reshuffling of the global economy. Mr Carney says investors should ask “who is on the right and the wrong side of climate history? Which companies have momentum, and which will fall by the wayside?”
Amid falling costs and a supportive policy backdrop, the International Energy Agency (IEA) estimates that renewables will overtake coal to become the largest global source of electricity generation by 2025. For oil majors Royal Dutch Shell (RDSB) and BP (BP.), they may well regret leaving their transition efforts until now rather than following in Orsted’s (DK:ORSTED) footsteps a decade ago. The diverging share prices of the green giants and big oil reflect the changing of the guard in the energy industry.
But this is about more than wind and solar power. There is the potential of hydrogen and a tipping point is also approaching for electric vehicles as cheaper and longer-range batteries and upcoming bans on new internal combustion engines pave the way for mass adoption. This will require additional infrastructure – from charging stations to grid reinforcement – as well as the metals and minerals underpinning the entire green energy transition.
2. Ethical consumerism: more than a fad
Fuelled by climate change and health concerns, UK consumer spending on ethical products and services has risen almost fourfold versus two decades ago, reaching £41bn last year.
Companies have been evolving to capitalise on consumers’ shifting attitudes. Before the pandemic spoiled the party, Greggs’ (GRG) vegan sausage roll proved a hit, piggybacking on the growing interest in veganism. As demand for plant-based proteins continues to grow, fast food giant McDonald’s (US:MCD) is set to roll out the ‘McPlant’ range in 2021, while rival Burger King launched its non-meat burger earlier this year with consumer goods giant Unilever (ULVR) as its European supplier.
Unilever aims to generate €1bn of revenue from plant-based meat and dairy alternatives over the next five to seven years, expanding ‘The Vegetarian Butcher’ business it acquired in 2018 as well as its range of vegan products from well-known brands such as Hellmann’s. But its overtures to ethical consumers extends beyond the food space. It is targeting net zero emissions by 2039, spanning from the origin of its raw materials through to the point of sale.
Sustainable goods go hand-in-hand with sustainable packaging and that will benefit the likes of Smurfit Kappa (SKG). Feeding into the ‘circular economy’, there will be opportunities for waste management and recycling companies as well.
3. Bonds. Green bonds.
Green bonds are almost identical to their conventional counterparts, but the proceeds are specifically used to finance projects with an environmental benefit. As capital is raised to fund net zero plans and investors gravitate towards sustainable assets, the green bond market is soaring. According to Bloomberg New Energy Finance, over $1tn of green bonds have been issued since 2007, with $200bn in 2020 alone.
UK companies such as Tritax Big Box Reit (BBOX) have been getting in on the action and the government is also set to issue its first sovereign green bond next year. But the UK is lagging behind European peers. Looking at the iShares Global Green Bond ETF (US:BGRN) – which tracks the green bonds of top-rated borrowers – French sovereign and corporate bonds account for 23 per cent of its holdings versus less than 2 per cent for the UK.
There are a few grey areas. Corporate green bond issues are currently akin to a gentleman’s agreement that the company will ringfence the proceeds and use them as promised. Some companies voluntarily agree to third-party audits so that bond investors can monitor their progress, and the EU is set to introduce its ‘Green Bond Standard’, which should help increase transparency.
Green bonds also aren’t restricted to green companies, which can be problematic. “There’s been some questionable deals out there that have been issued as green,” says Bryn Jones, lead manager of the Rathbone Ethical Bond Fund (GB00B77DQT14). “We saw a large oil tanker company issuing green debt that was looking to make its tankers more energy efficient. Why would you invest in that if they’re shipping oil about?”
As demand outstrips supply, there are concerns about a potential green bond premium. But Bertrand Rocher, portfolio manager at Mirova, contends that “given the flows of green bonds to be issued over the coming months and years, this premium will little by little vanish, I presume”.
Opportunities for UK retail investors to capitalise on the green bond trend are mainly concentrated in ETFs such as the Lyxor Green Bond UCITS EFT (CLIM), but the options should expand as this market develops.
4. Investing with an impact
The lack of a standardised framework means ESG investing has probably created as much confusion as excitement. What one portfolio manager views as acceptable, may be unacceptable to another. A more common-sense approach is perhaps ‘impact investing’, which focuses on businesses that have a positive impact on society.
As well as climate change, social issues are climbing up the agenda of impact investors amid the need for affordable housing and pressure on health and social care systems. Big Society Capital (BSC) estimates that the UK social impact investment market will swell from £5bn now to £10bn-£15bn by 2025.
There are already a number of social housing Reits – such as Civitas Social Housing (CSH) and Home Reit (HOME) – that offer income potential. There is also the new BSC Schroder Social Impact Trust, whose investments will target three distinct areas – high-impact affordable housing funds, debt solutions for charities and outsourced government contracts where returns are based on social outcomes. This could potentially offer investors a defensive haven thanks to inflation-linked returns and government-backed revenue streams.
5. Boardroom diversity
The killing of George Floyd in the US earlier this year has brought closer attention to racial injustice and the inequalities pervading society. While these aren’t new issues, corporations are facing renewed pressure to improve their ethnic and gender diversity.
The 2017 Parker Review found that51 per cent of FTSE 100 companies did not have any directors from a minority ethnic background and recommended they appoint one by 2021. By February 2020, 37 per cent of the FTSE 100 were still without a single director of colour.
Things are somewhat better on the gender front, with a third of FTSE 100 board members now women. Across the pond, Jane Fraser is set to become the chief executive of Citigroup (US:C) and the first woman to hold this position at a major Wall Street bank. But there is still a long way to go.
This is not about culture wars or political correctness. A study by McKinsey of more than 1,000 companies across 15 countries found that businesses with greater gender and ethnic board representation are more likely to see above-average profitability than those with more homogenous executives.
Saker Nusseibeh, chief executive of asset manager Federated Hermes, believes companies that fail to grasp the importance of diversity risk their “ability to think differently”.
The role of institutional investors will be key. Legal & General (LGEN), for example, has told FTSE 100 and S&P 500 companies with all-white boards it will vote against re-electing nominee committee chairmen if they do not hire a minority director by 2022.