Battling climate change via the energy transition will cost trillions. But where will the financing come from? With government budgets stretched to the limit, there are excellent opportunities for private investors to help the world - and themselves.
If moving to a clean energy system seems daunting, that's because it is. According to the International Energy Agency, the world must double progress on energy efficiency and triple renewable energy generation in the next six years if we are to meet our 2050 carbon emissions goals. Fortunately, with new opportunities appearing across asset classes, investors can contribute to the energy transition while at the same time pursuing a financial return.
But what exactly do we mean by the "energy transition"? Put simply, it's the shift away from using fossil fuels. But while we might think of this solely in terms of scaling up renewable energy and energy efficiency, it actually involves a great deal more.
It's not enough to power everything with renewables
For example, copper is an essential resource for building clean energy infrastructure and electric vehicle fleets, while aluminium is a key component of solar energy systems and because of its light weight, it's also essential for electric vehicle construction. Nature plays its part too, since water underpins clean energy, for example through biofuel crop production, and the process of capturing and storing carbon. These resources, and others like them (particularly minerals used in batteries), are not only critical to the energy transition, they also need to be sustainably sourced and managed.
The energy transition also depends on numerous other interventions, from installing thermal insulation in buildings to developing more efficient heating and cooling systems. "It's not enough to power everything with renewables," says Thomas Hassl, a sustainability expert and senior portfolio manager at LGT Private Banking. "We must also use the energy we have available more efficiently."
Hassl points to another prerequisite for the energy transition: policy. Around the world, governments have become increasingly focused on legislative frameworks and regulation to support a low-carbon economy.
Among the most ambitious: the USA's 2022 Inflation Reduction Act, with incentives for large-scale investment programmes in clean energy, and the EU's Green Deal Industrial Plan, issued in response, which is a package of policy initiatives designed to enable member states to become carbon neutral by 2050.
Governments have clearly acknowledged that our climate goals will be impossible to achieve without private investment. So it's good news that a wave of financial innovation in products is enabling investors to build sustainability into their portfolios.
From alternative investments, to venture capital, to real estate investment trusts, most asset classes can now be included in green or sustainable portfolios, allowing investors to gain a foothold in the energy transition.
When it comes to fixed-income investments, the market for labelled bonds issued by companies and governments to finance sustainability-focused initiatives has grown rapidly, according to Malte Stiel, a fixed-income strategist who focuses on sustainability at LGT Private Banking.
"Labelled bonds are an exciting way for fixed income investors to gain exposure to sustainability projects, whether social, or green, or sustainable (which includes both)," says Stiel, who manages a bond fund centred on the energy transition. The risks associated with labelled bonds are similar to those of traditional bonds, as the issuer is guaranteeing for the bond. "Hence the classic credit analysis in fixed income markets is still essential when investing in labelled bonds."
Sustainable investing take into account not only financial aspects, but also so-called ESG criteria - factors relating to the environment, society and good corporate or state governance. The aim of sustainable investments is to generate an attractive return while making a positive contribution to society and the environment. If sustainable investing is important to you, we have a number of options that cater to your needs.
He explains that because the funds raised cannot be used by the issuers on anything other than sustainable ventures, investors can be sure their money is being directed towards projects like wind farms, green buildings, sustainable fashion, and education, which match their values and fit their sustainability agendas. Best practice for labelled bonds typically includes transparency on the allocation of proceeds as well.
For investors focused on publicly traded equities, the impact may be less direct. However, fund managers have a number of powerful tools at their disposal to ensure that the companies in their portfolios are moving in the right direction.
Recycling is a double win
"One prominent tool at our disposal is stewardship," says Hassl, who manages an equity fund that invests in companies whose activities support the transition to a more sustainable economy. "We use our influence as part-owners of companies to enter into conversations with them and vote at shareholder meetings. All with the end-goal to improve their ESG credentials," he explains. "And by providing capital to companies that are sustainable, it should have an impact on their share price and ultimately reduce their cost of capital."
While bond and equity funds often have a number of sustainability themes, ranging from societal wellbeing to the circular economy, and from climate action to digitalisation and technology, many are connected to the energy transition.
Take the circular economy. Recyclable products often have a lower energy footprint because they can be dismantled and returned to the production chain. "You keep valuable resources in circulation for as long as possible," says Stiel. "And it's often less energy intensive to recycle than to manufacture new products, so it's a double win."
Other fund themes like digitalisation and technology will be critical in advancing towards a clean energy future, particularly when it comes to modelling energy flows, forecasting consumption patterns, and adjusting distribution in real time to optimise the use of renewable sources.
Of course, for investors with sustainability as part of their strategy, there is an important question: How do I know my investments are making an impact?
This is no easy task. While carbon emission savings made by a single company can be accounted for in tonnes, it's far harder to measure the energy used across complex global supply chains that may involve thousands of companies. There are also trade-offs. Copper might be essential to electricity infrastructure, but mining it requires large amounts of water and generates enormous volumes of waste.
While a variety of sustainability measurement models are emerging, LGT has developed a framework that evaluates sustainability across investments by considering two dimensions: company exposure and sustainability effects.
For example, a wind turbine manufacturer would score highly on both company exposure and sustainability effects, since 100 per cent of its activities are directed towards producing clean wind energy.
By contrast, while a multinational food manufacturer's company exposure might be small if only 10 per cent of its revenues come from products like organic fruits and vegetables and alternative meats, it might still offer high sustainability effects.
"Because of its size, with big markets, global supply chains, and vast amounts of money for R&D and marketing, this kind of company could make a real difference in terms of sustainability because it reaches a lot of people," says Stiel. "That's why we balance these two dimensions in our investment decisions."
While sustainable finance has come a long way, the challenge of financing the energy transition should never be underestimated. In fact, to limit global warming to 1.5 degrees Celsius, the IEA's Net Zero Roadmap calls for clean energy investments of USD 4.5 trillion per year by 2030.
For investors, helping to fill this gap presents an extraordinary opportunity, allowing them to build globally diversified portfolios that can generate long-term returns while making a real-world sustainability effect. And if enough investors place bets on financial products that enable the energy transition, it could be a true game changer.
