Table of Contents
Quick Guide: Five Steps to Getting Started in Green Investing
- Since the 1960s and 1970s, green investing has gained momentum and is now a mainstream investment option. The sustainability market has doubled in the last seven years, and socially responsible investments have grown by 34% over the past two years.
- Green investments can help close the financial gap needed to accelerate sustainable progress goals set out in global initiatives, such as COP26, the Paris Agreement and the Sustainable Development Goals.
- There are many ways for investors to create a diversified green portfolio. The key steps include outlining a clear investment strategy, assessing the risks, creating and properly managing the portfolio and being mindful of greenwashing.
- There are less capital-intensive options outside of traditional investments. The alternatives require less money and tend to represent a smaller fraction of a portfolio. Examples of opportunities outside of investing include offsetting carbon footprints, sustainability activism and impact philanthropy.
Green investing, also referred to as sustainable investing, sustainability-themed investing, or ethical investing, is an investment strategy that focuses on improving the world’s environmental and social conditions. It aims to reduce the negative impact on people’s lives and the planet as a whole.
During the 1960s and 1970s, the term Socially Responsible Investment (SRI) gained momentum by aligning investments with investors’ concerns. SRI mainly concentrated on social causes such as women’s rights, social justice, and the anti-war movement. In recent times, the term has expanded to include environmental causes and is usually referred to as sustainable investing. This term encompasses green investing, impact investing, socially responsible investing, and Environmental, Social and Governance (ESG).
Green investing continues to gain momentum and has become mainstream. The sustainability market has doubled in the last seven years, and SRIs have grown by 34% over the past two years. As a result, global ESG assets are expected to exceed $53 trillion by 2025, representing more than a third of the $140.5 trillion in projected total assets under management.
Sustainability is an urgent issue that needs to be addressed by governments, companies, and society as a whole. Steps have been taken through the 2015 signing of the Paris Agreement and COP climate change events, but SDGs are way off track. Tremendous progress needs to be made to ensure targets can be met.
Green investments can help bridge the financial gap required to help accelerate sustainable progress goals. For example, it is estimated that an investment of $2.5 trillion per year is needed in the Sustainable Development Goals (SDGs) to achieve the 17 goals by 2030. In addition, large institutional investors and small individual investors can positively impact the sustainable market and boost industries like renewable energy. Here are five steps to help get started in green investing.
Step 1: Outline Sustainable Investing Strategies
Of the seven investment strategies listed above, ‘ESG integration’ and ‘negative/exclusionary screening’ are the most common in the investment market, representing two-thirds of total asset allocation.
There are many ways to get involved in green investing, but one of the first steps is to outline a clear strategy. Here are some of the common structures of sustainable investing strategies:
- ESG integration
- Negative/exclusionary screening
- Positive/best-in-class screening
- Norms-based screening
- Sustainability-themed investing
- Corporate engagement
- Impact investing
Of the seven investment strategies listed above, ‘ESG integration’ and ‘negative/exclusionary screening’ are the most common in the investment market, representing two-thirds of total asset allocation. On the other side of the spectrum, impact investing is the least preferred among investors, which is unfortunate as it is the investment strategy that can result in the most significant impact on the environment and society.
It can be beneficial to lay out the sustainable investing strategies on an impact investing spectrum of capital which goes from traditional to pure impact investing. This allows the investor to compare investing strategies to measure the positive impact that each one can potentially have on the environment.
Step 2: Align Sustainable Investment Opportunities with Risk Appetite
The majority of listed stock market companies put profit and shareholder satisfaction as the primary focus, leaving environmental and social impacts as an afterthought.
Before rushing to create any sustainable investment strategy and allocating money to various investment opportunities, it is vital to understand the different asset classes and associated risks. Here are some examples of green investment types and the risk appetite which will need to be considered:
- Green, Social and Sustainable bonds
These are fixed-income assets with fixed interest rates. Green, Social, and Sustainable bonds tend to be issued by corporations and governments, with the proceeds exclusively being used for eligible environmental and social projects. The risk level is considered low as government bonds have a low risk compared to corporate bonds.
- Equity investing at listed companies
This is investing via the traditional stock market. It can either be through stock-picking, ETFs or index funds to allocate money on reasonably safe assets. Listed companies on the stock market are medium to large-sized. They are required to provide transparency of their business activities and publicly publish reports quarterly and yearly. Most listed stock market companies put profit and shareholder satisfaction as the primary focus, leaving environmental and social impacts as an afterthought. Due to the fluctuation of listed companies’ performances and economic changes, the risk levels can be low to medium.
- Peer-to-Peer (P2P) Lending or Crowdlending
It is possible to invest in debts or loans via crowdlending platforms that link borrowers directly to private investors. This investment opportunity allows investors to support entrepreneurs, small businesses, and even communities directly or indirectly. However, the risk of losing the principal and interests in case of loan default or platform insolvency makes this a high-risk investment.
- Crowdfunding (equity investing in startups or SMEs)
This is a way to fund green projects or ventures by injecting equity into startups or SMEs. There are crowdfunding platforms that allow investors to invest directly in green and ethical startups. This type of investment carries a high risk of the original capital and returns being easily lost as the early nature of startups and SMEs can be volatile.
Step 3: Create and Manage the Sustainable Investment Portfolio
The ultimate goal a sustainable investor should strive for is a portfolio that maximizes return and impact while minimizing risk.
Once a sustainable investing strategy has been mapped out and a comprehensive risk assessment completed, it is time to start creating a green investment portfolio. A green investment portfolio can be designed in a similar way to that of any standard investment portfolio. For example, the investment time horizon should be considered, along with the diversification of investments and the all-important investor risk tolerance. There is then the additional impact variable that should be considered. As a green investor, the aim is to balance the portfolio around risk, return and impact.
Green investors should be able to measure and account for the influence their investments have on the environment. They should go beyond the traditional risk/return assessment to evaluate how their green investment choices have the best possible impact on fighting climate change. A sustainable investor’s ultimate goal is a portfolio that maximizes return and impact while minimizing risk.
Unfortunately, there is a lack of industry consensus as the frameworks to assess the impact of investments are still maturing. This results in sustainable investors experiencing some difficulties when evaluating the impact of sustainable investments, and subsequently, the impact of an entire investment portfolio.
For example, the ESG framework has around 125 data providers, including well-known global rating agencies such as Thomas Reuters, Bloomberg, FTSE, and Sustainalytics. However, there is no established industry consensus on data sourcing, weighting and scoring of ESG factors. This lack of standardization and transparency in data collection and scoring methodologies present significant challenges for green investors.
ESG disclosure is also currently unregulated and non-mandatory, and when it is revealed, the ESG performance is not audited by a third party. However, on a positive note, the frameworks are constantly being improved by the investment industry. For instance, the European Commission has taken the first step in regulating ESG practices—this includes the Non-Financial Reporting Directive, Sustainability-Related Disclosures Regulation and Taxonomy Regulation.
One of the simplest ways for an investor to start a sustainable portfolio is to replace some of their current investments with green and sustainable alternatives. For example, if they have 40% of their portfolio invested in equities (ETFs and companies’ stocks), they could replace them with sustainable equivalents—ESG ETFs and high-ranked ESG companies.
A similar method can also be applied to bonds. Existing bonds can be replaced with green or sustainable bonds. If an investor has some more risky investments, such as crowdlending and crowdfunding, they can consider sustainable alternatives found on impact platforms.
Regardless of the growing number of sustainable financial options available on the market, diversification may be reduced by cleaning up a portfolio. The investor will no longer be exposed to the whole market resulting in the risk exposure being affected. They will be leaving entire industries out of the portfolio, such as oil, gas, and coal. It is best to ensure that this “reduction in diversification” is aligned with risk appetite and personal values.
Step 4: Be Mindful of Greenwashing
Greenwashing is the act of publishing false or misleading information about how green or sustainable a company’s products or services are.
The recent trend in sustainable investment and the popularity of ‘ESG’ products in the investment market has led to some unethical practices by corporations. They are trying to take advantage of the wave and partake in greenwashing. Greenwashing is publishing false or misleading information about how green or sustainable a company’s products or services are.
Greenwashing is a very complex topic, and it can be hard to spot for those new to green investing. Sustainable investors should be especially vigilant that some investment products may not be as environmentally friendly as they claim, including funds, ETFs, and stocks. The risk is more critical for investment funds, where the fund holdings may not be as sustainable as expected or not completely transparent about where the money is being invested. Investors wanting to make a positive environmental impact with their money should be vigilant and conduct thorough research before investing.
Step 5: Look for Green Opportunities Outside of Investing
The alternatives tend to require less money than traditional investment opportunities, representing a small fraction of a portfolio—resulting in lower impact.
Suppose an investor has already converted their investment portfolio into a fully sustainable one or is in a situation where more time is needed before transitioning to green investments. In that case, there are other less capital-intensive options. The alternatives tend to require less money than traditional investment opportunities, representing a small fraction of a portfolio—resulting in lower impact. Here are some examples of green options outside of investing:
- Offsetting Carbon Footprints
Money can be allocated to carbon offsetting initiatives, which can help compensate for personal carbon emissions. The average person emits around 4.8 tons of CO2 per year. The cost of offsetting a person’s carbon footprint tends not to be more than $100 to $200 per year. It is also feasible to go beyond this and invest or donate more than one person’s carbon footprint share to corporations that offset carbon dioxide emissions.
- Sustainability Activism
People can focus their efforts on dedicating their time or allocating money towards environmental causes that they care about the most. This can include donating to well-known, established global movements like Greenpeace to focus more locally, such as putting pressure on local councils to make communities more sustainable with solar power and recycling projects.
- Impact Philanthropy
Donating money to causes that are cared more about and aligned with the Sustainable Development Goals is also a great way to have an impact on saving the environment. Organizations such as GiveWell perform in-depth research to highlight the most effective charities worldwide to ensure donations are being made to the ones that have the highest impact.
There are now many options in the financial market for sustainable investors to start allocating their capital to corporations, SMEs and governments that positively impact the environment to make a real difference. The vast number of investment options available facilitate the creation of a sufficiently diversified sustainable portfolio, allowing the replication of an investors’ risk profile, time limit and return goals.
The addition of impact as the third dimension to portfolio management does create some complexity. For example, it may require more dedication from investors when reviewing and selecting investment options than traditional investments. However, this extra effort and due diligence necessary for green investments are compensated with the knowledge that the investment has a positive environmental impact.
Frequently Asked Questions (FAQs)
Why is sustainable investing becoming more popular?
One of the key drivers for sustainable investing increasing in popularity is the demand from millennials and impact investors who choose to only invest in companies with intrinsic values that drive positive change. Green investors recognize that sustainable investing does not mean forfeiting financial returns.
Is it worth investing in renewable energy?
Investing in renewable energy stocks can offer crucial portfolio diversification. For example, oil prices and stocks tend to be volatile, and if oil stocks fall out of favour, renewable energy stocks provide some protection to an investment portfolio. There is also tremendous growth potential in renewables so that it could result in solid returns in investment.
What is a Thematic Portfolio?
Thematic Portfolios refer to long-term investment products that allow investors to invest in what they believe could transform the world. Solar power is an example of a thematic investment as it maximizes exposure to promising long-term trends typically within a preferable risk preference.
Are political risks considered when investing in renewable energy?
As renewable technologies expand worldwide, so do the risks investors face—especially as the focus shifts from advanced economies to emerging markets. Of course, financial returns will remain the key concern for most renewable energy investors. Still, the rapidly evolving regulations and the politicization of renewable projects mean that assessing political risks is becoming a progressively significant step in the investment decision-making process.
What is investing?
Investing is when money is set aside for the future and making it work for you. To invest means owning an asset or item to generate income from the investment or the appreciation of the investment—an increase in the asset’s value over some time. Investments tend to generate profits in two ways:
- If an investment is made in a saleable asset, it may earn income by way of profit
- If an investment is made in a return generating plan, it will earn an income via the accumulation of gains.
Investments are primarily about putting savings into assets or objects that become worth more than their original worth or those that will help produce an income over time.