A conversation 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 to quantify their carbon impacts.
Genevieve Bennett: Why not just invest in a truly low-carbon portfolio, focused on clean tech for example? Why would you stay in carbon-intensive investments and pay for offsets alongside your portfolio?
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.
Genevieve Bennett: I can hear some readers asking, what about the argument that offsets allow companies to continue “business as usual” and delay decarbonization? Wouldn’t investors be enabling that?
Rupert Edwards: On the contrary, what this mechanism would do is reinforce competitive pressure by investors on companies to make the carbon transition. The closer a company gets to net zero, the less investors will need to pay to offset the carbon intensity of their portfolios.
Genevieve Bennett: So over time, you could see a drawdown in the use of offsets to get a portfolio to net zero. It reminds me of Bill Gates’ point during the Davos Dialogues last week – that offset markets are a way to bootstrap emerging green technologies and bring their costs down.
Rupert Edwards: Absolutely. Another way of looking at this is that revenue from offsets could complement other investments in companies’ decarbonization. The fact is that “hard to abate” sectors like oil and gas, agriculture, or shipping are critical to the transition to a carbon neutral economy. If we avoid these sectors in favor of investing only in low-carbon sectors like renewable energy, we undercut the investments that need to be made by the most responsible companies within those carbon-intensive sectors, that are adjusting their business models to transition to net zero.
Even if only a small percentage of investors decided to supplement their low-carbon and climate transition strategies by using carbon offsets to achieve “net zero”, they would reinforce corporate action in the real economy.
Gates spoke specifically about new technologies, but harnessing offset demand from investors could also unlock the vast potential for mitigation from REDD+ offsets generated by protecting tropical forests.
Genevieve Bennett: You’ve written in the past about the macroeconomic and financial stability rationale for Nature-based Solutions – that carbon credits generated by protecting tropical forests would help “flatten the curve” of the transition to a low carbon economy. How does that come into play here?
Rupert Edwards: Achieving the goals of Paris will be impossible without Nature-based Solutions, especially tropical forest conservation. EDF has done some great analysis showing how REDD+ opens up the opportunity to achieve tight emissions targets consistent with a sub 2°C budget, while keeping the global carbon price at manageable levels. We need a far larger supply of high-quality carbon credits to prevent carbon prices and costs escalating rapidly in the next decade. And, of course, forest countries need a massive increase in funding support.
We need a coordinated demand signal coming from governments and companies to unlock that supply, which is something that Forest Trends is already pursuing together with partners through the Green Gigaton Challenge. This climate finance priority would be given a huge boost from investors seeking to achieve net zero through the use of offsets.