Different types of green investments contribute to the green economy in distinct ways. Each of these functions is critical to making meaningful progress in the fight to curb greenhouse gas emissions and combat climate change, and each area offers investment opportunities.
From more eco-friendly waste management to recycling and circular economy initiatives, environmental remediation services, supply chain efficiency improvements, sustainable food production method development, and beyond, the array is nearly boundless, with innovation compounding the scope of investment opportunities.
Investors play a crucial role. To advance development goals, the National Renewable Energy Laboratory offers private-public partnerships with innovative small businesses and with those that sell supplies required for such work. This, in conjunction with Biden tax credits, makes the space particularly attractive for green-oriented venture capitalists.
No amount of green technology innovation will make a difference if the barriers to adoption remain high. It doesn’t matter to many skeptical investors that a dollar spent on solar or wind today delivers four times the energy than investment in traditional fossil fuels. The biggest hurdles are often a business’ first cost and the time required to see a return on investment.
The demand for such technology is there and growing. Additional capital influxes to companies producing technological solutions that can be adopted by consumers and businesses empirically drive down prices and causes surges in demand.
This, in turn, can deliver strong returns for savvy investors. Such opportunities are distinctive in that they may be the most easily understood and accessible investment points for individuals.
As technology advances and becomes more accessible, governments have greenlit more major renewable power plant projects across the world. This is, in part, a component of economic recovery plans in the wake of the COVID-19 recession. It is also part of the mandates many countries have adopted in pursuit of a net zero world.
Allocations to companies building new renewable energy power plants are not the only way to invest in renewable power production, though. Traditionally fossil fuel operations can be retrofitted to transition to green technology. As these plants are hooked up to the electrical grid, the transition to profitable renewable energy production is more easily achieved, but capital is required.
Investors have an opportunity to gain exposure to the green economy through more established operations with a potentially lower risk profile.
As green technology becomes more advanced and available, a bigger question comes to the forefront: how do we transmit the energy it produces?
In order for renewable energy to be a truly viable alternative to traditional fossil fuel power, consideration must be given to energy production variability. The wind is not always blowing in the same place, nor is the sun perpetually shining. The amount of energy produced through renewable technologies nationwide, however, has the potential to power the country if dispersed with consideration for these regional ebbs and flows.
Such a solution requires an overhaul to the way we approach energy grid planning, construction, and maintenance. Rather than state-by-state grid investments, regional development initiatives will enable reliable power transmission fueled by renewable energy technologies.
Regulatory and political hurdles need to be cleared for such an overhaul of the electrical grid. Nailing down interstate agreements requiring complex private-public partnerships is an onerous process. Recent actions by the Biden administration have demonstrated a political appetite for smoothing that process while a growing number of regional projects are moving forward.
Such projects require significant government and private sector investment, which is certainly an opportunity for institutional investors and private equity firms and will go a long way towards addressing a pronounced funding gap. Individual investors, however, may still gain exposure by investing in companies bidding on government contracts or with a track record of successfully managing electrical grid projects.
While there are a plethora of so-called “pure-play” green investment spaces, investors may also gain exposure to the green economy’s benefits by allocating to companies and projects which invest in, benefit from, or otherwise support pure-play green investments.
One specific area is the procurement of minerals necessary for everything from innovation to the production of technological components. A serious barrier to widespread cost-effective green solutions is mineral scarcity, with high demand for elements such as cobalt and zinc, keeping prices prohibitively high in some areas. Investing in companies dedicated to exploration and mining can expose investors to burgeoning demand in the green economy.
As investor demands push companies toward adopting green technology, investing in those stepping up to the challenge may prove profitable. Though these types of allocations may not be explicitly green, they offer access points that allow for sector exposure diversification within a portfolio.
There are a variety of investment instruments and vehicles that can simplify green economy exposure.
Targeted stock investments allow an investor to conduct extensive due diligence on companies to ascertain how green a stock is alongside the traditional evaluation of company financials. This approach also provides the flexibility to gain green exposure across multiple sectors. Depending on an investor’s risk profile, it opens the door to stock investments in smaller, newer companies with high upside potential.
The risk in selecting specific green stocks for investment is that the process is labor and time-intensive when executed in a measured, informed fashion. Parsing the technological, regulatory, and market considerations may prove overwhelming, especially in a space that may be viewed as both developed and emerging.
Green bonds, with an overall volume in the first half of 2022 at $417 billion, cannot be ignored. Generally speaking, there are four kinds of green bonds issued:
This schema is not entirely different from bonds in other sectors, but there are several distinctions. The primary distinguishing factor between green bonds and other bond issuances is the framework in which they operate. Unlike, for example, treasury bonds, green bonds are not as rigorously or consistently regulated. This variability can make investing in green debt an exceptionally complex process.
They can be particularly attractive to impact investors, as performance is frequently reported in qualitative terms in addition to financial results.
ETFs, or Exchange Traded Funds collect a basket of securities within a specific framework. Green ETFs seek to give investors exposure to green stocks, though that varies from product to product. Though some ETFs are actively managed, they typically track the performance of a purportedly green index, making them primarily passive investments.
To a certain extent, ETFs serve as a potentially lower-risk alternative to picking stocks, requiring less granular research. They may, however, limit exposure to companies with high growth potential.
Because they tend to track indices that generally pivot on stock inclusions and exclusions at a slower pace than the market moves, there is downside potential in terms of risk exposure. This is especially true in the green investing space, where broad market volatility can have an outsized impact on the evolving green landscape. Because shares in an ETF may be traded intraday, they give investors the option to pivot on their own.
An alternative investment to ETFs, mutual funds promise exposure to the green economy with a relatively low minimum investment. This may be accomplished in a myriad of ways, from stocks to debt instruments. They tend to be the more affordable access point for investors who would otherwise be interested in a hedge fund allocation.
The most distinctive facet of green mutual fund investing is the variety of options available to investors. Some funds are more conservative; others have a higher risk. Some are more actively managed, while others have a relatively inflexible allocation strategy due to regulation and their provided disclosures. In some cases, mutual funds have a narrow green mandate, while in others, you’ll find a heavier allocation to secondary green investments.
It is worthwhile to consider how concentrated the mutual fund’s exposure to the green economy is and whether that aligns with your financial goals and personal ethics. In some cases, returns may be the primary factor in your consideration, but if green investing is a matter of principle or even diversification, a fund’s level of commitment to green allocations should be an important element in your decision-making process.
Liquidity is another relevant consideration. Unlike ETFs, mutual fund orders are placed once a day. As mutual fund withdrawals can take as many as seven days to process, they also function as a less liquid allocation within your portfolio.
Hedge funds pool investor money for a specific trading strategy. Their goal is to deliver alpha — returns above and beyond conventional portfolio construction. As such, they are often framed as a diversification play or hedge against market volatility.
These strategies exist across a broad spectrum, from long-only value investing to long-short, global macro, convertible arbitrage, emerging markets, and more. Some use extensive leverage, while other programs are more conservatively managed. Some execute with systematic trading, others are discretionary programs, and others still will use a combination of both tactics.
Hedge funds are generally considered to be alternative investments and, as such, are regarded as higher risk. This, paired with the complex nature of their operations and substantial minimum investment requirements, renders them inaccessible to all but accredited and institutional investors. It is, therefore, understandable that conversations about green hedge funds are complicated.
Though hedge funds may market themselves as offering exposure to the green economy, the nature of that exposure can vary dramatically. That green marketing may only refer to a portion of the fund’s portfolio, with continued allocations to more conventional energy stocks still in the mix.
In a long-short hedge fund strategy, for instance, exposure to the green economy may include shorting green stocks, which may not align with your green goals. A distinguishing factor in the assessment of purportedly green hedge funds must then be their espousal of ESG, SRI, or impact investing philosophies. However, this nuance becomes difficult to objectively evaluate because hedge funds are notoriously opaque about their strategies and holdings.
This simply means that access to the green economy via hedge funds cannot be construed as a pure-play green investment.
While also considered alternative investments available only to accredited investors, venture capital and private equity firms differ from hedge funds primarily through liquidity. While a hedge fund may be able to trade instruments and convert to cash in a relatively short timeframe, venture capital and private equity firms are less liquid, requiring longer investment commitments.
Venture capital firms may be seen as a subset of the private equity space. Both types of firms invest directly in companies in exchange for an ownership stake, but there are notable differences between the two.
In the context of green investing, these differences are not immaterial. As the green economy evolves, a wide variety of explicitly green investment opportunities are available to venture capital firms. Private equity firms, on the other hand, are often looking for more established companies to invest in at a much larger scale, and this early in the green economy evolution, that may limit opportunities.
For those looking to bypass structures, regulations, and fees associated with financial instruments, direct investment may be attractive.
The most commonly understood version is a so-called brownfield direct investment. It involves securing partial or absolute control of assets, operations, suppliers, and/or the overall brand of an existing company. In contrast, a greenfield direct investment typically involves the provision of funds necessary to expand a company’s capabilities and reach, typically in an effort to establish exposure to markets in other countries.
Brownfield direct investments can offer significant support to the domestic green economy. They often include collaboration between the investor, the green project manager, and a financial institution to secure upfront funding and establish an ownership stake. This is most frequently supported by government initiatives like the recent Inflation Reduction Act, which incentivize financial institutions to engage in transactions.
The more common form of green direct investing, however, is a greenfield investment made by multinational enterprises (MNEs), also referred to as green foreign direct investments (GFDIs). Green technology direct investment companies such as Siemens, General Electric, and others are already making plays in furtherance of their own green commitments.
These investments are complex and largely unregulated. As such, they are generally only available to institutional and ultra-high-net-worth accredited investors. Investors hoping to gain exposure to direct investment-supported elements may consider investing in MNEs already engaged in such endeavors.
There is currently a significant shortfall in available direct investment for green initiatives around the world, but global organizations agree that such private financing for green initiatives is key to creating sustainable growth. The appetite for direct investment is certainly there should such an opportunity be feasible and appealing to qualified investors.
Check out the upcoming Earning Green by Investing Green event on April 27, 2023. A one-day event featuring experts from across the green economy, this symposium on navigating the green economy seeks to provide investors, asset managers, advisors, and other professionals with the information and perspectives they need to make smart, ethical, and lucrative choices in their portfolios. Attend in person or stream the event live, but don’t miss out!
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