If you ever needed a reason to consider investing in the energy transition, a new report by the United Nations on the pace of global warming may provide some added motivation.
According to the United Nations’ Intergovernmental Panel on Climate Change (IPCC), global warming is on track to push past the pivotal 1.5°C threshold between 2030 and 2035. That accelerated timeline means that we would have to cut back greenhouse gas emissions (GHG) faster and more aggressively than planned. “This is the decade to make that happen,” wrote Nathan Cooper of the World Economic Forum in response.
Transforming the existing energy system requires a massive investment – an estimated US$120 trillion through the entire clean energy value chain between 2020 and 2050. And while government and business are expected to contribute the bulk of those dollars, investors also have a role to play – while at the same time potentially enhancing returns from this tailwind – in the energy transition.
Whether owning investment funds focused on the transition and/or working with fund managers who can influence executives, demand for transition-linked products are on the rise. Reportedly, the number of mutual funds and exchange-traded funds globally with climate-related mandates topped 1,140 at the end of September 2022, with about 180 climate-themed funds launching in the first nine months of last year.
However, the increase in offerings also brings new challenges. If you want to use your holdings to further the energy transition, you have to sort through all these choices to find vehicles that align with your investment goals and personal values.
Where to start? Matt Soegtrop, Director of Responsible Investing at BMO Private Wealth, has watched this sector’s growth first-hand and offers the following guidelines – questions to ask, pitfalls to avoid – for investing in the energy transition.
1. Get beyond buzzwords
Many fund managers now talk about integrating environmental, social and governance (ESG) factors into their funds. However, “many products with an ESG label on them actually have a lot of overlap with an S&P 500 ETF, a NASDAQ ETF, even a S&P/TSX ETF,” Soegtrop explains. “So, you need to look deeper to see what it means.”
One helpful approach is to seek out responsible investing products that target themes aligned with the major structural shifts that define the energy transition – renewable energy, electrification, energy storage and so on. Products like these will only invest in names that are farther along in the transition to net-zero, says Soegtrop.
2. Weigh diversity versus divestment
Every investor has their own tolerance for holding specific products or companies within a portfolio. But Soegtrop cautions that ESG considerations are rarely binary. “It’s extremely difficult to categorize, say, the electric vehicle sector or fossil fuel sector as solely good or solely bad,” he says.
As a general principle, it may be more impactful to hold high-quality names in a range of sectors to help those industries evolve rather than simply excluding entire areas of the market.
In the same vein, while there are products linked to specific themes, he says that few funds limit themselves to a single segment of the energy transition, given the breadth and depth of the challenge. “Good portfolio managers structure themselves to look at every avenue of the economy to get maximum exposure to the transition,” he notes.
Taking a diversified approach is especially important over the long term. “The opportunities we see in the energy transition three years from now might be different than today,” he says.
3. Think policies, not just products
While the right portfolio mix is essential, investors who want to drive change should also examine a fund’s engagement and active ownership policies.
Leading asset managers will have a written engagement policy that spells out how they work with the management at companies held within their portfolios. Companies will also disclose which metrics they use to track and measure their sustainability goals, be it Sustainable Development Goals, carbon emissions or other impact metrics. Those, in turn, will determine their investment mix and engagement strategies.
Another way to narrow down the pool of funds that are genuinely committed to sustainability is to look for memberships in organizations like the United Nations Principles for Responsible Investment (UNPRI) or the Net Zero Asset Managers Initiative, an international group of asset managers dedicated to supporting the goal of net-zero greenhouse gas emissions by 2050 or sooner.
“It’s going a step further than just looking at the name of a fund or its top 10 holdings,” says Soegtrop. “Know what the asset manager cares about and know how they’re going to be engaging with the portfolio companies, and see if that aligns with your values.”
4. Maximize your influence
While some experienced investors might prefer to fly solo, by managing investments in specific companies directly, Soegtrop says, you’ll have much more impact by pooling your money with others in a larger fund.
“The degree of influence that a fund manager has relative to one retail investor is significant,” he explains. “Their larger ownership stake gets them in front of the C-suite, where they are obviously going to have more clout and expertise in pushing them towards a transition.”
5. Look for the win-win
There may have been a time when responsible investing meant sacrificing financial gains to maximize the return on your values, but that’s not the case today.
“Obviously, returns vary and the space is nuanced, but over the longer term, most of the leading responsible investing strategies have outperformed traditional indices,” says Soegtrop. “There’s a lot of empirical evidence that proves that.”
Investors focused on supporting the energy transition no doubt appreciate the potential win-win of helping the world reach its collective net-zero goals while at the same time growing their portfolios. It’s a message every investor should heed.
“Just look at it from an opportunity perspective,” suggests Soegtrop. “So much investment is required in this space. It’s happening and it’s only going to get louder. If you don’t have exposure to it, you might be missing out.”
BMO Private Wealth provides this publication for informational purposes only and it is not and should not be construed as professional advice to any individual. The information contained in this publication is based on material believed to be reliable at the time of publication, but BMO Private Wealth cannot guarantee the information is accurate or complete. Individuals should contact their BMO representative for professional advice regarding their personal circumstances and/or financial position. The comments included in this publication are not intended to be a definitive analysis of tax applicability or trust and estates law. The comments are general in nature and professional advice regarding an individual’s particular tax position should be obtained in respect of any person’s specific circumstances.
BMO Private Wealth is a brand name for a business group consisting of Bank of Montreal and certain of its affiliates in providing private wealth management products and services. Not all products and services are offered by all legal entities within BMO Private Wealth. Banking services are offered through Bank of Montreal. Investment management, wealth planning, tax planning, and philanthropy planning services are offered through BMO Nesbitt Burns Inc. and BMO Private Investment Counsel Inc. Estate, trust, and custodial services are offered through BMO Trust Company. Insurance services and products are offered through BMO Estate Insurance Advisory Services Inc., a wholly-owned subsidiary of BMO Nesbitt Burns Inc. BMO Private Wealth legal entities do not offer tax advice. BMO Trust Company and BMO Bank of Montreal are Members of CDIC.
® Registered trademark of Bank of Montreal, used under license. All rights are reserved. No part of this publication may be reproduced in any form, or referred to in any other publication, without the express written permission of BMO Private Wealth.
