A5. Green Investing

Investments in assets such as zero-carbon electricity generation (whether from solar, wind, nuclear, or elsewhere) drives change – without it, the assets they finance wouldn’t exist, nor would the zero-carbon electricity they produce. Trends on this front are promising: investment into renewable generation capacity has increased steadily since the mid-2000s, as shown in the chart below:

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Figure 27: Global Quarterly Renewable Investment, in Billions USD [i]

ESG (Environmental, Social, and Governance) investing refers to individuals and institutions evaluating investments (usually companies) with a “double bottom line”, i.e. evaluating not just financial factors. For example, investors may choose to only invest in companies on track to reach net-zero emissions status by a certain year, or those that are involved in certain industries (e.g. renewables), while choosing to avoid certain companies (e.g. firms in fossil-fuel industries, or firms without clear net-zero targets). Although narrowing the universe of investable securities should theoretically limit returns [1], ESG funds have tended to outperform the S&P 500 [ii]. There’s been considerable growth in the area: in the US, “sustainable funds attracted $51.2 billion in 2020, more than double the previous calendar-year record of $21.4 billion set in 2019” [iii].

However, ESG investing isn’t a panacea for driving the climate transition forward. For one, the criteria used by ESG funds and investors are often murky – because of the combination of factors involved, such criteria may not necessarily be effective at driving down the greenhouse-gas intensity of a portfolio (i.e. the carbon emissions per unit of revenue). As of March 2021, the largest American ESG fund had no direct holdings in renewable energy companies [iv]. Another fund with over $14 billion in assets had its greenhouse-gas intensity decrease by about 25% over 2020, although dropping the worst 55 emitters from the S&P 500 would have resulted in reducing greenhouse-gas intensity by 36% [v]. In other words, if the desire is for an investor merely to reduce the greenhouse-gas intensity of his or her portfolio, an ESG fund may not be the best method – individual investors are still required to do the legwork to understand which metrics investment managers are using to evaluate ESG standings.

Even then, there’s considerable skepticism as to whether ESG investing actually drives positive change in the real world, as such metrics may not be meaningful: for example, dropping higher-carbon-intensity firms and substituting them for lower-emitting ones is an effective way of reducing a portfolio’s greenhouse-gas intensity, yet it doesn’t truly change the ultimate outcome of carbon emitted, nor is it likely to create financial pressure on the company to change. Divestment of certain companies (i.e. selling or not buying shares in certain companies) may create downward pressure on the companies’ share prices, but unless the company is actively trying to raise capital, the company’s operations and bottom line are unaffected. Furthermore, such downward pressure is unlikely to be sustained – because the underlying company assets and operations are unchanged, the “underlying value” of the firm is unchanged. To that extent, lower stock prices are merely temporary opportunities to be exploited by investors not driven by ESG criteria [vi]. Actively choosing to invest in firms that are deemed sufficiently environmentally beneficial, likewise, only benefits the company if it decides to raise new capital at the marginally-higher valuation. Again, investors not driven by ESG criteria are likely to view the higher stock price as an opportunity for profit – after all, if the company isn’t any more or less intrinsically valuable, then selling the stock is essentially just a profit opportunity. Furthermore, identifying companies that are working toward reducing their carbon footprint can also be deceptive at a firm level: for example, companies can reduce their carbon footprint by divesting certain business segments or operations that are more carbon intensive. Again, the raw amount of emissions created doesn’t change, but the entity responsible does [vii].

ESG investing may not be useful at driving emissions outcomes in its current form, though at very large scales it could drive change – assuming only a few investors didn’t abide by ESG criteria, companies would functionally be required to adapt to ESG criteria to access markets. Furthermore, such investing can legitimately drive change if it provides funding for startups and firms working toward climate-beneficial goals that wouldn’t otherwise exist (though most ESG investment available to the general public is aimed at larger, public companies that usually don’t face a need to raise capital). Finally, such investing methods could help relieve the idea of personal responsibility from profiting off of polluting firms.

[1] The basic idea here is that the good investments should always be chosen by a money manager, and if you’re limiting your investment options, it should only be possible to limit returns. If the companies that you would have invested in are now barred due to ESG criteria, then you’re forced to choose worse investments (in terms of a risk/reward tradeoff). If the investments made by ESG criteria tend to “better”, then those investments should have been made anyways.