This article first appeared in Forum, The Edge Malaysia Weekly on November 8, 2021 - November 14, 2021

Governments, corporations and society as a whole now widely acknowledge that climate change is the greatest challenge facing the global economy and our way of living. In order to prevent disastrous socioeconomic consequences, we must limit global warming to 1.5°C, or at the least 2°C, above pre-industrial levels, in line with the Paris Agreement. To achieve this, global emissions must fall by 50% by 2030 and 100% by 2050. This leaves us less than 30 years to reverse emissions that have been rising steadily for the past 150 years.

The stakes are very high in Southeast Asia. By 2050, as much as 8% to 13% of the region’s GDP could be at risk due to rising heat and humidity, according to McKinsey.

Solving this challenge will require a radical transformation of the global economy. This will not come without a price: Goldman Sachs estimates that at current costs, fully decarbonising the global economy by 2050 will require an investment of around US$144 trillion (RM598 trillion) in decarbonisation solutions — roughly seven times the size of the US economy today.

With less than 30 years to reach net zero, investors everywhere need to play a vital role in accelerating the adoption of low-carbon technologies. Solutions that can cut out more than 80% of global emissions already exist today, but they need to be fully adopted globally. This can only be achieved by mobilising the funding needed to scale up decarbonisation solutions, which will help reduce development costs and lower the cost of capital for new technologies.

Carbon avoidance is not the answer, and neither is modest carbon reduction. Investing in low-emissions sectors, such as financials and consumer companies that are reducing their carbon footprint, only provides a modest contribution to cutting emissions.

To drive decarbonisation, investors must support the companies and solutions that will deliver the biggest impact. That means working with carbon-intensive companies on their transition, as well as investing in low-carbon technologies that will replace today’s high-emissions infrastructure.

While the transition to a low carbon society will span decades, it will affect every industry and will leave some business models obsolete. Investing in climate solutions could therefore offer protection from the disintermediation risk that the decarbonisation of the global economy will lead to. It could also contribute to lower climate change risk as long as these strategies help accelerate the transition to a zero carbon future.

If decarbonisation technologies in the market today were already fully adopted globally, CO equivalent emissions would be 80% lower. It is clear that the transition to a low carbon world will be a multi-decade megatrend that is in its early stages.

We have identified several investable decarbonisation solutions, which include electric vehicles, renewable power generation, alternative animal protein, recycling, and efficient agriculture and buildings.

As this is a nascent and fast-evolving area, the investment universe continuously expands as new technologies become investable.

We believe investors must look at all companies investing in and facilitating low-carbon technologies, including those within the more carbon-intensive sectors (such as industrials, energy and utilities) where there is the greatest scope for large-scale improvements. Furthermore, as stewards of capital, asset managers have a responsibility to engage and encourage the adoption of carbon reduction strategies and climate-related governance structures.

Tackling the biggest challenge facing the global economy in the next 30 years may also prove to be one of the most rewarding investment opportunities over this time.

So, how can investors take concrete steps to help avert a climate disaster and find compelling opportunities in this multi-decade investment trend today? One option is climate-aware funds, which have proliferated in recent years. These include:

•     Generic ESG (environmental, social and governance) funds — invest in companies with superior ESG characteristics;

•     Low carbon funds — invest in inherently lower carbon emitters relative to a benchmark;

•     Clean energy/tech funds — invest in energy/tech solutions that facilitate clean energy transition;

•     Environmental funds — invest in climate change beneficiaries, including some decarbonisation solutions;

•     Green bond funds — fixed-income funds holding green bonds (bonds issued to finance specific projects or activities with positive environmental outcomes);

•     Climate solutions funds — invest in a broad range of decarbonisation solutions (broader approach than clean energy/tech funds); and

•     Climate transition funds — invest in companies that are actively decarbonising their businesses.

Given the array of investment products available, it is important for investors to consider both the fund’s climate impact and potential for long-term returns. Generic ESG funds can offer diversified portfolios and good overall ESG standards but lack the focus on climate change that some investors seek. Low carbon funds can fill this void by selecting the sectors and companies with the lowest carbon emissions and avoiding those with the highest, but they do not proactively support the drive towards decarbonisation.

Clean energy/tech funds promote decarbonisation by investing in technologies that enable the transition. But their technology concentration exposes investors to potential risks around regulation and adverse technological developments, and their absolute impact on decarbonisation is limited by their narrow focus. Environmental funds attempt to overcome this via a hybrid approach that incorporates climate change beneficiaries and some decarbonisation solutions, but this dilutes the overall decarbonisation allocation. Climate solutions and transition funds offer a diversified way to achieve the highest level of climate impact, with less risk of disintermediation, though they will have higher carbon footprints than low carbon funds.

To find a way through this fund selection puzzle, investors can ask themselves questions such as:

1.     What is the stated objective of the fund or strategy, and does it match my objectives?

2.     What balance does the fund manager strike between climate impact and financial return?

3.     How consistently is climate research integrated into the investment process?

Finding the right fit may be challenging, but answering these questions should help investors navigate the dizzying proliferation of climate-aware funds. And it is important to remember there is no right or wrong answer: some strategies will suit certain investor groups more than others.

As the decarbonisation megatrend gathers speed, and as technologies develop and data quality and availability improve, we expect climate investing will continue to evolve and expand across all asset types and risk profiles.

Velislava Dimitrova is portfolio manager at Fidelity International. This column is part of a series coordinated by Climate Governance Malaysia, the national chapter of the World Economic Forum’s Climate Governance Initiative (CGI). The CGI is an effort to support boards of directors in discharging their duty of care as long-term stewards of the companies they oversee, specifically to ensure that climate risks and opportunities are adequately addressed.

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