Investors are increasingly recognizing that when you look at many of the macroeconomic trends of today – flooding, hurricanes, gun control, the opioid crisis – you have to look at your portfolio through a different lens. Today, more than one out of every four dollars under professional management in the United States is managed with some approach to impact investing.¹ The universe of sustainable funds is growing rapidly, with a record number of new sustainable funds launched in 2018. Morningstar identified 351 sustainable funds and ETFs available to US investors, which pulled in $5.5B in 2018, the third straight year for record inflows. Meanwhile, the net flows into the US fund universe overall hit a nine year low.

Many of us have heard the buzz about how younger generations are the catalyst for this shift. Over the next 30 years, an estimated $30 trillion of wealth will change hands from the Baby Boomers to Generation X and Millennials.² As this wealth transfer takes place, Millennials are twice as likely to make sustainable investments compared to the average investor, and hold an expectation that there will be investment options that achieve a positive ROI alongside positive impact.³ Moreover, 7 out of 10 Americans think it’s important that their values, the set of principles or ideals that drive and guide their behaviors, opinions and choices, align with their decisions around investing.⁴ In fact, a survey done by Morgan Stanley found that 75% of Millennials think that their investments can directly influence climate change.⁵

Getting to Know the Issue

Climate change is one of the most pressing issues of our time. The Intergovernmental Panel on Climate Change states that net damage costs of climate change will only increase over time, and in October 2018 released a report indicating that severe impacts of climate change could be felt as early as 2040 and cost $69 trillion in damages.⁶ According to NASA, carbon dioxide levels are the highest they’ve been in 650,000 years. As oceans absorb and trap carbon dioxide, they heat up, resulting in ice melt with global sea levels rising about 8 inches in the last century, accelerating every year. The effects of these climate related risks leave our economy vulnerable in several ways. Physical, technological and regulatory implications are increasingly affecting companies and impacting decision making, for example, when considering operations in coastal areas, or in resiliency and infrastructure planning in increasingly drought or flood prone areas.

An Overview of Climate Conscious Approaches

Today, it’s clear that there are investors paying attention to the effects of climate change, and seeking to construct and position their portfolios across a range of climate conscious and fossil fuel aware investment approaches. It’s important to consider the range of approaches that are out there and determine the most appropriate fit. Based on investment goals, constraints, and risk profile, what are you aiming to achieve? Is the goal to eliminate fossil fuels such as oil, gas and coal from the portfolio, or simply reduce exposure to the worst offenders with a low carbon strategy? Is the goal to invest in companies across industries that have prioritized mitigating climate impact, or seek out companies that are actively transitioning to a low carbon economy through clean technology and resource efficiency? Or is it a combination?

The fossil fuel divestment landscape is changing rapidly. According to a report by Arabella Advisors, close to 1,000 institutional investors with $6.24 trillion in assets have committed to divest from fossil fuels, a 120x increase from just four years ago.⁷ Several clean energy mutual funds exist as do mutual funds across asset classes with broad sector holdings that do not include fossil fuels.

But fossil fuel divestment is by no means the only option. Opportunities to align investments with climate solutions, while still limited, are becoming more readily available. These strategies can typically be bucketed into two categories: best in class and thematic. A best in class approach seeks to identify companies that proactively address climate change through products and services offered, efficient operations, and supply chain management, with the position that these companies may be better positioned to succeed in a low carbon economy. Thematic climate strategies explicitly focus on sectors that are directly addressing climate change and mitigating carbon risks, incorporating themes such as lower emissions, renewable energy/clean technology, energy efficiency, water and waste management.  Green bonds also fall into the thematic category, which are bonds that companies, governments and municipalities can issue to raise capital for new or existing projects that have explicit environmental benefits, such as green transportation or sustainable agriculture.

Another thing to consider is proxy voting and engagement. Investors are increasingly scrutinizing asset managers to put their money where their mouth is and not only engage with companies on climate change mitigation but vote in line with climate related shareholder resolutions at energy companies in their portfolios.

When considering the variety of climate conscious or fossil fuel free strategies, it’s important to closely examine the approach to climate change taken and the perspective reflected.

Reporting on a Climate Impact

A key element of constructing a climate conscious portfolio is being able to clearly demonstrate and communicate the investment’s positive impact on the climate meaningfully. Increasingly, investors are demanding better reporting on environmental outcomes.

Envestnet PMC measured the Carbon footprint of the Envestnet PMC Large Cap Impact Quantitative Portfolio, calculating that the strategy has an 11% lower carbon footprint than its benchmark, the Russell 1000 Index. For a $100,000 investment, you save carbon emissions equivalent to:

• 145 gallons of gasoline consumed
• 90 daily commutes by the average driver in the US
• 1,410 pounds of coal left unburned
• Carbon sequestered by 21 trees grown for 10 years, or 1.5 acres of US forest in one year.⁸

The goal is to create an investment portfolio in which financial objectives are met, and climate values are reflected. And it is possible to achieve both.

^FOOTNOTES

^{[1] https://www.ussif.org/files/Trends/Trends%202018%20executive%20summary%20FINAL.pdf}

^{[2] https://www.pwc.com/us/en/industries/financial-services/library/managing-millennial-money.html}

^{[3] Survey conducted by Morgan Stanley released in August 2017 https://www.morganstanley.com/assets/pdfs/sustainable-signals-asset-owners-2018-survey.pdf}

^{[4] https://hub.swellinvesting.com/articles/the-dawn-of-woke-investing}

^{[5] Survey conducted by Morgan Stanley released in August 2017 https://www.morganstanley.com/assets/pdfs/sustainable-signals-asset-owners-2018-survey.pdf}

^{[6] https://www.ipcc.ch/sr15/}

^{[7] https://www.arabellaadvisors.com/wp-content/uploads/2018/09/Global-Divestment-Report-2018.pdf}

^{[8] https://www.epa.gov/energy/greenhouse-gas-equivalencies-calculator}

^DISCLOSURE

^{The opinions expressed herein reflect our judgment as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities, or investment advice or a recommended course of action in any given situation. Investment decisions should always be made based on the investor’s specific financial needs and objectives, goals, time horizon, and risk tolerance. Information obtained from third party resources are believed to be reliable but not guaranteed. This article may contain ‘forward-looking’ information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this article is at the sole discretion of the reader.}

^{Investments in smaller companies carry greater risk than is customarily associated with larger companies for various reasons such as volatility of earnings and prospects, higher failure rates, and limited markets, product lines or financial resources. Investing overseas involves special risks, including the volatility of currency exchange rates and, in some cases, limited geographic focus, political and economic instability, and relatively illiquid markets. Income (bond) funds are subject to interest rate risk which is the risk that debt securities in a fund’s portfolio will decline in value because of increases in market interest rates.}

^{Neither Envestnet, Envestnet | PMC™ nor its representatives render tax, accounting or legal advice. Any tax statements contained herein are not intended or written to be used, and cannot be used, for the purpose of avoiding U.S. federal, state, or local tax penalties. Taxpayers should always seek advice based on their own particular circumstances from an independent tax advisor. Diversification does not guarantee a profit or guarantee protection against losses.}