Despite backlash, sustainable investment opportunities soar

Tuning out the anti-ESG rhetoric, institutional investors globally are charging ahead with opportunities to finance a sustainable future.

The number of sustainability-focused projects around the globe has grown rapidly in recent years, from hydropower plants in Brazil to electric bike infrastructure in India and power transmission lines in the American West, plus scores of other approaches.

The need for sustainable-minded investments is growing, notes the United Nations' 2023 Financing for Sustainable Development report.

This is especially true when it comes to addressing climate change. Meeting the Paris Agreement goal of limiting the global temperature increase to 1.5 degrees Celsius above pre-industrial levels will take an estimated $126 trillion investment in climate solutions, according to the Institutional Investors Group on Climate Change, a European membership body for investor collaboration with more than 400 pension funds, asset managers and other members representing 26 countries and a collective €60 trillion ($65 trillion) in AUM.

The IIGCC suggests 10 priority technologies to invest in to meet the Paris Agreement goal: solar photovoltaic (or PV), wind, grid-scale electricity storage, new electricity lines, electric vehicle batteries, building retrofits, chargers, hydrogen-based electricity generation, forest restoration and green steel.

And asset owners are ramping up their climate investments to help with the transition to a zero-carbon future. On April 5, two of the five pension funds in the $248.2 billion New York City Retirement Systems set a goal of $36 billion combined in climate change solutions investments by 2035 and an interim goal of $8.2 billion by 2025. All five pension funds have a collective goal of $50 billion invested by 2035.

Even some heavy-emitting industries can be part of the energy transition story, and there is increasing interest in keeping them on the balance sheet to get emissions lower, said David McNeil, head of responsible investment research for Insight Investment in London, with $786.2 billion under management. "We are seeing a lot of interest (from investors engaging) in hard-to-abate sectors — shipping, steel-making, real estate — that have been a perennial challenge," he said. While asset owners might have gone straight to net-zero strategies before, "now I think there's a lot more sensitivity to being part of financing the transition. There is definitely a bit more nuanced view of the transition that's starting to emerge," Mr. McNeil said.

He and others anticipate that COP28 (the United Nations Climate Change Conference beginning Nov. 30 in Dubai) and its expected push for countries to produce climate change transition plans will provide even more investment opportunities.

Investment opportunities in renewable energy are on the rise, with global renewable power capacity expected to grow by 2,400 gigawatts from 2022 to 2027, an amount equal to the entire power capacity of China today, according to a report from the International Energy Agency. Global solar PV capacity is set to almost triple over the 2022 and 2027 period, becoming the largest source of power capacity in the world, while global wind capacity could almost double, with offshore projects accounting for one-fifth of the growth, the IEA said. Together, wind and solar will account for over 90% of the renewable power capacity that is added over the next five years.

Some of the fastest growth in renewables has been in Europe, where the 27-country European Union recently committed to sourcing 42.5% of its energy from renewable sources like wind and solar by 2030.

In the U.K., the first major economy to legislate net zero by 2050, the pressure is on to generate clean and cost-effective power through a variety of approaches embraced by U.K. pension funds and other investors. New investment vehicles like the strategic partnership announced April 5 by Schroders Greencoat LLP, with £8.8 billion ($10.9 billion) under management, and Innova Renewables Ltd. will construct and operate solar energy generation and battery storage projects across the U.K. to add 5GW of renewable energy capacity over the next three to five years.

Beyond Europe, renewable power growth for the next five years will also be driven by China, the United States and India, which are all implementing policies and introducing regulatory and market reforms more quickly than previously planned, according to the International Energy Agency. One of the biggest kick-starts was the climate-focused Inflation Reduction Act signed by President Joe Biden on Aug. 16 that added $370 billion in production subsidies and tax incentives aimed at spurring private investment in cleaner energy sources like wind, solar and electric vehicles, and research into new technologies like hydrogen conversion and carbon capture.

Richard Lum, managing partner and co-CIO of private equity and infrastructure manager Victory Hill Capital Partners LLP in London, whose £457.2 million VH Global Sustainable Energy Opportunities fund targets climate and energy-related infrastructure investments, thinks the rising price of carbon provides further incentive for renewable energy, but cautions that long-duration storage to address some of renewable energy sources' intermittency problems is still not economically attractive. So investors need to prepare for "a post-subsidy world" and consider other approaches, like smaller power generation closer to customer demand, he said.

Solar energy capacity got a big boost in January when Korean solar company Hanwha Qcells announced that it would spend $2.5 billion to build a large U.S. manufacturing complex in Georgia to produce solar panels and critical components. Enticed by the Inflation Reduction Act, Hanwha Qcells also formed an unusual alliance with Microsoft Corp., which committed to run on 100% renewable energy by 2025 and to be carbon negative by 2030. As one of the world's largest purchasers of renewable energy, Microsoft joined forces with Qcells to ensure a strong supply chain for new renewable electricity capacity and to help get more solar energy to the grid faster.

Looking beyond wind and solar, London CIV, a pool for 32 local authority pension funds with £48 billion in collective assets, recently added a pure energy transition strategy to its £854 million LCIV Renewable Infrastructure Fund that will support technologies outside of traditional wind and solar generation, such as energy storage, hydrogen and renewable fuels and clean transportation.

The IEA report also sees global demand for biofuels expanding by 22% over the 2022-2027 period, with the U.S., Canada, Brazil, Indonesia and India making up 80% of the expected global expansion, given the countries' comprehensive policies to support growth.

Investors including the Canada Pension Plan Investment Board, asset manager for the C$536 billion ($396.5 billion) Canada Pension Plan, Toronto, and Bain Private Equity see the promise, too. Their biofuels investments include EcoCeres Inc., a Hong Kong-based biorefinery platform that converts waste-based biomass from palm oil mills and used cooking oil into biofuels, biochemicals and other biomaterials.

"EcoCeres is an early mover in the fast-growing global biofuel market and will play an important role to lead the energy transition with their global decarbonization solution platform," said Frank Su, managing director and head of private equity Asia for CPP Investments.

Investors also are looking at nature-based strategies for addressing climate change and cleaner energy needs, like CPP's $30 million commitment to Chestnut Carbon, a nature-based carbon offset developer focused on U.S. land with tree-planting, reforestation and improved forestry management projects.

A global framework for companies to manage their nature-related risks expected from the Taskforce on Nature-related Financial Disclosures this September could spur new and more ambitious investments addressing biodiversity challenges.

Affordable housing offers another approach to more efficient use of energy, water and waste, said Carl Chang, a co-founder and CEO of Kairos Investment Management Co. in Rancho Santa Margarita, Calif., with a $4.1 billion real estate investment portfolio. Solutions like energy efficiency programs and water reuse have helped bring down operating costs for tenants and "we see less capex because they are taking care of their homes," said Mr. Chang. He has seen increasing interest in affordable housing from larger pension funds and endowments in recent years, helped by strong returns. "There is lots of opportunity in the space and growing need," he said.

Ocean health may grab more investors' attention, according to Rockefeller Asset Management, New York, the asset management arm of Rockefeller Capital Management with $10.4 billion under management.

Its latest sustainability report in February predicted material growth in demand for strategies seeking to improve ocean health and generate returns. It cites an estimated $3 trillion in annual economic value from activities such as fisheries, waste management, shipping, and renewable energy, and predicts that the linkages between risk and return, waste, natural resources and climate ambitions will become more apparent.

Investing in companies addressing water needs is nothing new for KBI Global Investors, with $16.8 billion under management. "The tailwinds seem to get stronger over time for investing in water solutions," said Matthew Sheldon, senior portfolio manager on the firm's water strategy in Boston.

The asset manager and partner clients have invested nearly $3 billion in companies active in the water space, from water treatment facilities and desalination projects to pump manufacturers and consulting engineer firms that are increasingly being asked to help governments address water resiliency.

One partner is Swedish pension fund AP7 in Stockholm with 900 billion Swedish kronor ($86.6 billion) in assets. Along with helping to meet global demand for safe drinking water, AP7 is working with KBIGI to find ways to measure the impact of those investments, said Johan Floren, chief ESG and communication officer for AP7, at a World Water Day event on March 22.

Asset owners "arrive at water from different angles," said Mr. Sheldon. "In the early years it was a unique source of alpha, and in the last couple of years it's interest in sustainability. Water kind of threads the needle" because it satisfies both financial and sustainability goals, and investors in the water space have been happy because of outperformance, he said. KBIGI's water strategy reported annualized excess returns of 2.9% from January 2001 through December 2022, compared to the MSCI ACWI index, he said.

Elena Tedesco, senior portfolio manager on Vontobel Asset Management's sustainable equities boutique impact team in Zurich, Switzerland, with $220 billion under management, agrees that institutional investors like investing in water solutions companies for both performance and impact.

"It's really the two things together. The valuations are reasonable and they have strong growth profiles. It's just the right thing to do from an investment perspective. The companies are better positioned for the long term," Ms. Tedesco said.