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Seeking portfolio alignment in a climate solutions world

Making a new investment is not the same as the much more challenging endeavor of realigning an entire portfolio. Read More

(Updated on July 24, 2024)

GreenBiz photocollage via Shutterstock

Reprinted from GreenFin Weekly, a free weekly newsletter. Subscribe here.

Investors are collectively sitting on one of the biggest piles of cash of all time — nearly $5 trillion in money market funds known as “the wall of cash.” It’s a bizarre phenomenon after a year-long global pandemic that stalled economies around the world and highlighted social divisions — but the cash is still there.

Buoyed by low interest rates, an ongoing market rally, government stimulus and a healthy dose of fear, investors have simultaneously poured tens of billions of dollars a week into stocks, while also keeping holdings in money market funds about $1 trillion higher than they were before the pandemic.

That wall of cash is burning a proverbial hole in the market’s pocket — partially stockpiled for safety and partially waiting to tap into pent-up demand as economies reopen. For sustainability-minded investors, this wall of cash could be pretty exciting, a potentially unprecedented chance to back technologies that can align the future economy toward net-zero emissions.

You can see the beginnings of that today as money flows aggressively into backing a handful of technological solutions that have captivated the market: electric vehicles; microgrids; hydrogen; plant-based food; solar; and wind. A portfolio of those solutions has outperformed the broader market by more than 200 percent over the past few years, according to a new CleanTech tracking index from Energy Impact Partners. It’s an investment thesis that’s working.

But while climate solutions are incredibly exciting, all the new money backing early-stage companies and technologies will make only a dent in our collective chances to reduce global warming. Making a new investment is not the same as the much more challenging endeavor of realigning an entire portfolio.

You could think about it as making an investment in corporate energy efficiency projects in a building versus creating more renewable energy generation through a power purchase agreement. Sure, both projects will reduce a company’s fossil-fuel use and are critical to overhauling the energy system.

But the faster payback for your wallet and the planet comes from the efficiency project, which addresses the root problem. Incidentally, the best payback ultimately comes from pursuing both solutions at once. Simultaneously reducing energy demand and shifting to more renewable supply offers the best outcome for the most people and businesses.

Beyond divestment

In financing, achieving climate alignment — that is, aligning investments with the world’s climate goals — is potentially a much bigger prize. It involves a complete reorganization of priorities that shifts the existing capital stock underpinning modern society. It’s not easy to accomplish because it requires a change in inertia and asks companies and investors to pull levers where they may lack direct control. Traditional ESG approaches such as divesting from fossil fuels, offsetting emissions and building a new electric car can have an incremental impact on this, but what if we asked ourselves how to make that goal more impactful?

So, what does climate alignment look like?

Consider the 401(k). The extremely popular savings tool for workers, representing about $5.6 trillion, is an asset most workers won’t touch for decades — and something many could afford to align with the future they want to see. But the U.S. Department of Labor is only just now laying the groundwork to open more socially responsible and climate-aligned options for those assets. When a young worker invests money, they won’t likely access it until retirement age, so they don’t typically ask what the world will look like in 2040 or 2060. They end up in miscellaneous set-it-and-forget-it funds that are exposed to the broad market but largely would have missed out on that exciting run-up in clean technology stocks, for example.

The same story occurs outside of 401(k)s. Those big pools of capital and existing investment are challenged by backwards inertia — like a cartoon character walking around with an anvil strapped to its leg. Designing investment aligned for the future is something we’re just starting to figure out how to do. It takes a commitment in seeing that the decisions we make today will reverberate for years.

Charting that path forward is a pretty gritty task. The financial sector has already has committed $18 trillion of capital to achieving alignment with a 1.5 degree Celsius-consistent emissions pathway. That means spending years rethinking individual assets and loans in a variety of industries, from aviation and shipping to cement and real estate. But if there’s one thing we’ve learned in this pandemic, it is that change doesn’t always need to be incremental. What would Operation Warp Speed look like for climate alignment? 

If the goal of responsible investing is to reach climate alignment, then we’d likely be spending a lot more time thinking about such things as the incentives for financial investment, the social cost of carbon, the true stakeholders of every decision and what policies or decisions favor the future economy over the past. New cash and new investment are the most flexible tools we currently have, and they will drive the needle forward, but we also must prioritize fixing what is misaligned today.

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