Investing to Fight Climate Change

In his new book, How to Avoid a Climate Disaster, Bill Gates shares that he sold his oil and gas investments in 2019 as part of his personal response to combatting climate change. He’d been out of coal stocks already. While he believes that divestment alone won’t solve the climate change crisis, he knows that investing to fight climate change can have an impact by depriving energy companies of capital through lower stock prices and it signals disapproval of certain industries and industry practices. He also doesn’t want to profit if they do well because the world is slow to adopt clean energy alternatives. Many individual investors agree and are interested in investing sustainably to make a climate change difference or statement with their portfolios. This post will explain how through a live example of a strategy that does it well.

Sustainable investing includes a broad list of values (see Understanding Sustainable Investing) organized into three groups: Environmental – Social – Governance. Climate change is a major environmental focus. People concerned about it want to invest in environmentally friendly companies so we have a planet with resources for generations to come. And the investment industry has responded. Your portfolio can screen businesses based on environmental practices, like greenhouse gas emissions, waste, and negative events like toxic spills.

Investing Sustainably

Investing to fight climate change is primarily done via the Integration approach to investing sustainability. You exclude and include companies to get the “bad actors” out of your portfolio and emphasize the “good actors”. For example, an investor who wants a clean energy portfolio can remove the companies focused on fossil fuels and invest in renewable energy companies instead of just avoiding all energy companies.

There are a variety of ways to do this. I recommend pairing the sustainable approach with an investment philosophy you like. Your portfolio’s main goal is to earn enough money to fund your lifestyle, so the investment piece is important. This is why the investing to fight climate change example I’m sharing below is one my investment team believes does a good job with both investment and sustainability.

Investment Example

We are global stock market investors who tilt our portfolios toward smaller and cheaper companies. In the long run, we think those stocks have a chance to outperform the market. Therefore, when building a sustainable strategy to fight climate change, we want a manager who shares that philosophy and then layers on their sustainable approach.

At the portfolio level, they exclude or limit exposure to companies who are large greenhouse gas emitters. In doing so, they also look at a company’s potential for emissions based on their reserves. This is their primary focus and 85% of their scoring system. The other 15% focuses on Land Use and Biodiversity, Toxic Spills and Releases, Operational Waste, and Water Management. Finally, they consider for exclusion companies in certain industries, like coal, palm oil, tobacco, firearms and munitions, and companies that use child labor.

Investing Sustainably implementation
Source: Dimensional Fund Advisors and Heritage Financial

The end result is a portfolio that contains a sharp reduction in emissions and complete reduction of potential emissions.

Source: Dimensional Fund Advisors and Heritage Financial

Investment Performance

I took a deeper dive into performance expectations for sustainable strategies in Does Sustainable Investing Hurt Returns? Here, we can do a more direct comparison. Looking at the regular fund and its sustainable counterpart going back to March 12, 2008 when the sustainable version was launched, we see that they track each other quite closely and the sustainable version performed a bit better.

Sustainable versus regular fund performance

Past performance is no guarantee of future results. This information is for informational purposes only and not intended as investment advice.

Bonus Stewardship

A final bonus when it comes to sustainable strategies, including the one highlighted above, is a focus on investment stewardship. Mutual funds and ETF’s are large shareholders of many companies. They have an opportunity and obligation to drive positive outcomes at companies through shareholder votes, proactive management outreach, and feedback to regulators. Many have started producing annual stewardship reports sharing their stewardship priorities and actions taken. Think of it as more engaged owners focusing on positive changes and holding themselves accountable to their own investors by reporting on their activities.

An investor can research the stewardship priorities of funds before investing in them and track ongoing activity. Here is the 2020 report for the fund family I used as an example above – Dimensional Fund Advisors.