According to the 2018 Responsible Investment Association (RIA) trends report, more than 50% of Canadian assets under management now integrate at least one type of RI strategy. From 2010 to 2017, RI assets grew by more than 400%. They doubled again in 2019. The RIA is currently collecting data for its 2020 update; expect even further gain¬s. The demographic most interested – also millennials. According to an Environics survey published last year by Mackenzie Investments, they are twice as likely to be interested in RI as baby boomers.

Unfortunately, too little of this RI is getting to climate solutions.

The International Energy Agency reports that investment in the global renewable power sector has experienced small declines each year since 2017. Due to COVID-19, power sector investment is likely to fall by another 20% and efficiency investments over 10% this year. So how does one explain exponential growth in RI yet declining growth in climate solutions investment? Traditional investment products are increasingly being tattooed with labels like “sustainable,” “ESG” and “low carbon.” In our opinion, it’s creating as much confusion as the three-winged eagle inked onto the shoulder of (insert actor’s name here). It’s diverting “willing” capital away from the climate solutions we so desperately need.

Greenchip and other organizations have estimated that global investment of around $2.5 trillion is needed each year through 2040 to limit warming to 2 degrees Celsius above pre-industrial levels. Energy transition investments in 2019 were about $940 billion – we have an annual investment gap of at least $1.5 trillion. And each year that we fall short, the gap just gets bigger. It means that a very uncertain future becomes even more certain.

The problem starts with the taxonomy of “ESG.” The term is often used to capture the entire spectrum of responsible investments, but this is misleading. ESG is instead only one RI strategy of many. ESG is by definition a set of (unstandardized) standards that help score the environmental, social and governance behaviour of individual companies. In practice, ESG integration is a tool that can help identify and manage corporate behavioural risks.

Because of the “E” in ESG, it often leaves investors believing ESG strategies will be overweight in companies selling environmental solutions. This couldn’t be further from the truth.

A quick look at the top holdings of most so-called ESG funds will identify well-known banks, pharma companies and consumer technology stocks – businesses that have little to do with climate change, most of which are already spinning cash and don’t need capital investment. Recently, Greenchip studied the full holdings of the largest global ESG funds. We found that only 5 to 15% of their revenues might be attributed to climate solutions sales, but the higher end of this range is probably a stretch.

Most concerning is that ESG strategies are getting the vast majority of RI investment. According to the Global Sustainable Investment Alliance, almost $18 trillion had been allocated globally to ESG strategies by 2018 versus only $1 trillion to thematic “solutions” investments – 18 to 1! The biennial survey will be updated later this year, and the chasm will surely have widened even further.

Another label we find problematic is “low carbon.” These strategies rarely capture the emissions buried in supply chains (known as Scope 2), or worse, downstream emissions (known as Scope 3). It means the emissions from an oil producer might be captured for their extraction and refining, but carbon accounting generally fails to account for the emissions when their refined fuel is combusted.

A recent Economist essay offered an excellent example of how low-carbon accounting can steer investors in the wrong direction with this: “Apple has only a tiny fraction of Samsung’s operational emissions; but Samsung makes things, while Apple has others do that for it.” Accounting myopic focus on operating (Scope 1) emissions can distort investment decisions.

For Greenchip, the main problem with low-carbon strategies is that they also divert capital away from the very solutions they hope to address.

Envision building a large wind farm with all those blades and towers, transmission lines or a new subway system. Manufacturing this equipment and erecting this infrastructure is a pretty carbon-intensive exercise. We often say, “You need to get a little dirty today to build the cleaner economy of the future.” Low-carbon investing (and often the E in ESG) focuses only on the initial pollution that building this infrastructure creates and not on long-term emissions reductions. In our experience, when an investment committee says they want to see a carbon audit of our portfolio, we probably are going to lose that mandate.

We think there is a more effective way to measure impact than ESG scores or carbon audits: solutions revenues. Every six months, Greenchip attributes all the revenues in our portfolio holdings to specific environmental solutions. As of June 30, 2020, every dollar invested in our fund produced $1.86 in the past year of environmental solutions sales. So, of the $200 million that we oversee, about $370 million is helping to close that $1.5 trillion gap. Our focus on revenue measurement also enables us to attribute portfolio revenues to five United Nations Sustainable Development Goals (SDGs). Simply reallocating even a small portion of the least effective ESG and low-carbon strategies to those focused on thematic “solutions” would go a long way to closing the climate investment gap.

Greenchip still sees value in ESG integration, measuring carbon, engagement, proxy voting and so on. We use all of these tools. They help us mitigate risk and are part of our diligence process. Around the edges, we know better corporate behaviour matters. That said, too often the investment industry is using these labels to “greenwash” traditional allocations of capital. Otherwise, how can one explain the paradox of exploding RI fund flows with declining rates of environmental solutions investment?

John Cook is the president and CEO of Greenchip Financial Corp.

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I think we should be both optimistic and cautious about last year. I say this because to us it feels a bit like January 2006. That was the year Al Gore released An Inconvenient Truth. Actors drove Priuses to the Golden Globe Awards and gave strange environmentally-focused acceptance speeches, much like this awards season. Australia was still un-scorched but Katrina was fresh in our minds. 2006 was the year magazines launched their first annual green editions, and marketers greenwashed every product they could. My favorite was the entrepreneur pitching a green road salt product in our offices, that was literally road salt…colored green!

When the financial crisis hit in 2008, “green” became an ugly word. The self-righteousness was exposed. The hype was replaced with predictable cynicism. Central banks manufactured low interest rates pulling capital towards yield and consumption, and away from capital investment.

Promoting an environmentally sustainable strategy became almost impossible. By my count, there are still less than ten firms in the world today doing what we do that have survived since the financial crisis – ten. Smart thematic managers like Greenrock in Canada and Greentech in New York decided they couldn’t make a go of it. Even the Canadian Banks – almost all of them – had been incubating at least one environmental theme fund prior to the financial crisis and by 2010 they had shuttered them all for lack of interest.

From a professional standpoint those early years may not have been profitable but they were valuable. They helped us understand the competitive economics and business drivers behind green technologies. Greg Payne and I had the proverbial ring-side seat to clean tech’s earliest years. We witnessed technologies improve in both quality and price: solar, wind, LED lights, heat pumps, variable speed motors, and heat and pressure recapture technologies, all come to mind. Sectors consolidated, leaders emerged and some truly became Greenchips.

There are still overhyped technologies. Others still need incentives like electric vehicles, grid storage, offshore wind and biofuels, but the gap is narrowing and cost curves continue to bend down.

Here’s another reason 2019 might be different: in 2006, we had identified only 250 companies producing environmental solutions and many of these were effectively listed start-ups. Today, we track almost 700 businesses with a combined market capitalization over $7 trillion. In addition to these, we’ve seen more than one hundred companies acquired (of which our investors benefitted from 28) and another hundred declare bankruptcy. My point is that the environmental economy is much more mature than it was in 2006.

There is also better value today. Leading up to the financial crisis, we had trouble finding any companies in our space trading at a discount to our estimated intrinsic value. Today, our portfolio trades at a weighted average discount of 17% to our calculation of intrinsic value. In our opinion, many companies in our sectors have been mispriced by the market. Perhaps as asset managers have become increasingly obsessed with indexes and traditional economy names, value has been left behind for firms focused on emerging cleantech sectors.

There is a chance that Greta Thunberg turns out to be this decade’s Al Gore and that this modest burst in environmental interest turns out again to be fleeting. We’re more optimistic than that, but we also realize the Great Energy Transition will not follow a linear path.

A quick clarification about the ten environmental theme managers (our direct competitors). Asset managers have literally launched thousands of funds integrating environmental, social and governance (ESG) criteria in the past few years. Some of these use words like “environmental”, “sustainable”, and “impact” in their names. These funds are not like ours – they do not invest in environmental solutions. Instead, their top holdings consist primarily of financial service firms, drug companies, and consumer tech “platform” businesses. These holdings may score well based on their ESG behaviour but their products and services do little to solve environmental challenges and many arguably cause harm.

The same could be said for most low-carbon and fossil-free strategies too.  I think these managers and their funds will eventually be exposed for what they are. In the meantime, it is an industry head-fake that distracts capital away from the climate solutions we so desperately need.

John Cook is the president and CEO of Greenchip Financial.

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