"Green" refers to a product or activity that has a positive environmental impact.
According to the European Parliament Commission, to qualify as green, an investment would need to contribute to at least one of six objectives:
1) climate change mitigation
2) climate change adaptation
3) health ecosystem
4) circular economy
5) pollution prevention
6) sustainable use of water and marine resources.
As green includes climate mitigation and adaptation, sometimes the word “climate” is used, but the more general and universal term remains “green.”
Clear definitions and taxonomy are essential, also to avoid greenwashing, and several classification schemes exist that are quite similar. A universal standard has not been reached. However, no taxonomy will suit everyone; for example, nuclear power may be seen as appropriate for low carbon climate mitigation, but others may view it as inappropriate due to radioactive waste.
Typical green applications include the great variety of energy efficiency products and services (smart energy meters, efficient automobiles, high-efficiency home appliances, and energy savings in industry and transport); renewable energy systems (photovoltaic plants, wind turbines, biofuels, and electric transport); climate adaptation measures (building flood defenses and developing drought-tolerant crops); improvement of ecosystems (lakes, rivers, seas, forests); and pollution control and prevention. Application of the principles of circular economy involves the reuse of materials, ease of repair, recycling of products and parts, in addition to moderation in consumption.
Green activities may refer to two kinds of organizational endeavors: projects and companies.
Projects are limited in scope and time. They can vary from a municipality or company that is building specific green facilities, or a bank, financing climate mitigation measures in a developing country. Since projects have these constraints of time and scope, they are suitable to be funded as bonds with a fixed maturity and a well-defined rate of interest. For example, Apple Corporation issued in 2017 a green bond to raise $1.0 billion for its internal renewable energy and energy efficiency investments, paying 3.0%, with expiration in 2027 and an AA+ rating by S&P. In the year 2001, the City of San Francisco launched one of the first municipal green bonds for similar kinds of investments in homes, offices, and government buildings. The World Bank, International Bank for Reconstruction and Development (IBRB), and the European Investment Bank (EIB) have issued numerous green bonds typically aimed at projects in developing nations and Europe.
The best source of information concerning the description of project investments is found in the bond prospectus. The green bonds are rated for credit risk as other bonds, by the major rating agencies. The purpose is to develop environmental bonds that can be compared and compete with other traditional ones. This allows endowments, pension funds, public funds, and ETFs to increase their quota of green investments. Green bonds are exchanged in secondary markets allowing trading before maturation. The largest issuer by volume is the EIB, and in 2007, the Luxemburg Stock Exchange listed the first European green bond. According to Barron’s new issuance of green bonds could reach $250 billion this year, increasing 20 percent over last year. In the last several years, the composition of the green bond issuance has undergone strong diversification in terms of types of issuers and risk ratings, growing similar to the general bond market and making it easier to increase green bond allocation.
Therefore the green bond investor has the opportunity of making a specific environmental improvement with credit ratings related to the issuer's overall creditworthiness, not the economic returns of the bond project.
Investing in corporations is more complex, and businesses can be divided into two categories: one where the company is providing green products or services, and the second, more numerous group, where a company’s products or services are not aimed at improving the environment. Nonetheless, this second company may use environmentally friendly methods in its supply, production, and distribution processes. For example, to a certain extent, a producer of consumer goods may utilize recycled inputs, energy-efficient production, renewable energy resources, pollution control, and design products for little waste, easy repair, and recycling.
The idea of environmentally and socially correct business behavior anticipated the current acute phase of the climate crisis. In 1997 John Elkington (1997), co-founder of the business consultancy SustainAbility, identified a newly emerging cluster of non-financial considerations involving the environment, social aspects, and corporate governance, which should be included in the factors determining a company or equity's value. "Environmental criteria consider how a company performs as a steward of nature. Social criteria examine how it manages relationships with employees, suppliers, customers, and the communities where it operates. Governance deals with a company's leadership, executive pay, audits internal controls, and shareholder rights.” “The environmental, social, and governance (ESG) criteria became a set of standards for a company's operations that socially conscious investors use to screen potential investments." Chen (2019).
Companies declare their own ESG data, which are not always subject to external verification. As a result, there is some subjectivity in the results, also with different firms performing ESG ratings. Recently Larry Fink, CEO of the world’s largest asset management firm, wrote in a letter to his clients that BlackRock will now assess environmental, social and governance “with the same rigor that it analyzes traditional measures such as credit and liquidity risk” Henderson (2020). Given the significant research capabilities of BlackRock, this will undoubtedly help address the issue of increasing the reliability of ESG.
Researchers have found that stocks with poor ECG scores tend to have higher total and specific risk and higher betas, as reported by Dunn et al. (2018). “Given their increased severity and frequency, environmental crises are more likely to cause sudden changes in regulations, technology, and consumer tastes. These rapid changes can cause large swings in asset prices, leaving investors with limited ability to react. By incorporating ESG criteria into their investment strategy, portfolio managers can proactively select firms that are well prepared to deal with these changes and protect themselves from downside risk," conclude Jagannathan et al. (2018).
“In recent years, as younger investors, in particular, have shown an interest in putting their money where their values are, brokerage firms and mutual fund companies have begun to offer exchange-traded funds (ETFs) and other financial products that follow ESG criteria. According to the most recent report from US SIF Foundation, investors held $11.6 trillion in assets chosen according to ESG criteria at the beginning of 2018, up from $8.1 trillion just two years earlier," as reported by Chen (2019). The environmental improvements of high ESG companies are much less tangible than that of green bonds or companies producing green products, but the investment base is vast.
A more selective approach to sustainable investing has been the development of the Certified B Corporation. They are a new kind of business that balances purpose and profit. They are legally required to consider the impact of their decisions on their workers, customer, suppliers, community, and the environment, as reported by the B Corporation organization (2020). There are some 200 criteria, and an aspirant company must be certified to meet a minimum. Currently, more than 3,100 B Corps are operating in 150 industries in 71 countries around the world, including such companies as Ben & Jerry’s, Danone North American Operations, Eileen Fisher, and Patagonia. The companies are proud and explicit about their progress as Certified B Corporations, and the B Impact reports make impressive reading.
Finally, in the case of producers of green products and services (such as energy efficiency equipment, solar panels, wind turbines, and providers of solar-powered electricity generation), different issues emerge. Here the definition of the nature of green, as described for bonds, also applies; however, companies are more complex than projects. The amount of green products and services relative to the company's overall product mix helps one decide if the investment is appropriate. For example, Toyota sold traditional models while introducing the revolutionary hybrid electric car. The company NewEra Energy, the largest US producer of solar and wind power, maintains a base of gas and nuclear plants.
It is up to the individual investor to decide what amount of green activity is sufficient to warrant his attention and to analyze the role of the environmentally friendly products in the strategy of the given company. Other companies have more concentrated product strategies such as Tesla for electric vehicles, First Solar for photovoltaic modules, and Waste Management for environmental services. In any case, they are to be treated with the full complexity of equity analysis.
Of course, green is not synonymous with profitability. The primary source of information about these corporations comes by way of company statements and evaluations by brokers and independent research firms. Some provide sector outlooks that help compare green companies.
In conclusion, if an investor is more interested in achieving a measurable positive impact on the environment, then the appropriate investments are green bonds or shares in companies producing low carbon products/services. B-Corporations offer the possibility of investing in the more general realm of sustainability and are externally certified. High ETF stocks and funds have a more generic impact but cover a broad asset base.
With increasing forest fires, storms, floods, and record hot years due to climate change, measures for tackling the crisis, such as the European Green Deal, are growing. Investments in green products and services are multiplying and financial markets are evolving to allow ample private participation for the small and large investor. Public finance alone is not sufficient, nor desirable. You may become a green investor.
Bibliography
B Corporation, 2020, from their web site.
Chen, J., 2019, “Environmental, Social, and Governance (ESG) Criteria”, Investopedia, May 10, 2019.
Dunn, J., Fitzgibbons S., and Pomorski, L., 2018, “Assessing Risk through Environmental, Social and Governance Exposure”, Journal of Investment Management, Vol. 16, No. 1, 4-17.
Elkington, J., 1997, Cannibals with Forks: The Triple Bottom Line of 21st Century Business, Capstone/John Wiley.
Jagannathan, R., Ravikumar, A., and Sammon, M., “Environmental, Social and Governance Criteria: Why Investors Should Care”, Journal of Investment Management, Vol. 16, No. 1, 18-31.
Henderson, R., Nauman, B., and Edgecliffe-Johnson, A., 2020, “BlackRock shakes up business to focus on sustainable investing", The Financial Times Limited, 14 January.