The start of a new decade is a natural opportunity to reflect on progress the industry has made improving the tools and solutions for sustainable investing — particularly for climate impact.
It's easy to forget that just 10 years ago, "climate investing" meant investing in clean tech sectors to most. We know now that incorporating climate change into portfolios is a much more foundational exercise. For asset owners that have multigenerational investment horizons, this can involve the re-engineering of asset allocation, engagement efforts and benchmarks. In just the last few years, we have seen a growing number of asset owners reallocate AUM from traditional passive equity mandates into climate-adjusted benchmarks.
In 2010, climate investment data models were in their infancy, and asset owners weren't ready to embrace sustainable investing in a comprehensive way. FTSE Russell launched one of the first carbon strategy indexes at the time. These were essentially low-carbon indexes that used one data input — carbon intensity — to reallocate weights in the benchmark. While a few large clients used them, the indexes were not widely adopted. Building an index for a future low-carbon economy required new construction techniques as well as new data sets that hadn't been tracked before on a significant scale, if at all. So we went back to the drawing board.
Some important improvements in data have taken place since then. The quality and quantity of carbon emissions data that is reported by companies continues to improve. At the same time, additional measures have entered into investors' consideration of climate risk. Fossil fuel reserves, and the embedded emissions they represent, are now used alongside operational carbon emissions to get a more complete picture of a company's exposure to carbon risk. There was also a growing expectation that the low-carbon transition would produce winners as well as losers. This led to a recognition that more data is needed to understand which companies stand to benefit from providing the clean and green solutions that a lower-carbon economy will require.
After years of development and research we produced a "Green Revenues" data model that provides a taxonomy for low-carbon products and measures the revenue that companies were deriving from these activities. With this data we could start to deflate a number of false impressions about the global green economy. One myth was that it was small. The FTSE Environmental Opportunities index series, which requires companies to have at least 20% of their business derived from environmental markets and technologies, represents 6.4% of the market capitalization of the FTSE Global All Cap index. This is nearly 30% larger than the market capitalization of the oil and gas industry in the same index. Another myth was that the green economy was comprised of mostly clean energy companies. In fact, the renewable energy sector makes up only the third-largest component of the FTSE Environmental Opportunities All-Share index, whereas energy efficiency and waste and pollution control together make up nearly 75% of the market cap of the index, demonstrating the diversity of the green investment opportunities.
A third common myth is that investors sacrifice performance in exchange for environmental benefits. However, the FTSE Environmental Opportunities All-Share index has actually outperformed the FTSE Global All Cap index over the last 10 years.