What Kinds of Green Investments Contribute to the Green Economy?

Different types of green investments contribute to the green economy in distinct ways. Each of these functions is critical to making meaningful progress to curb greenhouse gas emissions and combat climate change. Each area offers different investment opportunities.

Initiatives, Innovation, and Investors

From more eco-friendly waste management to recycling and circular economy initiatives, the array is nearly boundless, with innovation compounding the scope of investment opportunities.

Investors play a crucial role. To advance development goals, the National Renewable Energy Laboratory offers private-public partnerships with innovative small businesses and with those that sell supplies required for such work. This, in conjunction with Biden tax credits, makes the space particularly attractive for green-oriented venture capitalists.

Green Technology Investment

Adoption

No amount of green technology innovation will make a difference if the barriers to adoption remain high. It doesn’t matter to many skeptical investors that a dollar spent on solar or wind today delivers four times the energy than traditional fossil fuels. The biggest hurdles are often a t cost and the time required to see a return on investment.

The demand for such technology is growing. Companies producing technological solutions that can be adopted by consumers and businesses drive down prices and cause surges in demand.

This, in turn, can deliver strong returns for savvy investors. Such opportunities are distinctive in that they may be the most accessible investment points for individuals.

Retrofitting Traditional Power Plants

Allocations to companies building new renewable energy power plants are not the only way to invest in renewable power production, though. Traditionally fossil fuel operations can be retrofitted to fit the transition to green technology. As these plants are hooked up to the electrical grid, the transition to profitable renewable energy production is more easily achieved, but capital is required.

Investors have an opportunity to gain exposure to the green economy through more established operations with a potentially lower risk profile.

Mineral Scarcity

One specific area is the procurement of minerals necessary for everything from innovation to the production of technological components. A serious barrier to widespread cost-effective green solutions is mineral scarcity, with high demand for elements such as cobalt and zinc, keeping prices prohibitively high in some areas. Investing in companies dedicated to exploration and mining can expose investors to burgeoning demand in the green economy.

Energy Transmission Infrastructure

As green technology becomes more advanced and available, there’s a bigger question: how do we transmit the energy it produces?

Energy Variables

In order for renewable energy to be a true alternative, the variables that are created by renewable energy should be considered.  The wind is not always blowing in the same place, nor is the sun perpetually shining. The energy produced through renewable technologies, however, has the potential to power the country if dispersed with consideration for these variables.

Such a solution requires an overhaul to the way we approach grid planning, construction, and maintenance. Regional development initiatives will enable reliable power transmission fueled by renewable energy technologies.

Political Considerations

Regulatory and political hurdles need to be cleared for an overhaul of the electrical grid to take place. Recent actions by the Biden administration have demonstrated a political appetite for smoothing that process while a growing number of regional projects are moving forward.

Such projects require significant government and private sector investment, which is an opportunity for institutional investors and private equity firms. It goes a long way toward addressing a significant funding gap. Individual investors, however, may still gain exposure by investing in companies bidding on government contracts or with a track record of successfully managing electrical grid projects.

Secondary Green Exposure

There are a plethora of so-called “pure-play” green investment spaces, defined by the Bloomberg Barclays MSCI Green Bond Index as “a legal entity with greater than 90% of activities (as measured by revenues) within one or more of the eligible environmental categories, except where proceeds are explicitly used to finance another company’s operations.” However, investors may also gain exposure to the green economy’s benefits by allocating to companies and projects that invest in pure-play green investments.

As investor demands push companies toward adopting green technology, investing in those stepping up to the challenge may prove profitable. Though these types of allocations may not be explicitly green, they offer access points that allow for sector exposure diversification within a portfolio.

Green Investment and Vehicle Options

There are a variety of investment instruments and vehicles that can simplify green economy exposure.

Stocks

Targeted stock investments allow an investor to conduct extensive due diligence on companies to ascertain how green a stock is alongside the traditional evaluation of company financials. This approach also provides the flexibility to gain green exposure across multiple sectors. Depending on an investor’s risk profile, it opens the door to stock investments in smaller, newer companies with high upside potential.

The risk in selecting specific green stocks for investment is that the process is labor and time-intensive when executed in a measured, informed fashion. Parsing the technological, regulatory, and market considerations may prove overwhelming, especially in a space that may be viewed as both developed and emerging.

Green Bonds

According to Bloomberg data, the issuance of sustainable bonds reached over $1 trillion in 2023. And green bonds, which reached close to $600 billion in 2023, cannot be ignored. Generally speaking, there are four kinds of green bonds issued:

• Asset-backed bonds are offered to fund specific green projects, such as the construction of privately held power plants or local infrastructure.
• Corporate bonds are put forth by individual companies to be used broadly for green initiatives to demonstrate commitment to green innovation or the importance of the environment to their business model.
• Financial institution bonds are issued by financial actors and organizations (such as the World Bank or International Monetary Fund) intending to create a positive environmental impact, often through “green financing” for other companies and organizations with that aim.
• Sovereign and Municipal bonds are government-backed debt securities used to fund public green projects.

This model is not entirely different from bonds in other sectors, but there are several distinctions. The primary distinguishing factor between green bonds and other bond issuances is the framework in which they operate. Unlike, for example, treasury bonds, green bonds are not as rigorously or consistently regulated. This variability can make investing in green debt an exceptionally complex process.

They can be particularly attractive to impact investors, as performance is frequently reported in qualitative terms in addition to financial results.

Exchange Traded Funds

Exchange Traded Funds (ETFs) collect a basket of securities within a specific framework. Green ETFs seek to give investors exposure to green stocks, though that varies from product to product. Though some ETFs are actively managed, they typically track the performance of a green index, making them passive investments.

ETFs usually serve as a potentially lower-risk alternative to picking stocks, requiring less granular research. They may, however, limit exposure to companies with high growth potential.

There is potential for downside due to ETFs tendency to track indices that pivot on stock inclusions and exclusions.. This is especially true in the green investing space, where broad market volatility can have an outsized impact on the evolving green landscape. Because shares in an ETF may be traded intraday, they give investors the option to pivot on their own.

Mutual Funds

An alternative investment to ETFs, mutual funds promise exposure to the green economy with a relatively low minimum investment. This may be accomplished in a myriad of ways, from stocks to debt instruments. They tend to be a more affordable access point for investors.

The most distinctive facet of green mutual fund investing is the variety of options available to investors. Some funds are more conservative; others have a higher risk. Some are more actively managed, while others have a relatively inflexible allocation strategy due to regulation and their provided disclosures. In some cases, mutual funds have a narrow green mandate, while in others, you’ll find a heavier allocation to secondary green investments.

It is worthwhile to consider how concentrated the mutual fund’s exposure to the green economy is. It’s also important to see whether the fund aligns with your goals and ethics.

In some cases, returns may be the primary factor in your consideration. However, if green investing is a matter of principle, a fund’s commitment to green allocations should be an important element in your decision-making process.

Liquidity is another relevant consideration. Unlike ETFs, mutual fund orders are placed once a day. As mutual fund withdrawals can take as many as seven days to process, they also function as a less liquid allocation within your portfolio.

Hedge Funds

Hedge funds pool investor money for a specific trading strategy. Their goal is to deliver alpha returns above and beyond conventional portfolio construction. As such, they are often framed as a diversification play or hedge against market volatility.

These strategies exist across a broad spectrum, from long-only value investing to long-short, global macro, and more. Some use extensive leverage, while other programs are more conservatively managed. Some execute with systematic trading, others are discretionary programs, and others use a combination of both tactics.

Hedge funds are generally considered to be alternative investments and, as such, are regarded as higher risk. Hedge funds are rendered inaccessable to only accredited investors due to their minimum investment requirements. Therefore, it’s understandable that conversations about green hedge funds are complicated.

Though hedge funds may market themselves as offering exposure to the green economy, the nature of that can vary dramatically. That green marketing may only refer to a portion of the fund’s portfolio, with continued allocations to more conventional energy stocks still in the mix.

Exposure to the green economy with hedge funds may include shorting green stocks, which may not align with your green goals. Therefore, a factor you need to access is a hedge fund’s ESG, SRI, or impact investing philosophies. However, this nuance becomes difficult to objectively evaluate because hedge funds are notoriously opaque about their strategies and holdings. This simply means that access to the green economy via hedge funds cannot be construed as a pure-play green investment.

Venture Capital and Private Equity

Venture capital and private equity firms differ from hedge funds primarily through liquidity. While hedge funds can trade instruments and convert to cash in a short time frame, VCs and PEs are less liquid. Therefore, they require a longer investment commitment.

Venture capital firms may be seen as a subset of the private equity space. Both types of firms invest in companies in exchange for an ownership stake, but there are notable differences between the two.

In the context of green investing, these differences are not immaterial. A wide variety of explicitly green investment opportunities are available to VC firms as green opportunities flourish. PE firms are often looking for more established companies to invest in at a much larger scale That may limit opportunities as the green economy is still in its early stages.

Direct Investment

For those looking to bypass structures, regulations, and fees associated with financial instruments, direct investment may be attractive.

Brownfield Direct Investment

The most commonly understood version is a so-called brownfield direct investment. It involves securing partial or absolute control of assets or operations of an existing company. In contrast, a greenfield direct investment — a type of foreign direct investment or FDI — typically involves allocating funds to expand a company’s reach and market exposure in other countries.

Brownfield direct investments can offer significant support to the domestic green economy. They work with investors, a project manager, and an institution to secure upfront funding and establish an ownership stake. Government initiatives like the recent Inflation Reduction Act support institutions to engage in transactions like this.

Green Direct Investing

The more common form of green direct investing is a greenfield investment made by multinational enterprises (MNEs), also referred to as green foreign direct investments (GFDIs). Green technology direct investment companies such as Siemens, General Electric, and others are already making plays in furtherance of their own green commitments.

These investments are complex and largely unregulated. They are generally only available to ultra-high-net-worth accredited investors. Investors hoping to gain exposure to direct investment elements may consider investing in MNEs already engaged in such endeavors.

Global organizations agree that private financing for green initiatives is key to creating sustainable growth. The appetite for direct investment is certainly there should such an opportunity be feasible and appealing to qualified investors.

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[Editors’ Note: To learn more about this and related topics, you may want to attend the following on-demand webinars (which you can view at your leisure, and each includes a comprehensive customer PowerPoint about the topic):

1. Why Green Investing?
2. Tech Talk: What’s Next in Green?
3. How to Access Potential Investments

This is an updated version of an article originally published on November 28, 2022.]

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