While climate-related disasters and record temperatures intensify around the world, commitments to decarbonization initiatives from governments and businesses seek to address the most pressing challenges.
But the transition to a net-zero future is no small undertaking. BloombergNEF Energy Outlook estimates it will take a staggering $194 trillion—or nearly $7 trillion a year—to decarbonize the global economy by 2050. This presents a significant multitrillion-dollar investment opportunity and is leading to an increased focus on transition investing.
Net-zero transition investing: A rapidly growing sector
In the simplest terms, transition investing provides financing to support progress toward net zero. This is particularly important in hard-to-abate sectors—like the trucking and steel industries—where it’s difficult to lower emissions without substantial investments in new technology and other improved climate strategies. It is essential to understand that the 2050 net-zero goal is not an endpoint but a midpoint in a century-long effort to stabilize emissions.
It’s a rapidly growing sector: According to BloombergNEF, global investment in low-carbon energy transition totaled $1.1 trillion in 2022 (up 31 percent over the previous year).
The energy sector—the source of approximately three-quarters of greenhouse gas emissions, according to the International Energy Agency—is integral to the global net-zero transition, with demand for traditional sources of energy expected to continue to grow over the next decade, before ebbing slightly by mid-century. The sector will need to continue pursuing decarbonization pathways and meaningfully reduce operational emissions to achieve net-zero targets.
Significant operational changes are also required in other high-emitting industries, such as industrials, manufacturing, mining, automotive and agriculture. Meanwhile, renewable energy sources like solar, wind, hydropower and biofuels need to scale significantly to become a larger portion of the global energy mix.
But businesses require considerable support to realize net-zero ambitions, especially if the move to a more sustainable economy is to be fair, inclusive and help address economic inequalities across society.
It’s widely recognized that governments cannot finance net-zero ambitions alone—some estimates indicate approximately 70 percent of investment will need to come from private finance.
Investors and net-zero transition
Investors—both institutional and retail—are increasingly aware of net-zero transition. The inclusion of environmental, social and governance (ESG) factors in portfolios, often with a focus on emerging energy technology, is now commonplace. As companies continue to innovate and strive for positive impacts, responsible investing opportunities continue to increase.
“I have seen consistent investor interest in responsible investing. Clients want to talk about—and invest in—sustainable technologies and have conversations with their advisors about this growing space,” says Kent McClanahan, vice president of Responsible Investing at RBC Wealth Management–U.S. “As new innovations in the energy transition space arise, we shouldn’t lose sight of engaging with all sectors. When we as investors work with companies across many industries and geographies, that is when we can help make an impact, leading us closer to our end goal of lower emissions.”
On the surface, transition investing seems like a natural fit for investors looking to drive impact in the economy. However, some may balk at investing in businesses that are currently high emitters, amid fears they are not transitioning quickly enough or stretching beyond their business as usual. “Greenwashing”—misleading or inaccurate statements about the sustainable performance of a firm or an investment—is also a common concern.
Transition investing focuses on the financial impacts on a client’s portfolio in response to a shift toward a low-carbon economy. Providing capital to high-emitting companies so they can decarbonize and transition toward net-zero targets is vital in reducing emissions in absolute terms. “The point is not to place blame or point fingers; rather, to understand what data is actually showing versus what we think it’s showing,” says Kyle Bergacker, a senior portfolio advisor for Responsible Investments at RBC Wealth Management–U.S.
How to invest in the transition to net zero
Interest in investing in the energy-transition and decarbonization efforts is reflected in the broad range of financial products available to investors. Your financial advisor can help identify investments that are suitable for your specific situation.
Transition investing can also help diversify an investment portfolio, not only in terms of asset allocation but in terms of widening the investable sectors and industries. This is particularly true for investors who want to consider ESG factors but have previously invested only in companies dubbed “green” or are low emitters. However, it’s essential these investments fit with your appetite for risk.
It’s also useful to take the time to understand how different funds perform—from a sustainability perspective—through their ESG ratings. Doing so can help verify that you’re comfortable with the companies the funds invest in, and that their transition goals align with your values. It’s worth noting that ESG ratings are imperfect and are regularly being refined. As a result, they should represent one of the factors in decision-making, rather than the factor.
It’s important to not only focus on the new innovative clean-energy businesses in the energy-transition space, as these business models are typically inflexible and unadaptable. “The key is to identify businesses with extremely flexible business models that can quickly evolve from their current high-carbon-emitting operations,” says Bergacker.
Net zero is more than an endgame
Commitments to decarbonization and net zero are now becoming a corporate norm. According to Oxford’s Net Zero Stocktake 2023 report, 65 percent of the annual revenue of the world’s 2,000 largest companies is now covered by a net-zero target. Of course, there are companies with aggressive decarbonization targets that are doing more than their peers, but it is the implementation at an operational level against which everyone is going to be judging them.
“Fossil fuel divestment seems to punish high carbon emitters through a hoped increase in their cost of capital, making it more difficult to operate,” says Bergacker. “However, it does not actually solve the long-term issue that investors are trying to address by investing in a climate-based portfolio—that is, lowering global emissions in absolute terms.”
Investors will also be questioning what returns might be realized. RBC Capital Markets analysis suggests that from December 2011 to April 2023, companies in emissions-intensive sectors (energy, industrials and utilities) that have reduced their emissions intensity the most have outperformed peers that reduced emissions the least.
As with any investment, performance must be reviewed as part of your overall, ongoing portfolio planning.
The transition to net zero will affect us all
The relevance of transition investing is an all-encompassing and ongoing effort, says McClanahan. “It’s not just an energy transition, but an economic transition—the implications of moving to net zero are broad across all sectors and in our everyday lives.”
McClanahan notes that as high emitters are fundamental to a functioning society, we can’t just turn them off; the logical way forward that will make a big impact is for them to reduce their emissions.
And investors can help.
“Forward-looking companies aim to identify these risks and opportunities and introduce new products and services to reduce their own emissions as well as those of their customers. Investors who utilize an ESG-integrated strategy can invest in these companies long term and participate in the transition,” says McClanahan.