Climate positive Investing

“Climate positive” investments go beyond “low carbon” and “net zero” targets to the point that every dollar invested is linked to net greenhouse gas (GHG) emissions reductions and corresponding net positive climate benefits. While low carbon and net zero goals aim to reduce or eliminate embodied pollution linked to investments, net climate positive strategies go several steps further to align portfolios with what the best available science says is needed to solve climate now, rather than waiting for far off 2050 targets.

While climate positive portfolio targets may sound ambitious, our Etho Capital team has found that many diversified equity strategies can already be adjusted for net climate positive alignment. Shifting to diversified climate positive strategies may also bring performance enhancements, particularly when coupled with a diversified index approach that also includes screening for other ESG risk factors. We have found that following the 4 step approach to climate positive investing can produce compelling results.

It’s said “you can’t manage what you don’t measure”; this holds especially true for investment strategies that aim to benefit our climate, and it’s essential to get the measurement right. Many climate-themed investment funds still only look at climate pollution linked to a company’s direct operations and electricity use (“Scope 1” and “Scope 2” GHG emissions, in climate geek speak), while ignoring more difficult to calculate GHG pollution linked to each company’s supply chain (“upstream Scope 3) and the climate impacts connected to the products and services each company puts out into the world (“downstream Scope 3”). 

However, while using only more readily available Scope 1 and Scope 2 data for “low carbon” strategies can be expedient, this approach misses most of the climate story and can generate misleading results. Upstream and/or downstream Scope 3 impacts dominate the embodied emissions for most types of companies, particularly those selling physical products. Supply chain pollution (upstream Scope 3) is the bulk of emissions for tech companies like Apple, for example, while the majority of a fossil fuel company’s climate impacts happen when the oil, coal, or natural gas they sell is burned for energy (downstream Scope 3). 

For the reasons above, authentic climate positive investing must start with a full accounting of Scope 1, Scope 2, and Scope 3 climate impacts for all portfolio holdings, and ideally this analysis goes much further to include the most relevant climate calculations for a broad investable universe. Etho Capital’s team starts with Scope 1-3 GHG footprinting for over 10,000 of the most commonly traded global equities, and we have found that Scope 3 climate impacts account for over 85% of the climate footprint for many equities.

Including downstream Scope 3 calculations is also essential for climate positive investing, since these calculations are necessary for companies with products or services that result in climate benefits, like renewable energy, electric vehicles, and sustainable food and land management. Much of our team’s recent research focus has been on adding the most relevant downstream Scope 3 calculations. These calculations reveal an even larger (and more complete) climate footprint for fossil fuel companies, and identify net climate positive companies, where the climate benefits from their emission-reducing products outweigh all climate pollution connected to product production. This more complete Scope 3 accounting can yield dramatic differences, as illustrated by this comparison of fossil giant ExxonMobil and the wind giant Vestas.

Once the most important Scope 1-3 climate impacts are properly accounted, the next step is to select and weight equities. One version of climate positive investing has already been around a while: cleantech funds. However, while 100% cleantech strategies may result in relatively high embodied emissions reductions, this thematic approach lacks diversification and historically has resulted in too much volatility to be used as a substitution for most core equity allocations.

Diversification is key for climate positive strategies to scale beyond niche applications, and our research has found that net climate positive portfolios can maintain sufficient diversification to replace both conventional active funds and passive core index benchmark allocations. Our Etho Global Climate Positive Index (described more below) employs a methodology that mixes net climate positive companies with the most “climate efficient” companies in a wide range of industries, resulting in a net climate positive index that maintains sector and industry diversification comparable to most global index benchmarks. Given our previous research revealing strong links between climate efficiency and financial outperformance, we think this approach lays the foundation for an especially strong and green investable universe which can be the basis for a range of active and passive strategies. As long as the underlying Scope 1-3 GHG account is sound, there are a range of other equity blending methodologies that can maintain diversification and net climate benefits. 

While climate positive investing starts with climate metrics, true climate solutions and climate justice connect to a wide range of ESG issues, and our research has found that adding overall ESG risk screening to identify and remove ESG bad actors can further enhance diversified climate strategy performance. All of Etho Capital’s climate strategies are also screened for ESG bad actors, using a combination of our unique internal analysis and external experts to filter out companies with fundamentally unsustainable and unhealthy business models (like fossil fuels, weapons, and tobacco), while also removing companies with recent bad actor flags connected to a wide range of ESG issues, including safety violations, workplace diversity and inclusion, toxics, plastic pollution, and animal cruelty. While ESG screening necessitates qualitative analysis, we find that most climate-concerned investors agree that thoughtful ESG screens can enhance both credibility and performance for climate strategies. 

Etho Capital was founded on our discovery that deeper climate analysis can identify better run, more efficient companies that often outperform their competitors, a thesis that has been validated by over 6 years of performance for our Etho Climate Leadership US Index. 

Our initial research indicates that thoughtful climate positive portfolio construction can further enhance both climate and financial performance. We have created the ETHO MarketVector Global Climate Positive Index, which follows the steps above to select a broadly diversified index of nearly 300 global equities, including a mix of both climate positive companies and climate efficiency leaders in a wide range of industries. This global index creates the climate positive universe for the Climate Action SMA portfolio, which Etho runs in collaboration with active management from Newday Impact, layering additional financial and ESG performance criteria onto equity selection and weighting while always maintaining portfolio-wide net climate positive benefits.

Our results have been clear: climate positive investing is already able to replace both broadly diversified index investing and more targeted active investing strategies. Asset owners and investment managers can already go climate positive today for virtually all asset classes, it just requires complete climate impact accounting and thoughtful portfolio construction. Given the severity of our climate crisis and the availability of solutions, investors and the world can’t afford to wait until Net Zero by 2050 targets.