Understanding Green Investing: Definition and Impact

view original post

What Is Green Investing?

Green investing refers to investment activities that support businesses with positive environmental impacts. These investments aim to preserve natural resources, reduce pollution, and promote sustainability. Although it’s often linked to socially responsible investing (SRI) or environmental, social, and governance (ESG) strategies, green investing focuses directly on environmental benefits. Understanding how it differs from related approaches and why it matters today can help investors make more informed, environmentally focused decisions.

Understanding Green Investing

Pure play green investments are those that derive all or most of their revenues and profits from green business activities. Green investments also can refer to companies that have other lines of business but focus on green-based initiatives or product lines.

There are many potential avenues for businesses seeking to improve the environment. Some green companies are engaged in renewable energy research or developing eco-friendly alternatives to plastics and other materials. Others may seek to reduce the pollution or other environmental impacts from their production lines.

Because there is no firm definition of the term “green,” what qualifies as a green investment is open to interpretation. Some investors want only pure-play options like renewable fuels and energy-saving technology. Other investors put money behind companies that have good business practices in how they use natural resources and manage waste but also draw their revenue from multiple sources.

Types of Green Investing

There are several ways to invest in green technology initiatives. While once considered risky, some green technologies have been able to return strong profits to their investors.

Investing in Green Equities

Perhaps the simplest form of green investing is to buy stock in companies with strong environmental commitments. Many new startups are seeking to develop alternative energies and materials, and even traditional players are making sizable bets on a low-carbon future. Some companies, such as Tesla (TSLA), have been able to reach multibillion-dollar valuations by targeting environmentally conscious consumers.

Investing in Green Bonds

A second route is to invest in green bonds. Sometimes known as climate bonds, these fixed-income securities represent loans to help banks, companies, and government bodies finance projects with a positive impact on the environment. According to the Climate Bonds Initiative, approximately $1.1 trillion in new green bonds were issued in 2021. These bonds also may come with tax incentives, making them a more attractive investment than traditional bonds.

Investing in Green Funds

Another route is to invest in shares of a mutual fund, ETF, or index fund that provides wider exposure to green companies. These green funds invest in a basket of promising securities, allowing investors to spread their money on a diversified range of environmental projects rather than a single stock or bond.

There are quite a number of green mutual funds, such as the TIAA-CREF Social Choice Equity Fund (TICRX), Trillium ESG Global Equity Fund (PORTX), and the Green Century Balanced Fund (GCBLX), to name a few. Several indexes seek to track environmentally favorable businesses as well. For example, the NASDAQ Clean Edge Green Energy Index and the MAC Global Solar Energy Index both target renewable energy industries. Funds that follow these indexes invest in renewable energy companies, allowing investors to support the new technology while earning a potential profit.

Outcomes of Green Investing

Once considered a niche sector, green investing has swelled after several natural disasters brought attention to the oncoming climate crisis. The amount of new money in ESG funds reached over $70 billion in 2021, almost a third of an increase over the previous year.

Although profit is not the only goal of green investing, there is evidence that environmentally friendly investments can match or beat the profits of more traditional assets. A 2022 study by Morningstar Inc. reported “another year of broken records” between environmentally sustainable funds and the wider market. The study also found that sustainable U.S. large-blend funds “beat their traditional peers in 2021 as well as the trailing three- and five-year periods.”

Key Considerations in Green Investing

Investing in green companies can be riskier than other equity strategies, as many companies in this arena are in the development stage, with low revenues and high earnings valuations. However, if encouraging eco-friendly businesses is important to investors, then green investing can be an attractive way to put their money to work.

The definition of “green” may vary from one investor to another. Some so-called green funds include companies that operate in the natural gas or oil sectors. Although these companies also may be researching renewable energy technology, some investors might hesitate to invest in a fund associated with fossil fuel companies. Prospective investors should research their investments (by checking out a fund’s prospectus or a stock’s annual filings) to see if the company fits their definition of green.

Green Investing vs. Greenwashing

Greenwashing refers to the practice of branding a company or product as environmentally friendly to capitalize on the growing demand for sustainability. While green marketing is often sincere, many companies have overstated the impact of their environmental practices or downplayed the ecological costs of their products.

For example, some companies have overstated their usage of recycled materials, leading consumers to mistakenly believe that their products were more sustainable. Many companies purchase carbon offsets to reduce their footprints, although verifying the true cost of a company’s emissions is difficult. In a more egregious case, IKEA was accused of using illegally sourced timber for some of its furniture products. To make matters worse, the timber had been verified by the Forest Stewardship Council, raising ethical questions about the business model of pay-for-play green labeling.

In the securities world, some managed funds have attempted to greenwash themselves by rebranding in a way that suggests a greater level of sustainability. The only way to evaluate a fund’s sustainability is to examine its assets.