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It’s a difficult time to be optimistic about the fight against climate change. This summer the world has seen devastating wildfires in Greece and Hawaii, deadly floods in China and Japan, and record heatwaves around the world. UN Secretary-General António Guterres captured the urgency of the crisis in July when he declared: “The era of global warming has ended; the era of global boiling has arrived.”
While I struggle to think of a similar period when we’ve seen so many natural disasters across the globe, it is important not to let our dismay give way to defeat. For while the need to confront the climate crisis has never been more pressing, similarly, there have never been more or better tools and processes available to deliver changes for the better. In this sense, financial decisions matter greatly, whether in areas like green real estate, or impact investment strategies, or allocating to private markets. There is real immediacy to these decisions. In its sixth assessment report (AR6) released earlier this year, the Intergovernmental Panel on Climate Change (IPCC) was stark in its warnings, noting that modelled pathways to limit global warming to less than 1.5°C by the end of this century all required a deep, rapid, and immediate reduction in greenhouse gas emissions.
But the report was also clear about the opportunities for mitigating the crisis. For example, although it noted that in 2019 around 79 per cent of global emissions came from the energy, industry, transport, and buildings sectors, it also reported that options to limit the impact from these industries are increasingly technically viable, cost-effective, and supported by the public.
“Feasible, effective, and low-cost options for mitigation and adaptation are already available,” the report notes with high confidence.
For me as an investor, one of the most exciting ways to combat climate change is through upgrading the buildings we use. That may not sound too dramatic, but the impact could be huge: the IPCC estimates efficient buildings could reduce net emissions by around 1.5 gigatonnes of CO2-equivalent per year by 2030 - or more than double the current annual emissions of Canada. Globally, there is the potential to cut greenhouse gas emissions from the building end-use sector by as much as two thirds from current levels, meaning that making improvements in buildings could be more effective in relative terms than improvements in areas like switching to fuel efficient cars or electric vehicles, or promoting bicycling and public transport, or cutting food waste, or even reducing methane in agriculture.
Retrofitting our existing real estate assets is one of the most effective ways in which we can reduce the carbon emissions of our built environment. This is particularly important in Europe, where buildings are responsible for 40 per cent of the region’s energy consumption, more than any other sector, and account for 36 per cent of the EU’s energy-related greenhouse gas emissions. Taking something that’s inefficient and upgrading it not only improves the emissions of the asset itself, but also cuts the amount of energy needed to run it, freeing up renewable resources to drive change across other industries. This means that not only can you create a faster route to net zero carbon emissions for the assets in question, but you can also leverage the improvements across other investments or sectors.
Regulation is now in place across many markets to support the upgrade of our real estate sector. In Europe we’re also seeing those that rent and occupy our buildings, particularly corporates, making net zero carbon pledges for the next decade or so, and that’s driving a commercial demand for more efficient buildings. But what’s lacking is equity capital.
As vocal as the investment community has been about the importance of ESG and sustainability, actual investment flows have still not been enough. Tucked away in the footnotes of the IPCC’s report is this damming statement, made with ‘high confidence’: “Public and private finance flows for fossil fuels are still greater than those for climate adaptation and mitigation.”
Private finance is especially key to driving change, and impact investing – whereby an investment is benchmarked against measurable and beneficial environmental outcomes, alongside traditional financial returns — can be particularly effective. In the real estate market, for example, where impact strategies are used to finance the retrofit of older buildings to reduce their carbon footprints, we have seen how capital can not only be used to reduce emissions of an asset and to create the potential for wider change, but also to offer meaningful returns.
Part of the problem, in my view, is that too few investors are including impact investment buckets in their strategic asset allocation frameworks. Instead, discussions around portfolio construction tend to revolve around the same old questions regarding 60/40 strategy, rather than shifting the focus to the potential benefits of an impact allocation.
Likewise, non-public markets have a role to play. Increasingly, private markets have become a core allocation for investors, but this is typically only permissible as a specified proportion of overall investments. When the value of public equity or fixed income holdings falls, the denominator effect means that the private holdings of such investors take up a relatively larger share of their portfolios, brushing up against caps or otherwise limiting how much they can commit to private holdings as an asset class. At a time when private markets are often offering strong returns and have the potential to contribute to tackling the climate crisis through impact strategies, this is counterintuitive to say the least, and stands out as another issue that allocators of capital must face.
For investors, the cusp of the horizon promises many more new ways to combat climate change, including many that will come through a combination of technological and financial innovation. But for a bigger, more immediate impact, we only need to make better use of the tools that are already available to us today.