Shining an energy efficient light on the green economy

As the Intergovernmental Panel on Climate Change issues its latest and most urgent call for action on climate change, government money is starting to move at vast scale into the green economy. Investors are taking notice, allocating growing volumes of private capital to what promises to be a multi-decade investment theme. But understanding, sizing and investing in the green economy can be challenging. That is why we have been collecting data on the sector since 2008, developing a suite of products and research to help investors participate in what will be a global industrial transformation.

That transformation is accelerating. Last July, the US passed its Inflation Reduction Act, which directs US$369 billion in subsidies and tax breaks to clean energy and climate technology – the largest single commitment of government funding to climate action. The EU has responded, with a proposed Net Zero Industry Act which aims to dramatically boost the bloc’s clean technology sector. China is continuing massive investments in what is already the world’s largest renewable energy sector. And in March, the UK launched its Green Finance Strategy, which sets out how the Government seeks to align financial flows with its ambition to move to a net-zero economy by 2050.

But the road to net zero will not be a smooth one. After several years of outperforming the broader market, many green thematic indices underperformed in 2022.^[1] Renewables and clean transport businesses, whose valuations had become stretched, faltered. Soaring energy prices saw investors return to previously shunned fossil fuel stocks.

A ‘risk-off’ mood disproportionately impacted the growth stocks that tend to dominate the fast-growing sectors within the green economy.

This demonstrates the importance of developing a nuanced understanding of the green economy. We have been working to define what qualifies as green, and calculating the revenues that listed companies generate from the green economy. This work helps investors better understand the contours of the green economy and the various trends underway within it.

Our Green Revenues 2.0 data model is a taxonomy that captures 133 micro sectors, across energy, transport, water, waste and pollution control, sustainable food and agriculture, and environmental services. Globally, it tracks green revenues at around 16,000 companies within the FTSE Global Equity Index Series and the Russell 3000 Index.

Within this universe, around 3,000 stocks generate revenues from the green economy. By market capitalisation, calculated pro rata, these revenues represented around 7.2% of the global economy in 2021, up from 2.5% in 2016. (We will publish figures for 2022 in June.)

Importantly, the model describes a green economy that is considerably more diversified than many appreciate: while energy management and efficiency and transport equipment account for 39% and 20% respectively of the green economy, it also captures highly regulated sectors such as water treatment and pollution control – which can be highly defensive during periods of market turmoil.

While our work on the green economy dates back 15 years, regulators have more recently stepped in, defining their own green taxonomies of sustainable economy activity. The EU, for example, began work on its Taxonomy in 2019, as part of an explicit effort to encourage flows of capital into action on climate change. With subsequent regulatory developments, such as the Sustainable Finance Disclosure Regulation, which is guided by the EU Taxonomy, it has become a central concern for providers of sustainable financial products.

Other jurisdictions around the world have followed with their own taxonomies. Because their designers have their own policy priorities, taxonomies tend to have their differences: the UK is planning to include nuclear power, for instance, and thresholds for acceptable levels of carbon emissions can vary.

This can make aligning portfolios, strategies and investment products challenging. However, the modular approach we have taken towards modelling green economy revenues allows us to help clients both gain exposure to the elements of the green economy which are of most interest, while at the same time demonstrating alignment with the EU Taxonomy or other emerging classification systems. (See, for example, our work with Aberdeen Standard Investments.)

Necessarily, corporate revenue data is backward-looking, representing a snapshot in time. But we are also using our green revenues data to support forward-looking analysis of which companies are likely to be best positioned to manage the low-carbon transition. FTSE Russell is data provider to the Transition Pathway Initiative (TPI), an investor-led organisation that assesses companies’ preparedness for a low-carbon economy. Among other data inputs, the TPI includes the proportions of a company’s revenues that come from the green economy as a proxy for that preparedness.

As well as providing analysis of the green economy, at LSEG we are also helping to grow it from the bottom up.

According to FTSE Russell research, the UK has 3% green exposure in its economy. The London Stock Exchange’s Green Economy mark recognises London-listed companies and funds that derive more than 50% of their revenues from the green economy. As of June 2022, it has been awarded to 108 companies with a combined market capitalisation of £156 billion.

The Green Economy Mark enables investors to identify an investible universe of green economy equities, providing broad exposure across industries, including companies in the technology, consumer staples, basic materials and telecoms sectors, among others. More than half of Green Economy Mark holders are in financial or industrial sectors.

From the Refinitiv Workspace Renewables Dashboard we find that East Asia is leading the way in terms of renewables installed capacity and generation.

At a country level, China is currently the country with the most renewables installed capacity, with 891 GW. The USA follows next, with less than half at 326 GW.

Out of the current installed capacities in these countries, wind is leading, followed by hydro and solar.