The federal government should incentivize impact investing
There’s been a lot of talk about divesting these days.
Some investors find directly or indirectly supporting companies they deem to be destructive to the planet or its inhabitants unpalatable, whether they be arms manufacturers or fossil fuel companies. That makes good moral sense.
Liquidating positions from fossil fuel companies seems like a natural decision for climate-conscious investors, but is it enough? Divesting alone can be a knee-jerk decision that doesn’t actually solve the problem at hand.
Your investments can have an even greater impact.
Divesting needs to be entwined with impact investing, an investment philosophy that aims to generate social and environmental benefits as well as robust financial returns.
The federal government should create policies to help incentivize impact investing so Canadians can more fully participate in this sustainable investment approach, while benefiting from the social and environmental impacts.
According to MSCI, a data and analytics provider, energy is indeed the world’s most-carbon intensive sector, with nearly 5,000 tons of carbon emitted per million dollars of sales, as of a few years ago. But the utilities sector isn’t far behind at almost 4,500 tons of emissions, and the materials sector is carbon-intensive too at more than 2,500 tons.
Almost all other sectors emitted less than 1,000 tons.
So, jettisoning one type of company from your portfolio may not make as big an impact as it first appears. It’s too simplistic an approach.
A similar philosophy may ring true about divestment from arms manufacturers. Semiconductors are essential to modern weaponry, like the Javelin anti-tank missile, which operates with approximately 200 chips. Should an investor avoid highly profitable semiconductor companies like Nvidia? Maybe.
But investors shouldn’t just stop at avoiding the most egregious offenders. A strategy by omission is not much of a strategy at all. If you want to make a real social and environmental impact — and be profitable — your investment strategy has to be more sophisticated.
Let’s start with the financial considerations. The annualized return of the Dow Jones U.S. Select Aerospace & Defense Index, which includes companies in the aerospace and defense subsectors, is 9.5 per cent over a 10-year period ending the second quarter of 2024. The S&P/TSX Capped Energy Index, a common benchmark for the energy sector in Canada, generated annual returns shy of two per cent over the same 10-year timeframe.
For reference, the S&P/TSX Capped Composite Index, the most used benchmark for Canadian equities representing the wider market, earned approximately seven per cent annually during the equivalent period.
From a financial perspective only, it pays to be invested in weapons. Energy sector performance has been strong in recent years, but dragged on returns relative to the broader Canadian economy.
If the goal is to actually change the composition of a portfolio to better reflect an investor’s values, simply cutting investments may not be enough. Rather, investing in businesses that actively contribute solutions to the world’s most challenging environmental problems, like clean energy providers or energy storage services, effectively redistributes capital to companies leading the way in the corporate fight against climate change.
According to the UN, an additional $337 billion U.S. of annual investment is needed until 2030 to achieve access to affordable, reliable and sustainable energy for all.
What’s the role of government in all of this?
Policy can play a role in encouraging capital flows to companies working to provide clean and consistent energy sources. For example, the notion of fiduciary duty ought to go beyond financial metrics and meaningfully encompass social and environmental outcomes.
Shareholders and stakeholders are affected beyond monetary measures alone. Other aspects matter too, and the fiduciary duty ought to explicitly consider effects on people and the planet as well.
Also, mechanisms like tax incentives can be implemented to attract investment in greener companies. Investors could benefit from lower investment income tax or capital gains tax due to their sustainable investment lens, while the companies take advantage of tax breaks based on their environmental mission.
Tax incentives should play a part in bridging the annual $337 billion investment gap needed for a more affordable, reliable and sustainable energy grid.
The good news is that making these investments can be profitable, too.
The AGF Global Sustainable Growth Equity Fund — an investment with holdings focused on the transition to clean energy, the circular economy, water services and healthy food systems — netted an annualized return north of nine per cent over the same 10-year period.
Moving away from fossil fuels during this time period would have already been a win, but reallocating capital to a fund focused on sustainability like the one offered by AGF would have led to some major financial gains.
You can make your investment dollars count. And governments should help push investments toward bolder social and environmental impact.
Photo courtesy of DespositPhotos
