Green Investing

What Is Green Investing?

Green investing seeks to support business practices that have a favorable impact on the natural environment. Often grouped together with socially responsible investing (SRI) or environmental, social, and governance (ESG) criteria, green investments focus on companies or projects committed to the conservation of natural resources, pollution reduction, or other environmentally-conscious business practices. Green investments may fit under the umbrella of SRI, but they are more specific.

Some investors buy green bonds, green ETFs, green index funds, green mutual funds, or hold stock in environmentally-friendly companies to support green initiatives. While profit is not the only motive for those investors, there is some evidence that green investing may mimic or beat the returns of more traditional assets.

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 can also 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 word "green," what qualifies as a green investment is open to dispute. 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 bet on green technology initiatives. While once considered a risky investment, some green technologies have been able to return strong profits to their investors.

Green Equities

Perhaps the simplest form of green investing is to buy stock in companies with strong environmental commitments. Many new start-ups 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, have been able to reach multi-billion dollar valuations by targeting environmentally-conscious consumers.

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, nearly $270 billion of green bonds were issued in 2020. These bonds may also come with tax incentives, making them a more attractive investment than traditional bonds.

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.

Green mutual funds include the TIAA-CREF Social Choice Equity Fund (TICRX); Portfolio 21 Global Equity Fund Class R (PORTX); and the Green Century Balanced Fund (GCBLX). There are also several indexes that seek to track environmentally favorable businesses. For example, the NASDAQ Clean Edge Green Energy Index and the MAC Global Solar Energy Index both target the 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.

$51 billion

The amount of new money invested in sustainable funds in 2020.

Results of Green Investing

Once considered a niche sector, green investing has swelled after a number of natural disasters brought attention to the oncoming climate crisis. The amount of new money in ESG funds reached $51 billion in 2020, more than double the figure of 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 2020 study by Morningstar, Inc. found that there is "no performance trade-off" between environmentally sustainable funds and the wider market. The study also found that "a majority of sustainable funds have outperformed their traditional peers over multiple time horizons."

Special Considerations

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, 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 may also 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."

Some green funds may also invest in more traditional companies, such as General Motors, Toyota, or even Exxon Mobil. Environmentally-conscious investors should be careful to check a fund's prospectus to decide if it fits their definition of "green."

Green Investing vs. Greenwashing

"Greenwashing" refers to the practice of branding a company or product as "environmentally friendly" in order 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 this is difficult to verify the true cost of a company's emissions. 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.

What Are the Best Green Stocks to Buy?

While there is no surefire way to predict a stock's future earnings, some of the most successful green investments have been in the field of renewable energy generation and storage. For example, Tesla's share price has grown more than tenfold between 2018 and the middle of 2021. In the same time period, China's LONGi Green Energy Technology saw its market capitalization rise from $11 billion to nearly $70.5 billion.

Are Green Investments Profitable?

While 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 2020 study by Morningstar, Inc. found that there is "no performance trade-off" between environmentally sustainable funds and the wider market. The study also found that "a majority of sustainable funds have outperformed their traditional peers over multiple time horizons."

How Do You Tell if a Green Fund Is Sustainable?

Each fund holds a basket of securities, representing a cross-section of a larger part of the market. In order to determine if a "green fund" is sufficiently sustainable, prospective investors should first examine the securities listed in the fund's assets. In addition, some research firms may offer independent evaluations, such as Morningstar's sustainability rating or State Street's R-Factor.