Exploring climate solutions: An introduction for investors
Climate solutions are vital to the transition to a low-carbon global economy – and also represent a key allocation option for investors, especially those that have a broader decarbonisation portfolio strategy.
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A ‘climate solution’ can be broadly defined as an investment that offers a product, service or technology that enables the low carbon transition. This generally includes both climate mitigation (activities that help to reduce, avoid or remove greenhouse gas emissions from the atmosphere) and climate adaptation/resilience (activities that help the world adjust to cope with expected or actual climate change impacts).
According to the Climate Policy Institute (CPI), to meet a 1.5C scenario (limiting global temperature rises to this level above pre-industrial levels), the expected finance need is around $7.4tn each year through to 2030, with a significant proportion focused on climate mitigation.
As the warming scenario increases – i.e. for scenarios where temperatures rise above these levels – the need for adaptation activities increases to prepare, for example, for expected and increased extreme weather-related events. The CPI estimates the projected losses that can be avoided by 2100 by limiting warming to 1.5C to be five times greater than the climate finance needed by 2050 to meet this target.
Defining and identifying climate solutions
Over the past few years, regulators and industry initiatives have undertaken work to define and categorise activities with climate solutions potential. This categorisation can be research or climate-scenario led, lifting details from scientific reports, such as the established Intergovernmental Panel on Climate Change reports, to find the activities needed.
Examples of these include:
- labelling taxonomies, such as the EU taxonomy;
- multilateral development banks such as the European Investment Bank’s Common Principles for Climate Mitigation Finance Tracking; and
- initiatives such as Project Drawdown’s ‘Climate Solutions Library’.
Within certain categorisations, such as the taxonomies, qualification is split into simplistically if an activity is ‘eligible’, and then further into ‘aligned’ activities, where an eligible activity meets the specific requirements to make a substantial contribution with limited harm or negative impacts. This takes the definition of climate solutions one step further from activity-based into specific expectations.
Climate mitigation and adaptation investment opportunities are largely considered separated, but the likes of the ‘aligned’ categorisation within the EU Taxonomy ensures that, while an activity can qualify under climate mitigation, it must still be assessed against a climate adaptation test.
Some investments can carry both climate mitigation and adaptation potential. As an example, a nature-based solution can enable both the removal of carbon from the atmosphere, while also providing coastal protection through the dissipation of wave energy and coastal erosion (e.g. mangrove forests). Another example is infrastructure investments that provide either a low-carbon alternative energy source or that are transitioning to a lower carbon profile, while also being developed or modified to reduce the exposure to material physical climate risks over the lifetime of the activity/asset.
Market opportunity for climate solutions
Investment opportunities in climate solutions exist across all sectors and geographies, providing opportunities across asset classes and stages of development, and offering different and differentiated financial risk/return profiles.
The categorisation of activities across ‘enabling’, ‘transitioning’ and ‘end solutions’ provides one route for exploring how the contribution could vary across asset classes:
- Real assets, such as infrastructure, lend themselves mostly to transitioning or end solutions in the case of the likes of renewable energy.
- On the other hand, enabling activities come through supply chain innovation, more closely linked to the likes of technology exposure in private equity.
Another route would be to speak to the type of financing that takes place, largely primary capital (investing directing into new projects or solutions) vs secondary markets (which provide exit opportunities for financers of new projects post-construction). Each market participant has a clear role within either or both of the development of new climate solutions, coupled with the expansion and embedding of these within the economic system.
In private markets, according to MSCI climate-named funds account for cumulative capitalisation of about $90.5bn. Within this, renewable electricity accounts for over 40% of private climate funds’ net asset value, followed by industrials at 21%. While this covers all climate-related investing, it is clear from the proportion of renewable energy and industrials, the latter largely through venture capital and private equity, that climate solutions investing plays as a central theme. Schroders Capital currently has $12.9bn under what we consider to be climate solutions strategies (as of December 2024, excluding mandates and cross investments).
Categorising climate solutions
Methods for categorising investments
As the interest and need for climate solutions has increased, various regulatory bodies, among other market participants, have attempted to categorise types of activities into different climate exposures. This includes the difference between climate mitigation and adaptation, as well as the difference between a solution activity and transitional activities.
The region where the classification system is created can provide insights into the relativity of what climate solutions are required within this regional context. Differences in definitions across climate solutions include the likes of the use of gas, agriculture, forestry and natural assets.
For many the differences in classification reflect the debates between end solutions, i.e. those that are the final solution required, compared to those in transition, that is those required to transition to a low-carbon economy, but that will ultimately be replaced by a new process or product. Highlighting the importance of regional context can change the climate solutions and deployment needed.
Finding a common definition
In 2024, we began developing our Climate Solutions Identification Tool to enable a common definition across asset classes for investments considered as climate solutions. Our Tool cross-compares different external classifications of climate solutions to understand ‘market agreement’.
Our developments on the tool at present focus on contextualising each climate solution activity, providing information on current regional deployments, technology stage, emissions mitigation potential or risk reduction, and financing requirements.
We believe this contextual information is required to be able to understand and prioritise areas of investment, while improving our understanding of what our ‘contribution’ means.
Measuring climate solutions contribution
While categorisation systems, and our identification tool, can help to identify activities that could be considered as a climate solution, that is only one side of the coin. Measurement would also be required, to both link the investment to a categorised activity as well as to understand an investment’s contribution to climate mitigation and/or adaptation.
Across both climate mitigation and adaptation, revenue alignment mapped to climate solutions activities is likely to be the easiest measurement. However, this relies on knowledge of each’s investments revenue information, which could be limited for the likes of private equity fund investments – and is generally less applicable across real estate and infrastructure assets.
Avoided emissions for climate mitigation is another common metric. Methodologies to calculate avoided emissions are largely non-standardised and determined by the company, with many investors having their own methodologies to enable assessment or portfolio output.
Measurement and metrics across adaptation remain nascent and investment or portfolio specific. In practice the preferable output metric across both climate mitigation and adaptation is rooted in the activity undertaken and the specific output or benefit achieved. For example, this could be the amount of renewable energy generated, net tons of carbon removed, avoided loss from extreme weather events, or estimated area or number of people protected. While detailed and outcome-orientated, the plethora of metrics can create difficulties when aggregating across investments and portfolios.
While climate solutions investing is not limited to ‘impact’ investing, the impact process lends itself to the requirements of objectively measuring outcomes and an investment’s contribution to climate mitigation or adaptation. Understanding and quantifying the impact of investments is a core principle within impact investing, with the reporting of impact performance indicators over time.
Schroders proprietary impact scorecard assesses across five dimensions:
1. What is the impact intent of the investment?
2. How much of an impact do we expect it will have, assessed against asset-specific KPIs?
3. Who will benefit from the impact?
4. What contribution is being made, financially and non-financially, to achieve the impact?
5. What are the risks to achieving the targeted impact?
Through the scorecard process, a climate solution would be thoroughly assessed for its climate-related current and expected impact, the investor’s specific contribution, and the level of need for said product or service, which speaks to components explored throughout this article.
Considerations for asset owners
Over the past few years, many asset owners have begun to make allocation commitments to sustainable themes, largely climate solutions. This is generally a component of their wider climate and decarbonisation strategy, and requires foresight in setting a climate strategy and investing specifically within thematic or impact funds to enable easy calculation and reporting. We have explored these decarbonisation objectives and commitments for private markets within our two-part guide.
For many asset owners, they may already have exposure to climate solution opportunities within their general or “mainstream” investments, rather than only through specific thematic and impact strategies. An asset owner could seek this exposure understanding by engaging with their managers, requesting either a direct percentage of climate solutions exposure metric, or an underlying activity metric such as avoided emissions. The ongoing question is then around continuity between managers of metrics reported.
Asset owners could attempt to simplify this categorisation, by creating their own definition of climate solutions, requesting activity-based metrics from each manager and determining which of these metrics meets their definition of climate solutions. For example, where a portfolio can report an avoided emissions figure, or some level of climate solutions allocation, querying the manager’s calculation of avoided emissions will highlight the underlying activity and output metric or revenue exposure to one or multiple activities.
Case Study: Multi-PA climate solutions
Schroders Capital has built a climate focused multi-private asset strategy, investing across the core asset classes across private markets, and within that focusing on an attractive set of investment opportunities with drivers of returns linked to having a positive climate impact. The flexibility to invest across asset classes, from developed market renewable infrastructure to emerging market private equity, allows for diversified exposure to assets which are classified as both “climate mitigation” and “climate adaptation”.
We see there being a significant portfolio construction benefit to having the flexibility to invest in this way, given the considerable environmental impact these investments can have, while also providing different economic exposures. For instance, targeting investments in climate mitigation strategies has led to investment in core renewable infrastructure assets, which can provide low volatility, long-term, inflation-linked and secure cashflows that act as a source of contractual revenue streams, with the potential to deliver low-volatility returns.
Conversely, targeting investments that focus on “climate adaptation” has led the strategy to invest in higher-growth, private companies (private equity) within emerging markets that are seeking to build businesses to strengthen the wider community’s resilience to climate change. These investments offer completely different economic exposures, providing attractive growth opportunities, which when balanced with complementary exposures can provide attractive risk-adjusted returns.
In summary, the ability of a holistic, multi-private asset solution to invest across the spectrum of private markets ensures its ability to gain exposure to differentiated investments that have the dual benefit of positively contributing to climate solutions while also delivering strong risk-adjusted performance potential.
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