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Climate change is top of mind for investors, as climate-related risks become more apparent and the environmental impacts of companies become easier to quantify. "Climate investing" is driving investors and advisors to look beyond the traditional environmental, social and corporate governance-focused (ESG) funds, toward opportunities in overlooked parts of the market.

While social factors are a key part of sustainability, they can be harder to define, explains Stephen Metcalf, head of sustainable investing for RBC Wealth Management in the British Isles and Asia. “People have heterogeneous preferences, whereas I think the consensus around climate change and tackling it is a bit stronger."

He points to the COP26 Glasgow Climate Pact , which was signed in 2021 by 197 countries to reduce emissions and contribute financially to global climate-change efforts. This high-profile commitment is having an amplifying effect across investor portfolios and creating new risk considerations.

“The whole economy needs to transition – that's going to affect the entire market," says Metcalf. “And you need to reflect that in your portfolio, right? It's not just a values-based thing; it's a core investment risk."

Sustainable investing is evolving

Over the past decade, sustainable investing has gained momentum as an alternative approach to traditional investing. However, investors are now thinking about sustainability issues in their core portfolios. This is particularly true with climate change, where they are starting to look beyond its role purely as a satellite investment, which was typically the case.

“A driving force of sustainable investing is a growing desire of investors to ensure their decisions are factoring in more than just financial information," says Jasmine Duan, an investment strategist at RBC Wealth Management in Asia.

She adds that sustainable investing has transitioned from being regarded as a niche strategy to becoming mainstream, which has helped it secure a position in the financial industry.

The sophistication of climate reporting is also adding a new dynamic to the investor-wealth manager relationship. Duan says this deeper understanding, enabled by consistent and reliable data, may offer the potential for better long-term investment returns; it may also reduce risk.

Incorporating climate investing into your portfolio

In the past, the simplest way to approach climate investing was to invest in something like a renewable energy ETF (exchange-traded fund) or an environmental-solutions fund. “Investing in those companies and allocating capital to capture some of the opportunity available is a really important part of it," says Metcalf. “But if your whole portfolio becomes that, [it] can be quite concentrated."

That concentration can leave an investor overexposed to risk. Thankfully, there are other approaches that can be impactful while also mitigating risk and driving performance. “[Climate change] is an economy problem," Metcalf says. “We have managers who will look for companies that aren't necessarily in the sectors that jump to mind."

Currently, the financial industry leans toward a "best in class" approach in which companies with strong existing climate credentials are preferred. However, this new strategy targets opportunities in industries in overlooked parts of the economy, which are still adapting to new regulations surrounding carbon neutrality and climate change. Metcalf points to industrials and basic materials: “Building materials, fertilizer, packaging – they are important products that we'll continue to need, but we have to produce them sustainably and in a low-carbon way."

Metcalf argues that investing in these types of sectors and their ESG initiatives can have a wider impact than higher-profile industries such as energy and transportation, where net-zero initiatives are more common knowledge and individuals are already queuing up to invest. “You can diversify your portfolio that way and still maintain integrity, from a climate perspective."

The future of climate investing

According to the World Economic Forum's Global Risks Report 2022 , climate-action failure is the gravest threat facing the world over the next decade. While countries have progressed in terms of climate-related disclosures, commitments made during COP26 will have a global impact, disrupting markets and creating new opportunities in the process. For investors, the key to capitalizing on those opportunities and having a positive impact will be navigating these changes.

Duan says the COVID-19 pandemic triggered the realization of how great an impact climate change can have on the world. Both crises are global and devastating to economies, with the pandemic putting millions out of work and unmitigated environmental degradation causing substantial economic damage. She recommends looking at "responsible investment" as a whole. The term is used to describe a broad range of approaches for incorporating ESG considerations into the investment process – and such methods are not mutually exclusive; multiple approaches can be applied simultaneously within the investment process.

“Speaking with an advisor and portfolio manager may go a long way in helping investors understand more about utilizing climate data and tools to support their investment decisions," she adds.

This includes measuring and reporting on climate risk exposure; implementing low-carbon, fossil fuel-free strategies; factoring climate change research into risk-management processes; and engaging companies and external stakeholders — all to better align with a net-zero trajectory.

Duan emphasizes that “personalization is key to the future of sustainable investing," because everyone believes in a unique set of values and has different causes they care about.