Energy management and efficiency sectors also flagged in FTSE Russell report, but investors warned of differing definitions across funds.
Institutional investors should be aware of the immediate and future opportunities arising from the development of the green economy, when assessing equity allocations in their portfolios.
According to a new FTSE Russell report titled ‘Investing in the Green Economy 2022’, technology companies offering green revenues are growing at speed, with both the energy management and efficiency sector and transport equipment now accounting for 39% and 20% of the green economy respectively.
Renewable energy equipment companies were found to be growing at a slower rate, according to the index, data and research provider, while some industries were ‘greening’ quicker than others; 42% of the automobiles and parts sectors’ market capitalisation are being driven by low-carbon solutions, such as electric vehicles.
Utilities was found to be the second ‘greenest’ sector behind technology, according to the report, with 27% of its market capitalisation currently focused on low-carbon alternatives such as renewable power.
The total value of the global green economy rose by an annual compound growth rate of around 14% over the past 12 years, said FTSE Russell, and is currently worth over US$7 trillion, accounting for 7.1% of global equity markets.
Its market capitalisation has jumped from US$2 trillion in 2009, nearly doubling its share of the global investable market from 4% to 7%.
This expansion has been accompanied by increased profitability for investors. Over the last five years, the FTSE Environmental Opportunities All Share (EOAS) Index outperformed the FTSE Global All Cap by 5.9%.
However, investment in the green economy must grow markedly faster in order to meet global climate targets, the report highlighted. Its share of the global economy will need to grow from 7%, to between 16% and 25% by 2050.
Over 75% of the green economy is currently driven by the technology, industrial goods and services, automobiles and parts, utilities, and construction and materials sectors, in terms of market capitalisation. Although technology currently accounts for 30% of the green economy, only approximately 10% of its overall US$21.7 trillion is categorised as green in the analysis.
Renewable energy generation and equipment, a critical component of decarbonising the power sector and the wider economy, accounts for 18% of the green economy.
On a sector basis, the value of transport equipment, including green road, rail shipping and aviation solutions, grew by over four times between 2018 and 2021, while energy management and efficiency more than tripled between 2016 and 2021, the latter being driven partly by the rise of cloud computing, accounting for 61% of sector growth in that time period.
According to the report, for investors to “fully capture” opportunities, they must consider exposures along entire value chains.
Using Tesla as an example of how “micro sector-level” green revenues might be found, the report noted various key exposures along the electric vehicle manufacturer’s value chain, including across extraction and processing of key metals, to manufacturing components such as batteries, power semiconductors, and control systems.
Looking at “downstream” opportunities, it highlighted battery-recycling companies that preserve valuable metals, which can in turn drive the manufacturing of new parts.
As further growth opportunities emerge, investors still need to exercise due diligence when accessing green revenues through fund solutions, said report author Lee Clements, Head of Sustainable Investment Solutions at FTSE Russell.
“Quite a lot of the offerings are relatively new, and have limited history, as the sector has become very popular in recent years. Different funds have different definitions of ‘green products and services’. This should improve with the various different national green taxonomies but this will still take a while to stabilise.”
Taxonomies are being introduced in a number of markets to define sustainable activities, with the aim of helping investors to direct investments toward green revenues. Europe’s environmental taxonomy is still subject to refinement and expansion, while the UK’s proposals are expected to be released for consultation shortly.
Clements added that investors targeting green revenues through smaller firms could expect higher levels of volatility than those prioritising already established firms.
“The small and mid cap challenge can be tricky, particularly as certain ‘name stocks’ have grown recently, with Tesla being the best example. Most indices are market cap weighted once they’ve made it through the green revenues’ threshold,” he said.
“One can either focus on specific small cap green products or products with a higher green revenues’ threshold. The downside to either of these approaches is typically more volatility.”
Large cap companies make up 75% of green economy market capitalisation, with medium and small sized companies accounting for 16% and 9% respectively. However, 79% of green companies are small and medium-sized businesses, with green exposure levels differing across all company sizes.
In terms of likely future drivers of green revenue growth, Clements highlighted long-term national net zero goals, energy independence and security, and high energy and commodity prices.
“Those sectors which have the greatest carbon emissions will see the biggest growth, followed by those sectors best placed to provide solutions, such as industrials and technology,” he said.
“We do, right now, see some high emissions sectors which have a clear solution, but still a lot of rolling out to do, however some sectors like oil & gas or basic materials do not yet have a totally clear technological solution yet.”
While concentrated in the US and China, which represent 54% and 12% of the green economy respectively, the FTSE Russell report reflected its global nature, with Japan and Europe, particularly France and Germany, retaining high levels of exposure.
On a regional basis, the report highlighted that North America was the largest and fastest growing area, playing host to 50% of the global green economy’s market cap.
The UK’s green economy grew by five times between 2009 and 2022, the report said, while Europe and Asia’s grew by roughly three times.
The report draws on FTSE Russell’s Green Revenue dataset, which collates disclosed information and additional data, such as from product volumes, to measure green revenues for over 16,000 equities, of which 3,000 have green products and services.