Despite the growing momentum in sustainable investing, emerging markets (EMs) continue to receive only a small fraction of capital allocated by investment funds to ‘green’ companies involved in carbon solutions. A recent analysis by Annamaria de Crescenzio and Etienne Lepers delves into the dynamics behind these investment allocation decisions, shedding light on the motivations and constraints at both the fund and country levels.
Key Findings:
Geopolitical Uncertainty and the Green Finance Outlook: Increasing geopolitical tensions are clouding the green finance outlook, particularly in the wake of rising transition risks that are often politically driven. Environmental policies in different administrations—particularly in the U.S.—are contributing to heightened uncertainty, which has already been reflected in negative pricing in green indices such as the S&P Global Clean Energy Index.
Emerging Markets and Green Investment Gaps: As highlighted in previous research, while emerging markets account for a significant portion of the investment needs related to carbon solutions, they continue to receive minimal private financing from advanced economies. The U.S. dominates the green investment landscape, capturing nearly 70% of green investments by specialized funds, followed by China, which receives the largest share of green investments among EMs. Other EMs such as Brazil, India, and South Africa lag significantly behind.
Factors Driving Fund Allocation to Green Companies: The authors identify several key factors that influence investment decisions, including:
Fund Domicile: Funds based in emerging markets or with single-country mandates (such as a focus on Brazil) are more likely to invest in green companies. These funds tend to be more specialized, which helps mitigate information asymmetries compared to foreign funds.
Fund Age: Newer funds are more responsive to trends and demand for sustainable investing, allocating more capital to green assets. In contrast, older funds tend to have a higher proportion of fossil fuel investments.
Institutional vs. Retail Funds: Institutional funds, driven by risk-averse strategies and a focus on stable returns, allocate less to green investments compared to more flexible retail-focused funds. Passive funds also show a higher preference for green assets, driven by broader energy exposure within traditional benchmarks.
Country-Level Green Investment Attractiveness: The allocation of green investments across EMs is not uniform. China and Brazil attract substantial green investments, partly due to their inclusion in major global indices such as the MSCI EM equity index. The authors emphasize the crucial role of benchmark inclusion—countries that are well-represented in these indices tend to attract more green capital.
Key Factors for Attracting Green Investment: Countries with high renewable energy generation, strong green exports, and an open economic environment tend to attract more capital. Structural barriers, such as concentrated ownership of listed companies, can hinder investment by limiting the availability of tradable shares.
Climate Policies: Interestingly, the study finds no robust evidence to support the idea that climate policies at the country level are a significant driver of green investment allocation in global EM portfolios. However, the presence of strong green sectors, like renewable energy and green exports, can enhance a country’s attractiveness.
Conclusion
The research highlights that the dominance of benchmark effects—especially inclusion in indices like MSCI—drives much of the allocation to green companies, underscoring the importance for EMs to ensure they are included in such indices. Additionally, fostering strong green sectors and maintaining an open, investor-friendly environment are critical factors for attracting green capital.
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