Transition to a low-carbon economy presents a significant opportunity to invest in a multi-year structural-growth trend while also helping to tackle an existential crisis
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Climate change is one of the most urgent challenges facing the world. The understanding that it is an existential issue is now widespread, as is the realisation everybody is responsible for supporting the transition to a low-carbon economy.
Of course, this includes investors, as such a monumental shift in the ways people produce and consume requires vast capital. But the savviest investors know funding a green industrial revolution offers them far more than the chance to make a positive environmental impact.
Efforts to cut carbon emissions are transforming not only energy and transport systems, but also the design and manufacture of products and buildings. This creates enormous growth potential for companies offering low-carbon products and services, and consequently opportunities for investors.
So much spending is required because green technologies need to play a far bigger role in the economy. To achieve the Paris climate goals, by 2025 100 million electric vehicles must be sold every year, for example, up from around two million in 20191, implying considerable growth not only for electric vehicle manufacturers, but companies in their supply chains.
Propelled by the decarbonisation tailwind, such companies have the potential to outperform the rest of the market. “Decarbonisation-fuelled growth is a structural trend that will persist through economic and political cycles, which is a crucial point during a time of such uncertainty in the world,” says Deirdre Cooper, co-portfolio manager at global asset manager Ninety One.
“Given the vast investment required to limit temperature rises, the growth potential of companies that support or benefit from decarbonisation is huge. It’s a misunderstanding that there need be a trade-off between investing sustainably and generating returns.”
However, she believes only the market leaders are likely to reap the full potential of decarbonisation. The key to leveraging this opportunity is therefore selectively investing in the leading businesses enabling and benefiting from decarbonisation, through a dedicated and focused approach.
Though first seen as a possible inhibitor of decarbonisation progress, coronavirus is now viewed as an accelerant as governments centre their post-pandemic recovery plans around the low-carbon transition. This is particularly the case in Europe where the European Union’s Green Deal and related fiscal policy is being positioned to help reshape economies.
Elsewhere, China pledged in September to become carbon neutral by 2060, which would require a faster decarbonisation than expected and a radical reconfiguration of its economy towards more sustainable ways of producing and consuming. Incoming US president Joe Biden’s announcement of a green agenda has further strengthened the tailwind behind stocks perceived as positively exposed to decarbonisation. Together, the United States and China account for 43 per cent of global carbon emissions2.
Investors seeking businesses most likely to benefit from environmental tailwinds follow these developments closely, given that government policy has a major influence on where, how and how fast decarbonisation drives economic growth. However, the necessary funding cannot come from governments alone.
“The world is investing just $500 billion of the $2 trillion to $3 trillion required annually to decarbonise the global economy,” says Cooper. “To make up the shortfall, we need companies to spend much more on tackling climate change. Investors can play a valuable role in this by engaging with listed businesses, as shareholders, to encourage them to accelerate spending on transitioning the global economy to a lower-carbon model.”
To find companies likely to contribute to decarbonisation, Cooper and her colleagues use proprietary models and detailed carbon analysis. “Within our portfolio, we analyse carbon impact for each company. This includes analysing emissions profiles, initiatives to align strategies with the Paris climate goals, and ‘carbon avoided’, which measures the extent a company’s products or services have a lower-carbon footprint than the alternative.”
Ninety One’s Global Environment strategy has identified around 700 businesses which earn at least half their revenues from areas impacted by decarbonisation and offer products and services that are quantifiably more carbon efficient than the alternative. These businesses have a combined market capitalisation of $6.5 trillion, but investors in broad benchmarks have limited exposure to them as together they account for only 7 per cent of the MSCI All Country World Index by weight3.
Cooper believes investors have a higher probability of outperforming the market if they take a selective approach, focusing on the businesses within this group that have the best growth potential, sustainable returns and competitive advantages.
The businesses in Ninety One’s Global Environment portfolio are predominantly in the industrial, utilities, energy, technology, materials, chemicals and automotive sectors.
However, rather than dividing the decarbonisation universe into traditional industries, Ninety One believes it is more useful to identify the pathways to a lower-carbon economy, such as renewable energy, electrification and resource efficiency. Within each pathway, the investment team looks at opportunities throughout the value chain, from makers of components to service providers and distributors.
The rising tide of decarbonisation will not lift all boats, so very careful analysis of the exposure of each company is crucial
The renewable energy pathway, for example, includes regulated utilities that provide clean electricity, as well as manufacturers of the equipment needed to generate wind and solar power. Electrification includes companies that provide semiconductors and battery technologies for electric vehicles, for example, while resource efficiency incorporates energy-efficient heating and lighting appliances.
But investors should remember decarbonisation is a nascent area because the world’s transition to a lower-carbon economy has only just begun. While this suggests tremendous growth potential, it also requires a targeted investment approach.
“The rising tide of decarbonisation will not lift all boats, so very careful analysis of the exposure of each company is crucial,” says Graeme Baker, co-portfolio manager of the Global Environment strategy with Cooper at Ninety One. “Seeking high-quality businesses with competitive advantages and defensible market positions gives us the best chance of handling whatever is around the corner.
“As an investment theme, decarbonisation comprises a hugely diverse group of businesses, but diversification doesn’t happen by chance. Given the economic uncertainty, it is strongly advisable for any decarbonisation portfolio to actively seek and manage it.”
1 Ninety One and Dr Daniel Quiggin, 31 March 2019
2 Union of Concerned Scientists, updated 12 August 2020
3 Ninety One, March 2020
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