As a theme, the energy transition offers opportunities to investors for whom sustainable outcomes matter. Fund managers Ulrik Fugmann and Edward Lees explain how they approach this in this edition of The Intelligence Report.
Climate change is real and urgent. Arguably, it even presents an existential threat. Companies can respond to this problem by conceiving innovative solutions for reducing CO2 emissions, or by disrupting existing market structures. It has been shown that investment strategies that incorporate environmental, social and governance (ESG) criteria can yield alpha, so that is something we look for.
We select stocks by employing bottom-up and top-down analysis, using both a quantitative filter and fundamental research. While the energy transition is the underlying theme of our strategy, there are three main sub-themes:
Sustainable energy is particularly important as a theme. About 70% of global CO2 emissions come from energy-related activities across a wide range of sectors including energy. The energy sector plays a large role on the emissions side, both as emitter and as a source of solutions. Many energy companies with a focus on reducing CO2 emissions and contributing to the shift in the energy mix towards renewable energy have interesting business models. They are operating in a huge growth market.
Source: Perspectives for the Energy Transition, Investment needs for a Low-Carbon Energy System; March 2017; this includes buildings, transport, district heat, power and industry.
While we see a growing range of opportunities, our investment guidelines are strict. As an example, we would still exclude financials that help finance the energy transition, as well as companies that extract and supply fossil fuels, even if they also offer – especially for financial reasons – sustainable energy solutions in addition to ones involving fossil fuel energy.
We believe the opportunities are diversified worldwide. Asia is an obvious growth market for companies focused on the energy transition. There is more pollution and thus more remedial work for businesses to address. But Asia also holds better potential growth as its energy infrastructure is generally less well developed, which makes possible the immediate adoption of alternative energy sources. In contrast, in the EU and the US, the energy transition is progressing much more slowly because of the need to convert the extensive existing infrastructure.
The increasing regulation of the energy market is a positive factor, in our view. While it is true that politicians can sometimes cause delays, they cannot entirely block progress. President Trump’s election was widely seen as a setback, for example, because of his campaign promises to reinvigorate the US coal industry. Three years on, we see many American states and municipalities establishing and implementing their own policies for alternative energy and the energy transition. They are often ahead of the federal government in Washington in this regard.
So, Trump’s decision to exit the Paris Accord has not stopped the energy transition in the US. In the EU, it is a good thing that more and more cities want to become car-free. This plays into the hands of providers of electric vehicles, which fall within our third core sub-theme.
We believe a two to four-year investment horizon works best for this strategy. Not because sustainable trends are as short as that – the energy transition will require major adjustments for decades – but because companies in this segment also have to deal with cycles. For example, when a new Chinese producer entered the solar panel market, it affected prices and margins in the West. Investors should be aware of such cycles and invest in the right companies at the right time and also exit again at the right time.
Opportunities are also diversified across large, mid and small-cap companies. Smaller companies need researching more. For the strategy as a whole, we have our own team of quantitative researchers and qualitative analysts.
There is an important political event coming up for investors in 2020: The US presidential election in November. Should the Democrats win, we expect a significant boost for sustainable energy companies as the party is generally more environmentally friendly than the Republicans.
Looking ahead, we also expect a great deal in terms of improvement in renewable energy storage. Ever-better batteries make it possible to store sustainable energy more efficiently and for longer, which should help boost this segment’s growth.
In terms of risks, any rapid rise in interest rates would be a setback. Many alternative energy companies have been financed with debt. If interest rates rise, it would increase their costs and inhibit growth. That said, the interest-rate risk can be easily hedged, and we do not expect interest rates to rise dramatically in 2020.
This interview was published on iexprofs.nl
This article appeared in The Intelligence Report – 26 November 2019
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Any views expressed here are those of the authors as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients.