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Investing in the low-carbon transition in a volatile world

Why invest in the low-carbon transition?

The world is currently only investing around 20% of the US$2-3 trillion needed annually to decarbonise the global economy. Because governments and private equity funds can’t make up the shortfall by themselves, it’s vital that listed companies spend significantly more on evolving to a lower-carbon model. Investors play a valuable role by engaging with listed businesses, as shareholders, to encourage them to accelerate spending on transitioning the global economy.

However, it’s important that investors are clear about their impact and do not overstate it. Within our own portfolio, we analyse and report carbon impact for each company, which means we can measure progress. This includes analysing companies’ emissions profiles, carbon avoided, and initiatives to align business strategies with the Paris climate goals. We report on the companies that are doing well, and call out those that are not moving as quickly as we believe they should.

When we’re doing our analysis, we look particularly closely at the ‘carbon avoided’ metric I just mentioned. This is a measure of the extent to which a company’s products or services have a lower carbon footprint than the alternative. It’s not a very well-known concept now, but it is becoming adopted more widely, and we believe it is the best measure of how a company’s products and services contribute to decarbonisation.

Decarbonisation fuels growth – and returns

There are three main pathways to a low-carbon future, and decarbonisation will fuel growth for businesses along the supply chains in each of those pathways.

  • Renewable Energy: Complete change in how we generate electricity, moving away from fossil fuels towards renewable energy, mainly wind and solar
  • Electrification: Increased electrification, including an overhaul of ground transportation, making the fleet more autonomous and efficient, and ultimately moving away from internal combustion engines to self-driving electric vehicles powered by renewable energy
  • Resource Efficiency: More efficient use of resources, including achieving higher standards of efficiency in many domestic and industrial processes, and in buildings and appliances

Consequently, the universe of decarbonisation-exposed companies is hugely diverse and spread across regions and sectors.

At Ninety One, we’re repeatedly asked how we reconcile investing sustainably with our fiduciary goals. This, in our opinion, shows a misunderstanding that there needs to be a trade-off between the two. I think you have a higher probability of outperforming if you understand a company in the context of all of its stakeholders – which is what a fundamental investment approach that incorporates sustainable investing helps you to do. Simply put, to fulfil your fiduciary duty to provide long-term returns to investors, we believe you absolutely have to understand a company’s sustainability performance. We have been able to put this philosophy to the test through different market environments and were recently recognised as Global Environment Fund of the Year by Environmental Finance for delivering both returns and impact.

Of course, sustainability data is generally less available in emerging markets so, as an active manager, the way to overcome this is to visit companies. We spend a lot of time with management teams in both emerging and developed countries, to try to understand companies from both a financial and a sustainability perspective.

That’s worth doing, because a significant amount of the growth potential linked to decarbonisation resides in emerging markets. This is especially true for China, which supplies more of the world’s solar panels and lithium-ion batteries than anyone else, and is a leader in several of the technologies that are key to decarbonisation.

Is there a trade-off between decarbonising and rebuilding the economy?

Interestingly, this year’s market turmoil taught us two things about investing in decarbonisation.

First, we learned that the decarbonisation sector lends itself to diversification. In the brutal global equity sell-off in the first quarter of this year, the defensive utilities in our universe – that is, providers of renewable energy – did their risk-mitigating job, helping to offset the heavy falls in cyclically exposed companies, such as auto-sector businesses that are enabling the shift to electrified transport.

Second, it was encouraging to see the resilience of the businesses we invest in. The Ninety One Global Environment strategy launched in 2018, but as portfolio managers we have been holding many of the companies we are currently invested in for a long time. We were with them through the 2008 Global Financial Crisis, and their results in the immediate aftermath of the Q1 sell-off showed they are generally stronger this time around.

Even so, market conditions are extremely tough and a careful approach to building a portfolio is essential. As McKinsey has pointed out, the coronavirus and climate change are both ‘risk multipliers’, in that they exacerbate existing vulnerabilities in the economy. To us, that argues more than ever for an active and selective approach to investing in the decarbonisation growth opportunity – one that focuses on quality businesses with competitive advantages and strong, defensible market positions.

All investments carry the risk of capital loss.

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