The corona crisis, the US elections, trade wars... the climate problem remains. And also the need for an investment strategy that specifically responds to climate change. If anything, the health crisis has created additional opportunities to outperform the market this year due to stimulus for green sectors, argue Ulrik Fugmann and Edward Lees, who head the Environmental Strategies Group at BNP Paribas Asset Management.
That is not to downplay the seriousness of the pandemic and its implications for economies around the world, but hard work and a strict focus on companies with solid growth, credible management and believable strategies can pay off.
While initially focusing on dislocated growth opportunities in the spring, more recently, as the crisis rumbled on, Fugmann and Lees became more cautious, choosing defensive companies that have proven their ability to weather a crisis. The strategy, however, always has some exposure to developing companies with novel technologies.
Overall, their climate change strategy has a sustainability angle: it is focused on ‘investing in companies offering products and services that provide environmental solutions.’
However, it is not pure ESG: it targets E (environmental solutions) and does not focus as much on the S (social) and the G (governance). S and G are important, of course, but E is where they believe the existential threat lies and where the associated capital flows and growth opportunities are.
The ecological aspects currently offer the most and best opportunities, Fugmann and Lees argue. Hence, ESG ratings do not themselves dictate investment decisions although they are used in the process.
Selecting companies that contribute to solutions to the climate problem usually means they have a strong ESG profile. It is critical though to be a returns-first strategy and so companies must have attractive risk/return characteristics.
The climate change strategy offers investors a way to invest in the fight against climate change, while seeking a positive return in multiple market conditions. Accordingly, beyond the traditional long positions, it can hold shorts as a hedge. It is able to respond to a market decline by shorting a company that, for example, risks missing the transition.
Take the steel sector. It has one of the largest carbon footprints in the world. However, there are ‘good’ steel firms that use renewable energy and only work with scrap and recycled steel which have a much smaller footprint. Given their contribution to reducing greenhouse gas emissions, but especially their ability to generate higher margins and better potential returns, they can make appealing investments.
Against such longs, one could set a traditional ‘bad’ steelmaking company that uses coal and iron ore and has a much larger footprint. This is not necessarily a case of setting a ‘green’ company against a ’brown’ company, but of seeking to achieve better returns and reduce the risks in the strategy.
Going into deeper into the opportunities, it is worth noticing that there is a broad set: in energy, materials, agriculture and industrials. The investment universe of up to 2 000 companies ranges from solar and wind energy to batteries, electrification, green buildings, biofuels, and pollution control and testing. There are opportunities even in green and cleaner shipping and ocean freight.
COMPANIES FOCUSED ON SOLUTIONS FOR THE GLOBAL ENERGY SYSTEM
Source: BNP Paribas Asset Management; July 2020
It is important to note that growth is a secular theme. To take an example, the global offshore wind market is set to expand significantly over the next two decades. The International Energy Agency is forecasting 13% growth per year and a 15-fold increase in capacity by 2040. This is expected to become a USD 1 trillion industry over the next two decades.
The EU has identified hydrogen – a source of clean energy – as a key instrument for its Green Deal objectives for 2050, indicating that cumulative investments in renewable hydrogen in Europe could be up to EUR 180-470 billion by 2050. Separately, it is estimated that turnover in the hydrogen economy will jump to EUR 140 billion  by 2030 from EUR 2 billion currently.
So, these are long-term opportunities and the solutions to the environmental challenges require large-scale investments: tens of billions of dollars are needed.
There is a considerable body of evidence that investments in companies with strong environmental scores outperform those in companies with weak scores over time, and that companies that can take advantage of the environmental challenges will outperform those less prepared, with stranded assets or inferior technologies.
Investing in such strong companies adds alpha to investment portfolios, while reducing risk. The performance of these companies has been more stable over time – they suffer less in market downturns and they are less susceptible to swings in market trends.
This has been reflected in investor attention: money has been flowing into sustainability themed investments, even in the first half of this year when the coronavirus outbreak and the subsequent pandemic disoriented many investors, and market volatility jumped higher.
Crucially, this highlights the growing importance of managing investments actively after more and more passive money indiscriminately supported a wide range of companies.
Any views expressed here are those of the author 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. This document does not constitute investment advice.
The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay. Past performance is no guarantee for future returns.
Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher-than-average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity or due to greater sensitivity to changes in market conditions (social, political and economic conditions).
Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation and conservation on behalf of funds invested in emerging markets may carry greater risk.
Investments in the aforementioned fund are subject to market fluctuation and risks inherent in investing in securities. The value of investments and the revenue they generate can increase or decrease and it is possible that investors will not recover their initial investment. Source: BNP Paribas Asset Management.
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