Avoiding more carbon
The key performance indicator in our Impact Report is carbon avoided – i.e., the emissions saved by using the products and services of the companies we invest in instead of typical products and services. Last year was another strong year for carbon avoided measurement and reporting across the companies we hold, with over three- quarters of portfolio companies avoiding more carbon last year than in the previous year. We believe this datapoint supports our confidence in our portfolio’s long-term growth prospects, given our view that companies with strong competitive advantages in providing products and solutions that help to avoid carbon will benefit from structural growth.
2022 was a record year for climate finance
On the subject of the structural-growth opportunity linked to decarbonisation, 2022 marked an important milestone in global climate finance. Not only was it a record year in terms of the absolute volume of capital committed, it was the first time that investment in climate exceeded that in the fossil-fuel system. We do not necessarily expect a near-term decline in fossil-fuel investment from here. But we are highly confident the rate of growth of climate finance will continue to outpace that of fossil-fuel finance. So after the past 12 months, we maintain full conviction that decarbonisation presents investors with the structural-growth opportunity of a generation.
The decarbonisation tailwind is strengthening for select companies
In developed markets and China, the rate of growth of climate finance is currently in double digits. Extrapolate that into the future – admittedly, not an easy target to achieve – and the world would get fairly close to the International Energy Agency’s (IEA) net-zero scenario (i.e., the conditions under which net zero could be achieved). We believe this would provide a very strong tailwind for the types of business Global Environment invests in, and for the strategy itself. But as we have always said, Global Environment is not predicated on financing reaching a level to deliver net zero. Our point is that the tailwinds for the strategy get stronger the nearer to that mark that we get, and we view developments in 2022 as highly encouraging in this regard.
Green shoots in EM-ex China (but a long way to go)
Outside of these regions, there continues to be a worrying shortfall in climate financing in emerging markets ex-China, and closing this gap remains a key focus of Ninety One’s advocacy work. The positive news is that we are seeing green shoots. In Q1 2023, shortly after the period covered in our Impact Report, we initiated a position in Power Grid, a leading transmission business in India, where we are seeing strong growth in power demand and ambitious plans to decarbonise the energy sector. Transmission will be a critical enabler of grid decarbonisation and the company has a leading market share in the country with a strong cost of capital advantage. Ultimately, this position is driven by conviction that the pace of decarbonisation in India is about to accelerate.
Policy momentum surprised us
Looking back to early 2022, it was not at all clear we would see such a positive trajectory for climate policy as we did – particularly after the Biden administration in January threw in the towel on the ‘Build Back Better’ US climate plan. However, the picture improved through the year. We were particularly heartened to see ‘Build Back Better’ reinvented as the ‘Inflation Reduction Act’ in July 2022. We continue to believe this is an incredibly important piece of policy that will drive both the reindustrialisation and decarbonisation of the US. We also saw positive policy momentum in China and India. Policy support is only one factor driving the structural growth of decarbonisation-linked sectors and companies, and the investment cases for none of our holdings hinges on it. Nevertheless, seeing a more helpful policy backdrop was an encouraging way to end the year in terms of the opportunity we see ahead for the companies we invest in.
Investing in decarbonisation remains complex and challenging
One thing that did not change in 2022 was that climate data must still be navigated with care and expertise. We discuss briefly in our Impact Report a piece of research last year by the Institutional Investors Group on Climate Change (IIGCC), which asked different data providers to show the percentage aligned to net zero of a 57-stock model portfolio. The results ranged from more than 50% to less than 15%. In other words, the answer to how much of the portfolio is net-zero aligned is clearly, “it depends who you ask”.
The point is that, for investors in decarbonisation, making sense of the world and the future implications of global warming is not getting any easier. We believe our analytical edge comes from our bottom-up approach, leveraging our diverse 15-strong team to stay on top of the current and emerging technologies that will help to tackle climate change – and identifying the leading companies in each of these areas with genuine structural growth drivers from decarbonisation.
Outlook
The Global Environment strategy’s investment objective is to outperform the MSCI All Country World Index, with an impact objective of quantifiable carbon avoided. The research we conducted for the 2022 Global Environment Impact Report has strengthened our conviction in our investment approach and our ability to deliver on these goals.
Specifically, we believe the past 12 months have further demonstrated that decarbonisation is driving a major structural-growth opportunity for select companies across industries and regions. Hence, we expect that the companies in our portfolio will continue benefitting from a tailwind which will drive revenues, margins and profitability, and ultimately share price performance.
General risks. The value of these investments, and any income generated from them, will be affected by changes in interest rates, general market conditions and other political, social and economic developments, as well as by specific matters relating to the assets in which they invest. Past performance does not predict future returns; losses may be made. Ongoing costs and charges will impact returns.
Specific risks. Commodity-related investment: Commodity prices can be extremely volatile and losses may be made. Concentrated portfolio: The portfolio invests in a relatively small number of individual holdings. This may mean wider fluctuations in value than more broadly invested portfolios. Currency exchange: Changes in the relative values of different currencies may adversely affect the value of investments and any related income. Derivatives: The use of derivatives is not intended to increase the overall level of risk. However, the use of derivatives may still lead to large changes in value and includes the potential for large financial loss. A counterparty to a derivative transaction may fail to meet its obligations which may also lead to a financial loss. Emerging market (inc. China): These markets carry a higher risk of financial loss than more developed markets as they may have less developed legal, political, economic or other systems. Equity investment: The value of equities (e.g. shares) and equity-related investments may vary according to company profits and future prospects as well as more general market factors. In the event of a company default (e.g. insolvency), the owners of their equity rank last in terms of any financial payment from that company. Sustainable Strategies: Sustainable, impact or other sustainability-focused portfolios consider specific factors related to their strategies in assessing and selecting investments. As a result, they will exclude certain industries and companies that do not meet their criteria. This may result in their portfolios being substantially different from broader benchmarks or investment universes, which could in turn result in relative investment performance deviating significantly from the performance of the broader market.
