Rise of the carbon-cutters: investing in climate-solution companies

Q You were at COP26. What are your takeaways for investors?

It was perhaps most telling that attention was already turning to COP27 in Egypt in 2022. The previous pattern was that a major climate summit happened every five years. But now these events are going to be significant each year. That shows how much decarbonisation has risen up the agenda – and consequently why this issue has become so important for investors, from both a return-generation and risk-management perspective.

Q What should investors in climate-solutions companies keep an eye on next year?

The three key drivers of the structural-growth being fuelled by decarbonisation are regulatory developments, technology advances and changes in consumer preferences. All of them will remain highly relevant in 2022. On the regulatory side, the Build Back Better legislation in the US is expected to pass towards the end of 2021, and we’ll start to see its impacts from next year. Although the stimulus plan has been cut from US$3 trillion to US$1.5 trillion, what remains are essentially all the climate measures. In China, the central bank’s decision to provide subsidised financing for ‘green’ sectors will also fuel growth for select companies in 2022 and beyond.

Q Where are you seeing technological advances?

The pace of technological development is rapid across many areas linked to tackling climate change, particularly in some sectors that are earlier in their decarbonisation journeys. For example, we have been adding exposure to software companies that are helping to make buildings more efficient, and to companies developing clean-tech solutions for areas that are difficult to decarbonise, like air transport. Food has been another focus of our research, given the need to reduce emissions from agriculture and food production. There have been exciting advances in this field too, for example in developing meat-alternative proteins.

Q What consumer trends are you watching?

One striking aspect of COP26 was how engaged civil society was in the discussions. Addressing climate change is on almost everyone’s agenda, and as a result consumer preferences are shifting further towards sustainable offerings. We see this as a major opportunity for companies that make the materials for sustainable consumer products, such as ingredients for bio-based shampoos and other household goods, as well as more sustainable food.

Q What are the key risks to watch out for next year?

Supply-chain disruptions are yet to be resolved. They have pushed up the prices of various components, which is a benefit for some companies but a headwind for others. Some businesses in our universe have seen slower sales because they haven’t been able to access raw materials, as well as lower margins. We expect these issues to dissipate during next year, but they need to be monitored. That said, as long-term investors, we view some of these short-term market dislocations as opportunities to gain exposure to companies we like at appealing prices.

Q What other big issues are you keeping an eye on?

The energy crisis is clearly one to watch. It’s really two separate issues. In Europe, the energy squeeze is supply-driven, and primarily hinges on the availability of Russian gas. But in China, it’s demand-driven. Chinese power demand is up 20% this year alone.

One consequence of more expensive fossil fuels is to make clean energy even cheaper by comparison. The cost of renewables has been falling over time anyway, and in many parts of the world wind is already by far the cheapest way to generate electricity. But I think the steep rises in fossil-fuel prices this year will accelerate demand for clean energy in the medium term. That will be a tailwind for a diverse group of companies, from clean-energy utilities to manufacturers of the technologies and components needed to ‘green’ the grid.

Q How is your portfolio positioned heading into 2022?

We own a number of companies that we think are well-positioned to benefit from decarbonisation in the US, including clean-energy companies and businesses that make efficient heating and cooling systems. If the Build Back Better legislation makes it through Congress, as we expect, that would significantly increase our forecasts for them.

We also have extensive exposure to electric vehicles (EVs) across the value chain, including via companies that make EV battery components and mobility software. In October 2021, 23% of new car sales in Europe were electric, which highlights how the switch to electrified transport is accelerating. And we are continuing to explore relatively undiscovered decarbonisation sectors, such as sustainable food and agriculture. But overall, we are maintaining our investment approach, which is to focus on a diverse but very select group of leading companies with competitive advantages, all of which are enabling sustainable decarbonisation.