2024 Investment Views: Global environment

Volatility is creating opportunities

Environmental equities have been hit by a downturn in market sentiment. This is creating new opportunities to get exposure to parts of the economy expected to grow fast as the energy transition progresses. Deirdre Cooper and Graeme Baker assess the outlook for investors in decarbonisation.

27 Nov 2023

3 minutes

Deirdre Cooper
Graeme Baker
Atul Shinh
Global environment | Q&A with Deirdre Cooper and Graeme Baker
Listen as Deirdre, Head of Sustainable Equity and Graeme, portfolio manager, assess the outlook for investors in decarbonisation.
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Q What has driven the volatility of decarbonisation equities in the past year

First, rising interest rates have weighed on the shares of clean-energy utilities and other renewables-focused companies. In the latter case, the market’s concern has been over the cost of capital. However, the energy transition remains eminently affordable at today’s interest rates. And across the climate solutions universe, ‘clean’ technologies such as wind and solar power are still generally much cheaper than ‘dirty’ ones. Second, negative sentiment towards Chinese equities has impacted our universe, as a number of globally leading climate-solutions companies are based in China.

Q What is your outlook for 2024 and beyond?

We think negative sentiment has created opportunities to acquire shares in companies that are contributing to sustainable decarbonisation cheaply. Shares in these businesses have underperformed on concern over capital costs, but we believe a select group of them continue to have positive growth, revenues and earnings outlooks.

The markets that climate-solutions companies are selling into remain healthy. For example, while electric vehicle (EV) demand has disappointed a bit in the US, it continues to accelerate in China (which is c.60% of the global EV market, vs. 15% in the US) and elsewhere. More broadly, supportive demand trends across all of the pathways to a lower-carbon global economy – renewable energy, electrification and resource efficiency – are fully intact.

Q Sentiment towards China has been negative. What’s your view?

While the Western world is worrying about higher-for-longer interest rates, the cost of capital is falling in China as the authorities implement stimulus. That has unleashed strong growth in our sector. For example, solar installations are up 160% year-on-year in China. In the first half of 2023 alone, the country installed new solar-power capacity equivalent to the entire UK electricity grid.

From a policy perspective, Chinese authorities are increasingly seeing clean-tech as a way to reduce reliance on the property sector. Consequently, renewable energy, batteries and EVs are focus areas for support to spur growth and employment. This is beginning to drive a larger export industry in select clean-tech products.

That said, selectivity remains vital. Not all Chinese companies in our sector have strong competitive advantages, and there are areas where policy impetus has led to oversupply. With that caveat, we are seeing interesting opportunities in China in inverters within the solar value chain; and in certain higher-quality batteries and heat-management components within the EV value chain, among other areas.

Q Where else are you finding interesting potential investments?

The biotech sector is a fascinating area to watch, given the contribution it can make to decarbonising food production and the agriculture supply chain. Biotech can also play a role in capturing carbon, for example via enzymatic recycling.

In addition, we are seeing more policy support worldwide for businesses that are enabling energy efficiency, for example via insulation and other construction solutions. Governments are increasingly recognising that the cleanest energy is the energy you don’t use. Finally, looking further ahead, there is a potentially exciting opportunity in green hydrogen. This is a very nascent industry and some of it is still loss-making. We think it is essential to focus on the select group of companies that are generating decent returns on capital. Nevertheless, it looks increasingly likely that green hydrogen will have an important role to play in transitioning the global economy to a lower-carbon model.

Q The market is focused on the potential for a growth slowdown in 2024 and elections in the US and elsewhere. How will this affect the climate-solutions universe?

If growth slows, there would be less upside potential nearer term in more cyclically- exposed companies relative to the more ‘pure-play’ decarbonisation companies – i.e., those that are more directly levered to the structural growth driven by the energy transition, such as the renewables value chain, utilities and EVs. The latter is where we think investors should focus.

As for US politics, it looks extremely difficult to get a wide-scale roll-back of the Inflation Reduction Act (IRA) through Congress, not least because a lot of its benefits in terms of jobs and growth will occur in Republican states. The IRA is a game-changing piece of legislation, and we continue to see it supporting climate-solutions sectors in the US. The headlines, however, could well be alarmist, so there could be buying opportunities.

General risks. All investments carry the risk of capital loss. The value of investments, and any income generated from them, can fall as well as rise and will be affected by changes in interest rates, currency fluctuations, general market conditions and other political, social and economic developments, as well as by specific matters relating to the assets in which the investment strategy invests. If any currency differs from the investor’s home currency, returns may increase or decrease as a result of currency fluctuations. Past performance is not a reliable indicator of future results. Environmental, social or governance related risk events or factors, if they occur, could cause a negative impact on the value of investments.

Specific risks. Currency exchange: Changes in the relative values of different currencies may adversely affect the value of investments and any related income. 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. 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. 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. 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.

Authored by

Deirdre Cooper
Graeme Baker
Atul Shinh

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