The role of Global Environment within a global equity allocation

What do you get the investor who has everything?

For those aiming to build diversified global equity portfolios, it can be tricky to find investment strategies that offer something different in terms of portfolio composition and return profile.

Equity strategies focused on decarbonisation – specifically, on the shares of companies whose products and services are in demand as the world tries to reduce carbon emissions – may be a potential answer. We believe a decarbonisation allocation can complement a core global equity portfolio, bringing diversification benefits and offering the potential for uncorrelated returns.

The structural growth opportunity of a lifetime

Concern about climate change – the single biggest health threat facing humanity, according to the World Health Organisation¹ – is driving vast flows of capital. To limit temperature rises to the international target of 1.5°C above pre-industrial levels, a significant increase in climate related finance is needed, as can be seen in Figure 1.

Figure 1: Current investment levels are not enough to limit global warming to 1.5⁰C

Source: Climate Policy Initiative – Global Landscape of Climate Finance, A decade of data. 31 October 2021.

Regardless of investors’ views on climate change, ‘decarbonisation’ matters because transitioning to a low-carbon economy is driving radical change in the global economy. As the International Energy Agency’s (IEA’s) report ‘Net Zero by 2050’ highlights, achieving carbon neutrality by 2050 requires the following milestones to be achieved by 2030, a mere six years from now:

• A >4x increase in annual wind capacity additions and a 3x increase in annual solar capacity additions, relative to 2022
• A c.5x increase in electric vehicle (EV) sales
• A 23x increase in energy storage system battery capacity
• US$4 trillion of annual investment in the energy sector alone

This is only part of the getting-to-net-zero story, as the IEA’s energy-sector focused report accounts for only about two-thirds of global emissions. Reducing the remaining one-third will require radical changes to agriculture, food production, industrial processes, buildings and more. These shifts across sectors are resulting in enormous flows of capital, fuelling innovation and creating a long-lasting tailwind for companies enabling the transition.

Investing in climate solutions offers the potential to align a portfolio with a powerful structural growth trend. We believe that companies whose products and services help the global economy to decarbonise have the potential to grow revenues and profits faster than the market average. We also believe the earnings and growth potential of these companies are often underappreciated by the market.

If appropriately executed, an investment strategy based on this opportunity has the potential to generate above-market returns over the long term while contributing to a positive real-world impact. This isn’t prioritising impact at the expense of returns; we believe these returns are achievable because of the impact climate-solutions companies are making.

The decarbonisation opportunity is broad

The climate-solutions investment opportunity set extends far beyond the wind and solar farms that often come to mind. It spans companies that are helping to decarbonise the buildings we work in, the homes we live in, the food we eat, the products we consume and the transport we use. The universe encompasses not just the direct beneficiaries of the energy transition, but the entire supply chains around them. It is also global. Emerging markets offer significant potential for investors in decarbonisation. Certain companies in China, as an example, are global leaders in technologies that are crucial to efforts to tackle climate change.

The opportunity set for the Ninety One Global Environment Strategy – a high-conviction global equity portfolio – encompasses three pathways to a low-carbon future, as shown in Figure 2.

Figure 2: Three pathways to a low-carbon future

Finally, contrary to a common misconception, decarbonisation isn’t a small- and mid-cap opportunity. Although such companies are well represented in the decarbonisation investment universe, we find that the type of companies Global Environment seeks – those with strong growth, persistent profitability and competitive advantages – leads to a large-cap orientation.

Approximately 85% of the portfolio was large cap, defined as having a market capitalisation of >US$10 billion, at 31 December 2023.

Historically, Global Environment has held between 22 and 27 companies in the portfolio, with the top 10 holdings representing 50-55% of the Strategy/portfolio². The active share relative to the MSCI All Country World Index (ACWI) has been around 98%, indicating significant variation both in terms of the holdings and sizing relative to global equity indices.

The investment approach is intentionally high conviction and highly concentrated, for three main reasons:

• It enables us to focus on the best companies in this space.
• It means that individual company outcomes matter more for both our investment returns and real-world impact.
• It helps us to have more meaningful company engagements.

The diversifying role Global Environment can play in a portfolio

As noted, there is a significant difference between the positions held in the Ninety One Global Environment Strategy and the MSCI ACWI. As at 31 December 2023:

• Two Global Environment holdings were not in the index³ (we construct a proprietary ‘decarbonisation’ universe for the Strategy which screens for companies with carbon avoided and environmental revenues in the MSCI ACWI and beyond), and only one company was within the index’s 100 largest constituents by weight⁴.
• Global Environment has structural sector biases (i.e., it favours industrials, utilities, materials and ‘green tech’, and does not invest in US mega-cap tech, energy, financials, real estate or healthcare); and country biases (i.e., lower relative exposure to the US and higher relative exposure to China), which accentuates the differences to the MSCI ACWI.

The result has historically been a very distinctive return signature that we believe may complement other global equity approaches. The Global Environment Strategy has typically generated alpha at different times to the most common equity styles – quality, value, growth and momentum – which can help to smooth an overall portfolio’s alpha through time⁵.

Figure 3 plots Global Environment’s monthly returns against the monthly returns of MSCI’s Quality, Value, Growth and Momentum indices since inception in September 2018. The absence of a pattern in the dots indicates Global Environment’s differentiated return profile versus each of the indices. This is reinforced by the low correlations in each instance (whether positive or negative).

Figure 3: Global Environment’s monthly returns

Past performance does not predict future returns, losses may be made.

Source: Ninety One, Bloomberg, 31 December 2023. Uses weekly data from 1 September 2018 onwards, MSCI ACWI Quality, MSCI ACWI Value, MSCI ACWI Growth and MSCI ACWI Momentum used for the respective charts. “Alpha” is defined as excess returns relative to MSCI ACWI. Based on a related portfolio with substantially similar objectives as those of the services being offered. Assumes a management fee of 0.85% p.a.

Figure 4: Global Environment’s track record

Annualised performance (%) since inception in USD

Past performance does not predict future returns, losses may be made.

Source: Ninety One, 31 December 2023. Where performance is gross of fees, returns will be reduced by management fees and other expenses. Net performance is net of the highest institutional segregated portfolio management fee.

Both gross and net returns are shown net of all trading expenses. Income is reinvested, in USD. Performance start: 01 September 2018. Strategy: Global Environment.

Benchmark: MSCI AC World Index NDR. Indices are shown for illustrative purposes only.

To illustrate how Global Environment may complement a global equity allocation, we modelled the historical effect of incrementally adding an allocation to the Global Environment Strategy to the MSCI ACWI Index (Figures 5 and 6). The Global Environment allocation was funded from the Quality and Growth components of the MSCI ACWI, respectively, as these parts of the market are where many investors have focused their recent global equity allocations. Perhaps unexpectedly, given Global Environment’s high tracking error, allocating to the Strategy increases the overall portfolio’s information ratio for allocations up to about 20% when funded from Quality and 50% when funded from Growth. This is because of the low alpha correlation between Global Environment’s monthly returns and those of the global equity index.

Figure 5: Impact on tracking error and information ratio relative to MSCI ACWI of adding Global Environment (funded from MSCI ACWI Growth)

Past performance does not predict future returns; losses may be made. These returns are hypothetical, were not attained by any client, or portfolio managed by Ninety One, and are for illustrative purposes only.

Source: Ninety One, 31 December 2023. The chart shows the historic hypothetical returns from combining an allocation to the Global Environment Strategy with a passive allocation to the MSCI ACWI Growth index using different weightings. Tracking error and information ratio are calculated for the combined allocations using MSCI ACWI as the reference index for calculation. The performance outcome for the different allocations are rebalanced on a monthly basis, and assumes gross of fees, in USD terms. These results do not assume any transactional costs from rebalancing, and assumes that the MSCI ACWI Growth index can be perfectly replicated. For further information model returns, please see the Important information section.

Figure 6: Impact on tracking error and information ratio relative to MSCI ACWI of adding Global Environment (funded from MSCI ACWI Quality)

Source: Ninety One, 31 December 2023. The chart shows the historic hypothetical returns from combining an allocation to the Global Environment Strategy with a passive allocation to the MSCI ACWI Quality index using different weightings. Tracking error and information ratio are calculated for the combined allocations using MSCI ACWI as the reference index for calculation. The performance outcome for the different allocations are rebalanced on a monthly basis, and assumes gross of fees, in USD terms. These results do not assume any transactional costs from rebalancing, and assumes that the MSCI ACWI Quality index can be perfectly replicated. For further information model returns, please see the Important information section.

2023 highlighted how the decarbonisation equity universe has distinct performance drivers that may behave differently to the wider market. While broad equity indices generally gained, led by the US ‘Big Tech’ stocks, sentiment towards renewable-energy and clean technology equities became about as negative as we have seen in our investment careers, partly because investors were worried higher interest rates would increase the costs of ‘greening’ the energy system. However, our analysis shows that the energy transition is still eminently affordable at current borrowing costs, and clean energy remains the cheapest form of power in much of the world.

As every investor knows, stock-market sentiment can be fickle. What has remained constant is the urgency to act on climate change. The first month of 2024 was the hottest January on record and marked the first time the critical threshold of 1.5C above pre-industrial temperatures had been breached over a 12-month period⁶. So for all the negative clean-tech headlines last year, we believe the net zero transition is unstoppable and will have to accelerate to meet global decarbonisation goals. For long-term investors who share that view and value diversified sources of return, we think recent stock-market volatility has created an interesting entry-point to add a differentiated decarbonisation allocation to their portfolios.

Summary

• We believe Global Environment can play a valuable role in a global equity allocation.
• The Strategy invests exclusively in climate-solutions companies, which we expect to benefit from a long-term structural growth tailwind as global efforts to cut emissions continue.
• With a high-conviction, highly concentrated portfolio, Global Environment has little overlap with broad equity benchmarks.
• Our modelling suggests Global Environment may complement a global equity allocation.

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¹ WHO.int, ‘Climate Change and health’, 31 October 2021.
² Since the Global Environment Strategy’s inception in September 2018 to end-December 2023.
³ Industrie de Nora and Wuxi Lead Intelligent Equipment (Global Environment portfolio holdings as at 31 December 2023) are not constituents in the MSCI All Country World Index.
⁴ NextEra Energy, as at 31 December 2023.
⁵ Source: Ninety One. Statement based on analysis of correlation between Global Environment weekly returns and MSCI indices for quality, value, growth and momentum, from Global Environment Strategy inception in September 2018 to 31 December 2023. We would be happy to share the analysis on request.
⁶ Source: Financial Times, 8 February 2024.