In this week’s investment soundbite from Fund calibre, Deirdre Cooper, co-manager of the Ninety One Global Environment fund, talks about climate change and the carbon footprint of individuals and companies. She considers a range of topics from the growing opportunity set in climate finance to the impact of legislation in China, Europe and the US when it comes to achieving long term goals, such as net zero by 2050.
(Recorded 24 April 2023)
Can you give us a bit of background on what it is that this fund is trying to achieve?
The Global Environment fund only invests in companies that have products and services that avoid carbon. This means those companies that are selling things that are either generating clean electricity – for example, wind, solar, and maybe investing in the electricity networks that use that clean electricity and bring it to our houses; or investing in electrification, so, things like electric cars, and also heating and industrial processes. And then, of course, we’ve got a big bucket of companies that are effectively energy efficiency companies. That includes making buildings and factories more efficient. It also includes changing the way that waste is disposed of, making consumer products that are built not from fossil fuels, but perhaps from biologics. And, of course, looking at more efficient agriculture and changing the way that the foods we eat, are produced.
That’s a pretty big set of activities. And, interestingly, in 2022, for the first year ever, all of the investment in those areas altogether topped $1 trillion, for the first time in history. Also, for the first time in history, the investment in climate finance was bigger than the investment in the fossil fuel ecosystem. And I think that’s quite important.
When I started doing this – I started Morgan Stanley’s Cleantech Investment Banking Group in Europe in 2005 – at that point in time, the investment in climate finance was about 200 billion USD. So, there has been this enormous growth. And of course, at that point in time, the investment in the fossil fuel ecosystem was many multiple times bigger. What I think we’re going to see from here won’t be linear and it won’t be every sector and every country every year, but what we’re going to see going forward, is continued growth in that climate finance.
In fact, if we as a planet were investing in line with net zero, that $1trillion would actually need to be $6 trillion. And that’s really why we developed this bespoke investment universe that we’ve worked on over the five years we’ve been running the strategy, working with external partners like the Carbon Disclosure Project, which is the biggest database of carbon data in the world, to try to find those companies that have products and services that avoid carbon, because those companies are selling into what is already a $1trillion end market, but has that structural growth tailwind, so, we think that will help those companies to outperform over the medium term.
What do external macro factors such as the conflict in Russia/Ukraine, higher inflation, the cost of living and the threat of recession mean for the net zero 2050 target?
What does the Russian invasion of Ukraine mean for decarbonisation? In general, it means that governments are much more conscious of how important energy security is. And you will hear – mostly from the oil and gas industry – that energy security means fossil fuels. And of course, it doesn’t just mean this. If Europe was a hundred percent net zero and only used renewable energy, then Europe would not rely on any imported energy. Energy security means wind and solar because nobody imports the wind, nobody imports the sun. If you electrify and you use that wind and solar, then you are completely energy secure. Imported, whether it’s oil instead of gas or LNG from America instead of gas from Russia, that’s still not a hundred percent energy secured. Governments understand that and the EU in response to the invasion, has accelerated and continues to accelerate their net zero plans.
You’ve actually also seen, which is much less widely reported, an acceleration in China, because energy security and security concerns generally have gone up the agenda. So, for example, in China, we’re now at a place where almost 30% of the cars sold last year were electric. And that number continues to accelerate into this year. And that, from a Chinese government perspective, is great, because those are all Chinese cars. Volkswagen’s electric penetration in China last year was only 4%. They’re using Chinese batteries and they’re running off Chinese electricity instead of imported oil. That is exactly what the Chinese government thinks about, when they think about energy security; they think about a domestic value chain.
And then in the US, you’ve seen in response – to some extent, not entirely – the Inflation Reduction Act, which passed last year, which is effectively an enormous step forward in terms of investment in decarbonizstion in the US but also done in a way to encourage domestic industry. So, huge tax credits for investment in EVs. You know, if China EVs are 30% of cars sold, in the US you’re only in single digits which means there’s lots of room to grow and there’s been big tax incentives for that sector. The tax credits for solar are so generous in the Inflation Reduction Act, there’s probably parts of the country where you can make a return on the tax credits alone and you could actually give the power away for free. So, this bill really sets the US up for, first of all, reindustrialisation, massive investment in the economy, and decarbonisation.
In Europe, the drive to decarbonise electricity is still mired to some extent in planning. But on the other side of the ledger, energy efficiency in Europe has massively accelerated; gas demand in Europe was down, you know, partly because of the mildness of the weather, but even weather-adjusted, you were down high teens in terms of gas demand last winter. Now, back in September, everyone was worried – would Europe survive the winter? What were we going to do without this Russian gas? And the answer has been, actually we survived just fine. And a lot of that is the low hanging fruit of energy efficiency investments.
Now, let’s look at inflation. The honest answer is, higher interest rates – all other things being equal – are not helpful, not from a stock valuation perspective. Not that we only own super high duration unprofitable companies because we don’t; we own really attractively valued companies, but ultimately we’re investing in a sector where the world is currently investing $1 trillion and we want it to invest $6 trillion. We’d rather – all other things being equal – a lower cost of inflation. If you are of the view that actually, global inflation is going to be really hard to control and the Fed is going to have to go much, much higher, then it’s going to be hard for us to outperform in that environment. And we’d be very clear with our investors on that.
On the other hand, if you are of the view – and I think some of the leading indicators in the US, for example, are already starting to turn – that actually, we’re close to the end of the interest rate cycle, but we’re going to enter a period of much lower economic growth, that’s where our companies do a lot better, because they tend to have structural tailwinds behind them that are not cyclical.
We also see technological progress. At Shanghai Auto Show recently there almost wasn’t a combustion engine to be seen! You had to go down the back and really root around to try and find a combustion engine.
Historically you’ve said that things like regulation, technology, and a change in consumer behavior will help to drive decarbonization. Which one do you think is the most important of those factors over the next five years, and why?
I think it really depends on the sector and the country because there are different drivers in different places. Let’s take each theme in turn and start in the East with China.
The most exciting growth in China is clearly in that EV value chain. The reason that the combustion engines were down the back at the Shanghai Auto Show is that my Chinese colleagues tell me they are starting to call combustion engines ‘zombie cars’. Nobody wants to buy a zombie car! But this anecdote feeds into the massive pace of change in China, and the new products look really cool. The Chinese customer wants tons of infotainment in their car. So, you might have two or three iPads on the front screen in your Chinese electric car. They are beginning to look much more like consumer electronics, than like a car. So, that’s a sector that we’re quite bullish on in China.
Moving on to Europe, I think regulation has been disappointing. We never thought we’d have European leaders going to the US to complain that the US was being too generous on climate subsidies, but that’s what happened last summer, when Emmanuel Macron and Ursula von der Leyen complained; they’re giving all the money to these battery plants and the battery plants are moving and the hydrogen investments, from Europe to the US. So, you know, in policy, Europe’s been a bit disappointing, but the market environment – because of those much higher commodity prices – has led to that really, really strong driver on the energy efficiency side.
However, I wouldn’t write-off policy. The most important thing that the EU did in the last three or four months was relax state aid rules. State aid means that if you are a member of the EU and you wanted to give incentives to battery manufacturing or to companies that are building new semiconductor factories, you can’t do it because it violates EU law. Those rules have now been relaxed for our sector, which means what will happen, will be much more at the country level as it’s just so difficult to form agreement across all 27 EU countries.
And then we move to North America and it really is about policy; that Inflation Reduction Act, you just can’t underestimate how important it is. As an aside, I would expect the rolling back of the Inflation Reduction Act to be a bigger and bigger topic for Republicans. We’ve already seen Kevin McCarthy [Speaker of the US House of Representatives] as he talks about the debt ceiling, debate that if we are going to agree to a debt ceiling, you need to change the Inflation Reduction Act. I think whoever is the Republican nominee – which looks increasingly likely to be a rerun of President Trump – I think they will run on rolling back the Inflation Reduction Act.
Having said that, I think it’s highly unlikely that they actually do roll it back. And the reason for that is that most of the investments are in red States, so the EV plants, the battery plants – they’re in Kentucky and in Georgia. The hydrogen’s all been built in Louisiana. The biggest location for wind and solar in the US, is Texas where it’s very sunny, it’s very windy, and there are no planning laws whatsoever. It takes you seven years to get a wind farm permitted in most European countries, but you can do it in six months in Texas. This is why I think it’ll be really hard to get any kind of change through the Senate.
In addition, the Inflation Reduction Act is based on tax credits, which is hugely valuable for Goldman Sachs and Morgan Stanley and JP Morgan, because they have to structure all those tax credits. So, there’s just way too many vested interests and money being committed and real jobs and employment, which is really, really important. So, while we would expect lots of headlines on the end of the Inflation Reduction Act, don’t expect it to die.
Listen to the full interview here
