Last year saw an unprecedented amount of money flow into climate change focused investments – some even termed the rush to buy, a ‘green bubble’. Now that the market has retreated, investors need to be much more discerning, says Blair Couper, investment manager, abrdn.
There’s no argument that revolutionary action needs to be taken in the years ahead to both slow and adapt to climate change, and there’s going to be enormous investment required – an estimated $130 trn. What’s under the spotlight now is which companies are going to be the leaders, the FAANGs, if you like, of this net zero future?
For investors willing to do their homework, now could be the time to discover where the future winners and good value opportunities can be found. In the aftermath of the dot-com bubble, many early-stage tech companies did go to zero, but the rise of the FAANGs shows that the winners from the digital transformation went on to be some of the largest companies in the world. With such transformational opportunities ahead, there is no reason why the winners from the energy transition can’t do the same.
Over the past five years, investing broadly in climate change mitigation has provided strong returns – the MSCI World Climate Paris Aligned Index has outperformed the MSCI All Countries World Index, while the S&P Global Clean Energy Index has also outperformed over the same period.
This was a time of ‘easy money’ for the sector and, on hindsight, funding was perhaps too available for speculative solutions and companies which have not gone on to live up to their hype. The global attention leading up to the COP26 climate summit in Glasgow in November 2021 added to the enthusiasm for every kind of climate-change linked investment.
Since the end of 2021, climate-aligned indices have lagged significantly behind the MSCI ACWI. Plus, interest rates are climbing, inflation is rising and access to ‘easy money’ has virtually dried up. The Covid-19 pandemic has turned the favourable macroeconomic conditions of the last decade upside down, bringing significant challenges that will separate the best companies in the field from their weaker peers.
Companies that cannot absorb the higher costs and supply-chain delivery delays are currently under pressure. Equally, early-stage growth companies are also struggling, as investors look for more defensive stocks and, as rate expectations lower, the value of many promising companies has plummeted with the crowd, but in some cases, this drop is not justified and there may be opportunities to make good investments.
Take for example, Shoals Technologies, a small company in the US that specialises in electronic ‘balance of systems’ products. This appears to be a prime example of a company that, like the proverbial baby, has been thrown out with the bath water. Shoals manufactures the electronic cabling and harnessing for utility scale solar projects that transports the electric current from the solar panel, through the inverter and to the grid. While this may not sound like a product with particularly exciting prospects, Shoals has invented a process to manufacture these systems off-site, reducing the need for configuring and installing systems on-site. In our opinion, this is a company with solid growth prospects, despite its current lower valuation.
On the other side of the Atlantic, SSE is at the heart of the UK’s energy transition. The company is a leading developer of renewable projects, including wind and hydro. In addition to clean energy investment, SSE is also investing heavily in the networks and supporting infrastructure vital for the grid to handle the renewables buildout. SSE has been caught up in the market’s fears around an energy company windfall tax, but given SSE’s importance to the UK’s decarbonisation, we remain confident the company will deliver strong returns over the long term.
Another notable case study is Ameresco. What makes Ameresco interesting is its ability to offer solutions on both sides of the energy equation: supply and demand. Reducing demand is often overlooked, but is a powerful way to reduce emissions and costs. Today’s energy prices highlight the benefits of demand reduction for company bottom lines as well as the planet. As companies around the world seek to reduce costs, we believe attention will turn to the energy-efficiency measures that Ameresco provides.
It’s important for investors to realise that while the climate fight urgently needs to be accelerated, this transition cannot happen overnight. The materials and infrastructure required to achieve net-zero targets are not yet fully available. Companies will need to overhaul their supply chains from the ground up to meet their transition aims.
Even if a company is involved in a useful activity, there still needs to be a solid business case for investing in it. We recently engaged with a sustainable lithium mining company to understand the market dynamics around this key transition material. There appears to be a supply deficit of lithium, which may last for some time, but we have not yet taken a position due to the commodity nature of the exposure, the possible volatility of the lithium price and the project execution risks. However, investment into these materials will be crucial and we continue to look for the companies with solid prospects.
The huge challenge of transitioning the world’s energy is not going to be straightforward and there are many obstacles ahead, but the climate fight represents an opportunity worth $130 trillion. Our aim as investors is to focus on the high quality, innovative companies with sustainable competitive advantages that can play an important role in this transition. These forward-looking companies are the ones that should be able to generate long-term financial returns, while also contributing to the net-zero future.
[Main image: malcolm-lightbody-4MbiKlr1kgU-unsplash]