Clean Economy strategy - June 2023

AI beneficiaries in the Clean Economy experience strong interest

• Global equity markets declined on concerns over the US debt ceiling and high inflation
• Most sectors’ returns were negative except for those exposed to AI applications
• We started two positions in French and US software & services companies

What’s happening?

Global equity markets declined in May in US dollar terms on concerns over the US debt ceiling and stubbornly high inflation in the US and Europe. Japanese equities performed well during the month while Europe and China were notably weaker. On a sector basis, returns were broadly negative except for information technology and communication services where strong momentum for artificial intelligence (AI) applications saw big gains for certain chip makers and software companies. Growth outperformed value on the back of the narrow market leadership from technology companies.

The recent turmoil in the banking sector is incrementally negative for funding costs, particularly for early stage companies, and raises concerns over future credit events more broadly. However, we do not think the clean tech sector will be overly affected given strong demand for energy efficiency solutions and the predictable nature of renewable energy project cashflows which are supported by government incentives. Elsewhere, mild winter weather combined with aggressive liquified natural gas buying and lower demand has boosted gas storage levels in Europe resulting in lower prices over recent months. This comes as a welcome relief for European households but fears remain that shortages could persist over the longer term if there is no resolution to the conflict in Ukraine.

Despite broader macroeconomic concerns, the momentum behind the Energy Transition continues to build. The US Inflation Reduction Act, which dedicates almost $400bn over the next 10 years to address energy security and climate change, provides a boost to energy transition companies while putting the US on a much closer path to achieving its climate targets. In Europe, the recently announced EU Net Zero Industry Act will provide production tax credits, changes to state aid rules and expedited permitting to speed up the deployment of clean energy. Market reaction has been muted thus far but should improve when more specific details on incentives and dedicated funds are provided over the coming months.

The reopening of the Chinese economy is a positive development both for domestic activity and supply chains more broadly. The latter of which have been easing over recent months and we continue to monitor the situation closely given the implications for clean tech companies.

Portfolio positioning and performance

The portfolio underperformed the broader equity markets represented by the MSCI All Country World Index in May driven by weakness in ‘Agriculture & Food Industry’ holdings. Meanwhile, ‘Low Carbon Transport’ and ‘Smart Energy’ performed in line with the broader market.

Returns in ‘Agriculture & Food industry’ were impacted by our position in ingredients company DSM-Firmenich where low vitamin prices, cost pressure and weak demand continue to weigh on its Health, Nutrition and Care division. Looking further ahead, however, the integration of Firmenich is expected to provide strong revenue synergies, mainly in Food and Beverage, and its Fragrances unit offers a more resilient and higher growth earnings stream. Our position in Deere & Co, which offers agricultural, construction and forestry equipment, also detracted from performance on signs that small agriculture equipment inventory levels are building. Despite this, the fundamentals for larger equipment remain supportive given an aging fleet and lower input costs while demand for precision agriculture technology continues to be robust.

‘Low Carbon Transport’ was boosted by our position in leading electric vehicle (EV) manufacturer Tesla. Shares were supported by a surge in interest in companies with strong AI credentials given its leading position in machine learning and almost 5 million vehicles equipped with full self-driving hardware. Investors also welcomed the news that CEO Elon Musk intends to transition out of his leadership role at Twitter over the coming months.

In ‘Smart Energy’, returns were aided by our position in Taiwan Semiconductor Manufacturing Company (TSMC), which is the world’s largest dedicated semiconductor foundry, after NVIDIA forecast its second quarter revenue to be 50% higher than consensus on strong demand for AI chips. TSMC is the dominant provider of AI chips and sole supplier to NVIDIA so is well placed to benefit from a proliferation of AI applications.

We increased our exposure to software & services during the month with the initiation of Cadence Design Systems and Capgemini. Cadence is a leading provider of Electronic Design Automation (EDA) software used to design and develop electronic systems and is benefitting from accelerating chip design activity focused on electrification and automation, among other things. Capgemini is a global consulting and technology services company which is well placed to benefit from digitalisation and sustainability trends across various industries. Conversely, we reduced our position in Xylem following the completion of its acquisition of Evoqua Water Technologies and took some profits in First Solar, which meaningfully outperformed on the back of updated domestic content guidance in the US which is highly supportive for the solar manufacturer.

Outlook

The outlook for companies that provide solutions to the world’s greatest environmental challenges remains extremely positive despite the volatile macroeconomic backdrop. Support for the energy transition continues to increase with most major nations now having meaningful decarbonization plans in place. The European Union led the way with its ‘Fit for 55’ package, which aims to reduce net emissions by 55 percent by 2030, while China’s goal of peak carbon emissions in 2030 and net zero by 2060 is a significant step in the right direction for the world’s largest polluter. In the US, the Inflation Reduction Act is the largest climate investment in US history and will help to lower the nations carbon emissions substantially by the end of the decade. Meanwhile, the newly adopted Global Biodiversity Framework sets out an ambitious plan to halt and reverse biodiversity loss by 2030.

Achieving these goals requires significant investment in the areas of ‘Smart Energy’ and ‘Low Carbon Transport’. New energy infrastructure requires smart grids and interconnect capacity between regions, renewable energy and energy storage solutions while transportation systems will move away from fossil fuels towards a combination of solutions including electric vehicles, biofuels and green hydrogen. Within ‘Agriculture & Sustainable Food’, high crop prices and rising input costs are supporting demand for agritech solutions which improve yield and farming efficiency. Elsewhere, companies in the area of ‘Natural Resource Preservation’ which facilitate recycling and reusing, along with better management of resources, are helping to mitigate environmental damage while meeting the needs of a growing population.

The Russia-Ukraine crisis has served to underscore the need for Energy Independence and has therefore strengthened the resolve of both policy makers and those for whom energy security and uptime is critical. This strong and resilient demand for clean technology solutions, now further underpinned by energy security considerations, encourages further innovation which continues to enhance the investment potential within the clean economy.

We retain the view that high quality management teams, operating businesses with a sustainable competitive advantage in their markets and with the benefit of secular tailwinds are best placed to weather the current storm and to seize opportunities for growth. The portfolio is therefore well positioned to benefit from the secular growth opportunities we see within the Clean Economy.

No assurance can be given that the Clean Economy strategy will be successful. Investors can lose some or all of their capital invested. The Clean Economy is subject to risks including Equity; Emerging Markets; Global Investments; Investments in small and micro capitalisation universe; Investments in specific sectors or asset classes.