Clean Economy strategy - May 2023
Outlook for cleantech companies remains extremely positive despite near term volatility
- Global equity markets rose as falling energy prices helped bring down inflation
- ‘Low Carbon Transport’ and ‘Smart Energy’ posted negative returns
- ‘Agriculture & Food Industry’ was boosted by a Dutch ingredients company
Global equity markets rose in April in US dollar terms as falling energy prices helped bring down headline inflation across most developed economies and economic data remained fairly resilient. Europe and the UK led returns while China was notably weaker. On a sector basis, returns were led by the energy sector and more defensive areas like consumer staples and healthcare. Conversely, consumer discretionary and information technology trailed the broader market. Value marginally outperformed growth for the first time in several months.
The ongoing 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 meaningfully underperformed the broader equity market represented by the MSCI All Country World Index in April driven by weakness in ‘Low Carbon Transport’ and ‘Smart Energy’ while ‘Natural Resource Preservation’ and ‘Agriculture & Food Industry’ performed somewhat better.
Returns in ‘Low Carbon Transport’ were impacted by our position in semiconductor company Wolfspeed which is a leading provider of silicon carbide materials and devices used in electric vehicles, 5G mobile and industrial markets. The ramp up of its Mohawk Valley facility continues to be held back by operational issues and wafer supply leading to lower than expecting utilisation. However, Mohawk Valley is the world’s first 200mm fabrication facility and we remain convinced its superior economics, combined with strong demand for silicon carbide devices, will drive strong earnings growth as utilisation improves.
‘Smart Energy’ was hampered by our position in Enphase, which is a leading provider of residential solar systems in the US and Europe. The company provided in-line results for the first quarter of 2023 but weaker guidance for the rest of the year was taken negatively by the market. Higher interest rates are weighing on the affordability of solar systems in the US which has led to weaker demand and a build-up of inventory. However, the company remains the leading innovator in the space with a strong competitive position in the US and significant growth opportunity in Europe.
In ‘Natural Resource Preservation’, returns were impacted by our position in Japanese water treatment company Kurita Water Industries which declined after management announced goodwill impairment losses relating to the merger of its US businesses and a slightly weaker outlook. We think the US remains an attractive growth opportunity and are constructive on its transition to a service contract business model, particularly in the area of ultra-pure water systems for the electronics industry.
In ‘Agriculture & Food Industry’, our position in ingredients company DSM added most. DSM is in the process of merging with fragrance and flavour company Firmenich which, combined with the sale of its Engineering Materials business, means it will be more squarely focused on nutrition, beauty and well-being solutions. The two companies have similar top line growth and margins but there are potential synergies of around €350m in annual EBITDA, mainly from their overlap in Food & Beverage.
Trade activity was limited during the month.
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.
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