Clean Economy strategy - September 2022

The Inflation Reduction Act  provides a welcome support amidst volatile backdrop

• Global equity markets fell sharply in September  
• The ‘Natural Resource Preservation’ was more resilient
• We initiated a position in one of the world’s leading solar PV wafer manufacturers

What’s happening?

Global equity markets fell sharply in September in US dollar terms as further interest rate rises and hawkish central bank commentary raised fears of more severe recessions in most major economies. All regions and sectors posted declines although more defensive sectors such as healthcare and consumer staples did slightly better. Growth underperformed value during the month although both were down.

The combination of lower gas supplies from Russia and exceptionally warm weather conditions has led to a sharp increase in energy prices over recent months. Storage levels of gas in Europe have improved due to aggressive liquified natural gas buying and lower industrial activity but may not be enough to meet winter demand. In response to higher energy prices, several European countries have moved to protect consumers by socialising the cost through windfall taxes and other special mechanisms.

Despite broader macroeconomic concerns, however, the impetus behind the Energy Transition continues to build. The Ukraine conflict has brought energy independence into focus and become a key strategic priority for nations globally. The EU has strengthened policy commitments to the energy transition and we expect further easing of permitting and process bottlenecks which have limited the pace of investment to date. In the US, the recently passed Inflation Reduction Act, which dedicates almost $400bn over the next 10 years to address energy security and climate change, provides a welcome boost to energy transition companies while putting the US on a much closer path to achieving its climate targets.

Protracted lockdowns in China have weighed on certain areas of production and continue to disrupt supply chains. Although measures have been relaxed slightly over recent months, the “zero covid” policy remains in place so we continue to monitor the situation closely given the implications for clean tech supply chains and inflation more broadly.

Portfolio positioning and performance

The strategy underperformed the MSCI All Country World Index in September led by holdings in ‘Smart Energy’ and ‘Low Carbon Transport’ while ‘Natural Resource Preservation’, where we hold companies with more defensive characteristics, did somewhat better.

In ‘Smart Energy’, our position in Hannon Armstrong declined on concerns that higher interest rates will weigh on the margin it makes financing renewable energy, energy efficiency and sustainable infrastructure projects. We are comfortable with our position given strong tailwinds in renewable development while opportunities in more niche areas such as battery storage, hydrogen and biofuels offer further potential for growth supported by the Inflation Reduction Act. Fees from securitisation transactions and advisory services also provide diversification.

Returns in ‘Low Carbon Transport’ were impacted by Aptiv, which is a leading provider of electrical architectures, safety products and electronics for light vehicles. The company recently lowered guidance for the year citing higher input costs, supply chain inefficiencies and volatility in customer production schedules which has weighed on sentiment. However, the company continues to outgrow the market with strong momentum in new business bookings which suggests they remain well placed to benefit from further EV penetration and increasing electrical content in cars more broadly.

On the positive side, our position in consulting and engineering company Arcadis notably outperformed in ‘Natural Resource Preservation’. The company works on environmental, infrastructure, construction and communications projects with a special focus on environmental quality and is seeing strong demand from companies looking to better position themselves for the energy transition and improve sustainability. Shares were supported by the completion of its acquisition of Toronto based IBI Group, which is a technology-driven design firm with a focus on sustainable buildings and efficient infrastructure.

During the month, we exited wind turbine blade manufacturer TPI Composites and solar panel glass producer Xinyi Solar to fund a new position in Longi Green Energy, which is one of the world’s leading solar PV wafer manufacturers. Longi benefits from strong vertical integration and high quality management making it well positioned in the fast growing solar market. Elsewhere, we took some profits in renewable energy solutions companies Ameresco and Alfen Beheer and topped up residential solar system manufacturer Enphase and leading solar inverter company SunGrow as we looked to increase our exposure to the solar industry. Elsewhere, we took some profits in renewable energy solutions companies Ameresco and Alfen Beheer and topped up residential solar system manufacturer Enphase and leading solar inverter company SunGrow as we looked to increase our exposure to the solar industry.

Outlook

2022 was already set to be an important year for the Energy Transition in all regions due to ‘Fit for 55’ regulations within European Climate Law and progress with the EU Green Taxonomy; China’s goal of 2030 peak carbon emissions followed by a goal of net zero by 2060; and a significant step up from corporates across the globe, with notable progress in the US.

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 generation, 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. Meanwhile, 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.