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Investment views

A hitchhiker’s guide to the decarbonisation universe

23 September 2019
Authors: Graeme BakerPortfolio Manager, Deirdre CooperPortfolio Manager

Global efforts to cut carbon emissions are driving vast flows of capital and creating a multi-year tailwind for select companies. A portfolio focused on ‘decarbonisation’ therefore offers investors the potential to:

  • Gain exposure to an area of long-term structural growth
  • Offset carbon risk in other investments
  • Make a positive impact by financing businesses tackling one of the planet’s biggest challenges

But how do you actually invest in ‘decarbonisation’? For most people, this is terra incognita. Fortunately, though the decarbonisation investment universe may be unfamiliar, it is no longer uncharted territory.


The diverse, undiscovered decarbonisation universe

Our Global Environment strategy has mapped a global universe of companies driving decarbonisation. Using proprietary energy models and detailed carbon analysis, the strategy has identified businesses earning at least 50% of their revenues from areas impacted by decarbonisation, and that offer products and services that are quantifiably more carbon-efficient than the alternative.

The decarbonisation universe has three notable characteristics, namely that it’s:

  1. Large: Global Environment’s bespoke universe comprises ~700 companies, with a combined market capitalisation of US$6.5 trillion.
  2. Diverse: Companies benefitting from decarbonisation tend to be in the industrials, utilities, energy, technology, materials, chemicals and automotive sectors (i.e., about 60% of GICS sectors).
    They also exist across the value chain, from makers of components, to service providers, to end-product distributors.

    Mapping the decarbonisation universe by industry

    Mapping the decarbonisation universe by industry
    Source: Investec Asset Management, February 2019

  3. Undiscovered: Decarbonisation companies account for only 10% of the MSCI All Country World Index by weight. Investors in broad benchmarks will have limited exposure to them.


To limit temperature rises to 1.5ºC, the world needs to spend…

US$2.4 trillion every year to 2035

Source: Investec Asset Management, February 2019


The three paths to decarbonisation

Rather than dividing the decarbonisation universe into traditional industries, it can be more useful to view it in terms of the three pathways to a lower-carbon economy: renewable energy, electrification and resource efficiency.

Below we offer a guide to the pathways, with a small selection of the types of business within each.

Three paths to decarbonisation
1 Renewable energy 2 Electrification 3 Resource efficiency

1 Renewable energy

To limit global temperature rises to safe levels, a complete change in how we generate electricity is required.

Sample Businesses

Investment Notes

Low-carbon regulated utilities

The cost of wind and solar generation is falling in many parts of the world, not only versus new-build fossil-fuel plants but also relative to the marginal operating cost of existing generation capacity. This is creating a huge opportunity for regulated utilities to decarbonise their generation mix and rapidly grow their regulated asset base. We only invest in utilities whose generation mix is lower than the average of the grid, thereby avoiding carbon emissions. But sector dynamics vary by country, and investors must consider policy-related drivers and risks.

Wind and solar power producers

Renewable power capacity is growing in all major economies. By 2050, the amount of solar and wind energy capacity in the US is forecast to be 1,100% and 150% higher, respectively, than it was at the start of 2019. Independent power producers will play a big role in the build out of renewable energy infrastructure, alongside regulated utilities. As with regulated utilities, sector dynamics vary by country and investors must consider policy-related drivers and risks.

Solar and wind energy capacity in the US

Solar and wind energy capacity in the US

Source: BNEF

Renewable energy equipment

From makers of wind-turbine blades and solar-panel components to whole-system manufacturers, a broad spread of companies supply the renewables sector. However, some of the technologies are easily replicable, meaning that not all of these companies possess defensible competitive positions.

Waste to energy providers

With waste-per-capita increasing in many countries and limited landfill capacity, as well as mounting concern over landfill pollution, the need for waste-to-energy solutions is growing. Waste to energy can be a low-carbon solution, though that depends on the average footprint of the grid in which it is located.

2 Electrification

Electrification is key to controlling emissions and saving energy. It will entail an overhaul of ground transportation, with a move ultimately towards self-driving electric vehicles and mass electrification of heating and many industrial processes.

Sample Businesses

Investment Notes

Semiconductor companies

Electrification is a significant driver of semiconductor demand. For instance, electric vehicles (EVs) require double the semiconductor content of internal combustion engine cars, and many multiples of the power semiconductor content. With cars becoming smarter and more connected, advances in semiconductor technologies are a key driver of e-vehicle development. Longer term, new materials (like silicon carbide) are on the horizon that will make power semiconductors more efficient. Monitoring technology change is key to picking winners in the sector.

Software providers

McKinsey estimates there will be 20.5 million self-driving vehicles by 2030, from almost nothing today. Alongside semiconductor makers, specialist mobility software providers will be needed to enable the shift towards smarter transport.

Transport sensors

The future of transport is electric and connected. This transition will require huge increases in sensor content per car, including radar, lidar, ultrasonic sensors and electric current sensors.

Battery technologies

Batteries hold the key to electrification. Companies active in this area include battery makers, battery-component suppliers and battery capital equipment manufacturers. In-depth analysis is vital to understand which pieces of the supply chain are likely to maintain margins and long-term sustainable returns. Given the use of precious metals in batteries, commodities expertise and ESG analysis is particularly key for investors.

3 Resource efficiency

Less discussed than the other themes, resource efficiency is a crucial aspect of decarbonisation.

Sample Businesses

Investment Notes

Electric efficiency

From the generating plant to the consumer, the electrical grid requires efficiency solutions at every stage. The broad range of products that apply here include meters and sensors.

Energy efficient heating, appliances and lighting

Heating needs not only to be electrified but made more efficient. Appliances and lighting also need to reduce their energy usage. 60W LED bulbs can save up to 75-80% of energy relative to traditional bulbs.

Building materials

Around 30% of greenhouse gas emissions come from buildings, making building efficiency a key area of decarbonisation. Higher building-efficiency standards in various countries are driving demand for insulation and a range of other products.


A map — and a clear sense of direction

Of course, mapping the universe is just the first step. Decarbonisation is a nascent and disruptive area, consequently requiring careful navigation.

compass

For this reason, the Global Environment strategy invests in a focused portfolio of leaders in their fields, targeting companies with three key attributes: growth potential, sustainable returns and competitive advantage. That’s because when you’re taking a road less travelled, you need more than a map. It’s also crucial to have a clear sense of direction.

 

Forecasts are inherently limited and are not a reliable indicator of future results.

General risks: The value of investments, and any income generated from them, can fall as well as rise. Where charges are taken from capital, this may constrain future growth. Past performance is not a reliable indicator of future results. If any currency differs from the investor's home currency, returns may increase or decrease as a result of currency fluctuations. Investment objectives and performance targets may not necessarily be achieved, losses may be made.

Specific risks: Commodity - related investment: Commodity prices can be extremely volatile and significant losses may be made. Concentrated portfolio: The portfolio invests in a relatively small number of individual holdings. This may mean wider fluctuations in value than more broadly invested portfolios. Currency exchange: Changes in the relative values of different currencies may adversely affect the value of investments and any related income. Derivatives: The use of derivatives is not intended to increase the overall level of risk. However, the use of derivatives may still lead to large changes in value and includes the potential for large financial loss. A counterparty to a derivative transaction may fail to meet its obligations which may also lead to a financial loss. Emerging market (inc. China): These markets carry a higher risk of financial loss than more developed markets as they may have less developed legal, political, economic or other systems. Equity investment: The value of equities (e.g. shares) and equity - related investments may vary according to company profits and future prospects as well as more general market factors. In the event of a company default (e.g. insolvency), the owners of their equity rank last in terms of any financial payment from that company. Geographic / Sector: Investments may be primarily concentrated in specific countries, geographical regions and/or industry sectors. This may mean that the resulting value may decrease whilst portfolios more broadly invested might grow.

Graeme Baker
Graeme Baker Portfolio Manager
Deirdre Cooper
Deirdre Cooper Portfolio Manager

Important information

This communication is not for general public distribution and is intended for institutional investors and financial advisors only. It is not an invitation to make an investment nor does it constitute an offer for sale. In Australia, this document is provided for general information only to wholesale clients (as defined in the Corporations Act 2001). All the information contained in this communication is believed to be reliable but may be inaccurate or incomplete. Any opinions stated are honestly held but are not guaranteed and should not be relied upon. This is not a buy, sell or hold recommendation for any particular security. Portfolio holdings may change significantly over a short period of time. Any decision to invest in strategies described herein should be made after reviewing the offering document and conducting such investigation as an investor deems necessary and consulting its own legal, accounting and tax advisors in order to make an independent determination of suitability and consequences of such an investment. This material does not purport to be a complete summary of all the risks associated with this Strategy. A description of risks associated with this Strategy can be found in the offering or other disclosure document for the Strategy. Investec does not provide legal or tax advice. Prospective investors should consult their tax advisors before making tax-related investment decisions. Issued by Investec Asset Management, September 2019.

The content of this page is intended for investment professionals only and should not be relied upon by anyone else

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