Investing in the future of energy
Huge growth investment opportunities exist with companies driving the energy transition from fossil fuels to sustainable sources
When it comes to investing, people generally think about risks through a backward-looking lens: historic security price performance and volatility, liquidity (ability to sell without affecting price), or traditional market risks like inflation and interest rate movements. But “there are new risks that investors need to consider,” says John Cook, senior vice president and portfolio manager for Mackenzie’s Greenchip Team. “Climate change poses both physical and transition risks to assets, as does the availability of resources that companies need to operate. The idea of risk management needs to adjust to these new realities.”
The risks associated with climate change pose ample threat to people – our homes, businesses and infrastructure – around the world. We’re already seeing it happen in the form of floods, heat waves, droughts and other extreme weather events that have increased wildfires, reduced agricultural yields, and caused costly damage to properties, crops and human health. Declining water supplies and other limited resources also pose perils for many major industries such as manufacturing.
“Environmental thematic investing refers to investments in companies that actually address environmental problems; the companies whose products and services drive the transition.”
The Great Energy Transition
In order to stem the tide of climate change, we need to make a giant economic and societal leap from existing ways of producing and consuming energy based on fossil fuels to a new energy economy based on renewable sources that are sustainable. At the same time, the integration of new energy-efficiency technologies is helping business produce more with less. Known as the “Great Energy Transition,” this shift is already underway, driven by a large and growing set of industries, sectors and companies that are doing and making what’s needed to support the transformation.
Right now, more than 80 per cent of the energy consumed to power the global economy comes from fossil fuels. And much of our current power infrastructure will exceed its operating lifespan and need to be replaced. That means the opportunity for investment is immense. Many of the solutions to these challenges already exist. For example, solar and wind power have become the cheapest way to generate new electricity in most parts of the world. The cost of electricity from new renewable plants is half that of new gas or coal generation. It’s not surprising then that in 2020 alone, 90 per cent of new electricity-generating investment went to renewables.1
“It’s not just about replacing fossil fuels with renewable sources, but also the myriad of technologies that make the economy more efficient,” says Cook. “This transition will take a very long time and be very disruptive. It will not be a straight line, and it’s in investors’ best interest to pay attention to both emerging opportunities and risks.”
Many investors are becoming familiar with environmental, social and governance (ESG) factors like carbon emissions, customer satisfaction, diversity and labour standards when it comes to deciding who or what to invest in. However, ESG integrated strategies alone are not enough to capture adequate exposure to the Great Energy Transition. Only by looking thematically can investors harness the potential to benefit from the growth and hedge risks.
ESG integration vs. environmental thematic investing
“Environmental thematic investing refers to investments in companies that actually address environmental problems; the companies whose products and services drive the transition,” explains Cook. “ESG integrated strategies focus more on company behaviour. For example, a company in a high-polluting industry can have strong ESG scores, but still be on the wrong side of the transition. Right now, a lot more money is going towards ESG integrated investments than thematic, and investors may not realize the difference.”
Environmental thematic investing represents an unprecedented opportunity for investors to invest early and make a meaningful contribution to a sustainable future. “This is a ‘have your cake and eat it too’ situation,” emphasizes Cook. “There are sound financial reasons to invest in these types of funds. The ‘feel good’ side is a bonus.”
In order to meet the commitments of the Paris Agreement, at least $60-trillion USD would need to be globally invested in renewable energy and carbon-reducing technologies by the year 2050. According to early research by the Greenchip Team, $2.5-trillion in annual capital investment is required to deliver on these climate change goals. In each of the past four years, however, investment has only been about $800-billion leaving a $1.7-trillion gap.
“We’ve been under investing in the transition for years,” says Cook. “There’s a significant capital gap. The good news is that you can do very well investing in this gap. We are talking about investing in the most basic necessities – water, food, transportation and energy. Yet the market often misprices basic infrastructure and technologies related to these sectors.”
Where the opportunities lie
Thematic strategies identify industries and companies based on themes addressing climate change such as alternative energy or clean technology as well as solutions to facilitate the leap from old to new forms of energy. These opportunities are vast, but many are with companies likely to be unfamiliar to most people. That is where thematic fund managers must actively do the legwork to find manufacturers of power infrastructure and companies that produce and sell the equipment needed to make the economy more resilient for the future.
“In our Greenchip funds, where we are finding value right now is not necessarily in nameplate technologies,” explains Cook. “We find value under the hood so to speak. We look at the materials that go into making electric cars or materials that connect solar panels. Electric cars sales are growing rapidly. While Tesla and other electric car company stocks have climbed to unprecedented valuations, the materials and technologies needed to build those cars have often been overlooked.”
Many of these holdings are not found in North America, so thematic portfolios tend to provide greater diversification. Add to that, many of the securities in this space tend to be mispriced because they have different geographical and industrial exposures than most core North American funds, offering great investment value and growth potential. “We believe these companies have great growth ahead of them, and they are cheap,” he affirms. “We want investors to grow with us over the long term because that’s where you get the best investment.”
Investors can look for sustainable investment products that meet the specific themes they’re interested in, but perhaps more important is looking for those that are actively managed by firms taking a global approach, offering a strong value strategy and that possess a strong track record in environmental investing. “There’s a pretty small group of us who have been doing this for almost 15 years. We understand the risks and the business drivers,” says Cook.
The key then to successful thematic investing is to take the long view. Previous energy transitions have taken 60 to 100 years to play out, but have created enormous wealth for those who made investments to reach the other side. “You must have a long-term horizon to realize any value. We’re trying to lay down the bits and pieces to get us to a more sustainable place, but it won’t happen quickly.”
That said, the transition will undoubtedly happen, and sustainable investing will help us get there. “In our view, all investors should have at least a small portion of their portfolio invested to help mitigate this transition,” affirms Cook. “If you’re overly exposed to the wrong side of it, that’s a big risk.”
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To view the full report as it appeared in The Globe's print edition: ESG Investing