Schroders Lead Portfolio Manager Simon Webber: Why the Going is About to Get Tougher for Investing in Climate Change
Investment commentary on Why the going is about to get tougher for investing in climate change by Simon Webber, Schroders Lead Portfolio Manager (July 2021):
Schroders is a global active asset manager managing more than £574.4 billion (€641.7 billion / $785.1 billion 31/12/20) assets and managed locally by 42 investment teams worldwide. As a global active asset manager, the way we direct capital not only shapes the financial returns we achieve for our clients but also the impact that the companies in which we invest on their behalf might have on society.
Why the going is about to get tougher for investing in climate
2020 was an extraordinary year for climate change action. Public opinion, governments, businesses and financial markets all had major shifts in their appreciation of the urgent need to address the climate crisis. More investment, research and development, and international collaboration will now come together to enable a faster transition to a net zero economy.
While this is just a start, it is undeniably fantastic news for the planet and our chances of avoiding a climate disaster. So far, the new political and business momentum has also been exceptionally supportive for investors in businesses working to mitigate climate change.
1. Valuations Heating Up
However, investing is rarely that straightforward. As financial markets woke up in 2020 to the scale of the transition ahead, company valuations started to reflect this.
There was a large upward re-rating in the valuations of companies with strong technology in areas such as renewable energy, electric vehicles (EVs), hydrogen, circular economy and sustainable foods.
This re-rating mainly reflects the improved growth prospects for those industries and the companies that have invested to create solutions as the transition gathers pace.
2. Competition is too
Higher market valuations for climate change assets not only represent a headwind to future investment returns, but broader awareness of the transition and growth opportunity ahead will now inevitably lead to stronger competition.
Solar
There have already been several examples of competition driving down returns in climate-related industries, the best example of which is the solar industry. A wave of investment and capacity expansion over the last decade has commoditised and fragmented the industry. Overall, the solar industry has been a terrible long-term investment.
Another recent example is cathode materials, which are essential components in lithium-ion batteries. The suppliers to this industry have dramatically scaled up their production, but there has also been a wave of new entrants building capacity. The industry structure has, therefore, fragmented and despite the strong growth the market has gone into oversupply with margins and returns on capital under pressure for all involved.
Electric vehicles
Established pure play manufacturers are now being joined by a raft of new entrants. Numerous other start-ups have raised capital and listed via special-purpose acquisition companies (SPACs). And there has been an explosion of new model introductions by incumbent carmakers.
This competition will be good for volume growth, and some suppliers will do very well, but it will likely be a lot more challenging for the automakers competing for market share with the consumer.
Renewable energy power generation assets
Here, the market is fragmenting amid a large increase in the number of companies seeking to build and own renewable assets. The new competitors include newly established developers funded by capital markets, incumbent utilities making the shift to cleaner generation, and most recently several traditional oil and gas companies which are reallocating their capital budgets from fossil fuels to renewable power.
In this environment of plentiful funding and an increase in competition, successful companies will be those that have a clear and sustainable competitive edge. The better industries to remain invested in will be those where there remains a reasonable number of rational competitors because there are high barriers to entry and the potential for product differentiation.
3. The Wind of Change
One example where the competitive environment remains reasonable, in our view, is the wind equipment industry.
The wind turbine industry had a major shakeout over the last decade, and market share has consolidated naturally around the strongest companies. Furthermore, there have been no major new entrants in recent years, and the key players have different propositions, so the wind industry is one where we believe the prospects of achieving profitable growth at good returns look strong.
Important Information
This document is intended to be for information purposes only and it is not intended as promotional material in any respect nor is it to be construed as any solicitation and offering to buy or sell any investment products. The views and opinions contained herein are those of the author(s), and do not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds. The material is not intended to provide, and should not be relied on for investment advice or recommendation. Any security(ies) mentioned above is for illustrative purpose only, not a recommendation to invest or divest. Opinions stated are valid as of the date of this document and are subject to change without notice. Information herein and information from third party are believed to be reliable, but Schroder Investment Management (Hong Kong) Limited does not warrant its completeness or accuracy.
Investment involves risks. Past performance and any forecasts are not necessarily a guide to future or likely performance. You should remember that the value of investments can go down as well as up and is not guaranteed. You may not get back the full amount invested. Derivatives carry a high degree of risk. Exchange rate changes may cause the value of the overseas investments to rise or fall. If investment returns are not denominated in HKD/USD, US/HK dollar-based investors are exposed to exchange rate fluctuations. Please refer to the relevant offering document including the risk factors for further details.
This material has not been reviewed by the SFC. Issued by Schroder Investment Management (Hong Kong) Limited.
Schroder Investment Management (Hong Kong) Limited Level 33, Two Pacific Place, 88 Queensway, Hong Kong www.schroders.com.hk
About Schroders
As a global active asset manager, the way we direct capital not only shapes the financial returns we achieve for our clients but also the impact that the companies in which we invest on their behalf might have on society. The relationship between these two outcomes has rapidly evolved as we see a fundamental shift in how companies are viewed and valued. Understanding the impact that they can have on society and the planet is crucial in assessing their ability to deliver risk-adjusted profits.
Our ongoing success is built on a history of experience and expertise, whereby we partner with our clients to construct innovative products and solutions across our five business areas consisting of Private Assets & Alternatives, Solutions, Mutual Funds, Institutional and Wealth Management and invest in a wide range of assets and geographies. By combining our commitment to active management and focus on sustainability, our strategic capabilities are designed to deliver positive outcomes for our clients.
We are responsible for £574.4 billion (€641.7 billion/$785.1 billion 31/12/20) assets of our clients, managed locally by 42 investment teams worldwide. As a global business with over 5,500 talented staff across 35 locations, we are able to stay close to our clients and understand their needs. We have over 200 years of experience in investment and innovation.
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