Climate opportunities beyond the energy sector

The popularity of the climate and environment space has grown exponentially in recent years, with investors increasingly recognising the multiple drivers supporting this long-term megatrend. Despite this, two deep-seated investor misconceptions remain difficult to overcome.

The first misunderstanding is the belief that climate and environment solutions essentially begin and end in the alternative energy sector. However, this narrow description significantly understates the broad investment opportunities available in this megatrend – particularly in companies within resource efficiency. The second fallacy is the perception that companies offering positive environmental solutions cannot deliver shareholder returns. While many companies were not able to generate steady cash flows in years past, this rapidly evolving sector is now being driven by healthy fundamentals.

The thought that investing in the climate and environment sector will only be fruitful in a generation is also flawed; these solutions are delivering right now.

A convergence of interests within society

Before the financial crisis, the climate and environment scene was mostly driven by politics, in areas such as subsidies and regulation. Today, it is all about economics. Investing in climate solutions is a rational decision for consumers and enterprises. The economic incentive, where it makes economic sense for both consumers and corporates to invest in climate solutions, has clearly reached an inflection point. Companies understand improving sustainability is vital to remaining competitive in today’s world. At the same time, taking positive action for the environment is something society as a whole is getting behind. However, the impact of climate and environment as a driver of company cash flows remains under-researched and underestimated by most market participants.

More than just alternative energy

We focus on three main investment areas in the climate and environment space – innovators within the alternative energy sector, companies aiming at resource efficiency, as well as adapters focusing on environment protection. Our exposure to alternative energy is roughly 5 per cent, in companies focusing on eco-friendly and innovative technologies to generate cleaner energy. While the global share of primary energy from renewable sources is still very low, emission-free renewables like solar and wind have shown an economic feasibility and further improvements will lead to higher adoption. Our research leads us to believe that electricity will in the long run become the primary form of energy used for consumption, with the age of oil and coal coming to an end. We have a 25 per cent allocation to companies with strong offerings in protecting the environment and safeguarding nature. This area is often driven by environmental regulation and risk management considerations, as well as constant improvements in the quality of products and services. Preventing potential future costs of negative externalities is of as much importance as dealing with issues of the past.

The opportunity in ‘optimisers’

The majority, or 70 per cent, of our strategy is allocated to optimisers in resource efficiency – companies improving efficiency with products and services. An example of a company thriving in this space is Hexcel Corp, the leading carbon fibre producer in the world. Carbon fibres offer significant material advantages, being significantly lighter and stronger than steel and aluminium. New generations of airplanes, such as Airbus’ A380 and Boeing’s 787 Dreamliner, are built with approximately 50 per cent carbon fibre, resulting in 20 per cent more fuel efficiency than older airplanes of equal size. With fuel being one of the largest costs for airlines, Hexcel is providing significant savings for airline companies and value creation for shareholders – not to mention helping to decarbonise the aviation industry. In addition, carbon fibres are also making inroads into other industrial applications – such as wind turbines and high-end cars. The numerous tailwinds for Hexcel has helped drive its share price up almost tenfold since the beginning of the bull market in 2009 – far in excess of the rise for the broader market over the same period.

Trump cannot derail climate revolution

Finally, the withdrawal of the United States from the Paris climate agreement earlier this year was clearly a negative development, as we view the accord as positive for the planet over the long term.

However, political support is only one of the drivers of this mega-trend. Donald Trump aside, we remain convinced the world is witnessing a revolution in attitudes towards the climate and environment – with corporates at the forefront of this change.

Thomas Sørensen and Henning Padberg are portfolio managers of the Nordea Asset Management’s Global Climate and Environment strategy