Investing in companies linked to climate change may become more profitable than ever

A turbulent 2022

The year 2022 brought about a welcomed improvement in the pandemic-driven disruptions of the previous two years. Nevertheless, financial markets around the world lacked stability. 2022 was a turbulent year for global equities, defined by a shift toward higher and stickier-than-expected inflation, along with rising interest rates and fears of slowing economic activity. In some areas of the economy, supply chain challenges persisted and China’s stringent COVID strategies exacerbated the situation. Europe faced extreme challenges in addition to the aforementioned inflation and rate rises, stemming from the Russia-Ukraine war and subsequent weaponization of the region’s gas supply.

European authorities renewed their focus to diversify the region’s energy sources to eliminate or at least significantly reduce its traditionally heavy reliance on Russian supply as a consequence of this geopolitical shock. In fact, an increased desire for energy security and independence, along with decarbonization ambitions, has accelerated the drive toward renewable energy in many places around the world. The August passage of the Biden Administration’s “Inflation Reduction Act” (IRA) should usher a new era of policy support in the United States via tax incentives through the mid-2030s for renewables including the wind, solar and EV battery industries as well as the respective supporting supply chains.

Looking ahead

As markets approach 2023, the global economic and geopolitical outlook remains highly uncertain, in our opinion. However, the commitment to decarbonization efforts is robust and the outlook for renewable energy remains bright. According to Merrill Lynch, net-zero emission targets were in place in countries accounting for 91% of global gross domestic product (GDP) as of June 2022 (vs. 16% of GDP in 2019).¹ A notable development out of Europe was that, in spite of higher economic growth compared to the prior period a year ago, the region’s emissions declined between August and October of 2022.² This is a promising development, showing that the recent efforts to decarbonize may be bearing fruit as well as confounding the idea that economic growth and emissions reductions are mutually exclusive. Political developments were also positive, including the passage of the IRA in the United States and the election of Luiz Inácio Lula da Silva (Lula) in Brazil. Lula ran on a platform of halting deforestation and generally undoing policies linked to environmental degradation in the country. 

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Offsetting this is our general concern that the current global response is likely too little, too late for tackling climate change meaningfully, and our base case expectation is that without material, incremental regulatory intervention or societal shifts, the world will almost certainly overshoot the 1.5 °C warming goal set under the Paris Climate Agreement. Tackling this important human-wide challenge has the potential to cause further trade barriers and restrictions between countries if the commitment and action toward mitigating climate change varies by region. Moreover, ongoing efforts to decarbonize are likely to intensify inflation pressures through the economic cycle as material bottlenecks and/or the imposition of higher taxes and regulatory requirements drive inflation higher. We believe the themes of decarbonization and deglobalization are interlinked and in fact magnifying each other as we enter what may prove to be a very different macroeconomic environment than in the recent past.

Significant investment opportunities

Against this backdrop of urgency, we see significant value across companies that provide products and services to aid in the global decarbonization challenge. We found some in the industrials sector, including renewable energy equipment companies, and particularly those that benefit from the US IRA. We have also found opportunities in companies that focus on energy efficiency solutions, particularly those benefiting from higher power prices short term and decarbonization efforts long term.

Elsewhere in terms of portfolio composition, we remain optimistic about the materials sector. In particular, we see strong demand growth in metals which is needed to enable the transition to a low carbon economy, including nickel, lithium, copper and aluminium. Additionally, we anticipate that sustainable packaging solutions such as cardboard, aluminium and recycled plastic should continue to take market share from traditional plastic packaging, with the potential for both consumer tastes and regulation to accelerate this trend.

Within the information technology sector, we identified significant opportunities in semiconductor companies through the year as valuations became more attractive, in our analysis. Regarding electric vehicles, we feel the opportunity set has broadened and we found value in transitioning automotive companies that are committing to meaningful change as well as auto suppliers geared toward the transition to greener auto solutions.

While the market consensus is focused on the near-term macroeconomic environment, we invest in companies for the long-term, and we feel the case for investing in climate-change mitigation and adaptation has never been stronger. In our opinion, broad declines such as those the market experienced in 2022 are undoubtedly painful, but also prove to provide the greatest long-term investment opportunities. We continue to believe the themes of decarbonization and deglobalization could define the years ahead. Amidst this backdrop, we continue to see substantial opportunities in companies we deem undervalued that can also have a meaningful impact on climate change mitigation and adaptation.