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While much of the world has implemented net-zero emissions targets, the US is just getting started from a federal level. With government support, the movement may become a tailwind for some companies while becoming a headwind for others, according to Takano.
At the end of January, US President Joe Biden signed a major executive order to combat the climate crisis.1 Some of the stipulations to get to a net-zero economy by 2050 include: 2
An essential component of getting to a net-zero economy by 2050 is achieving a carbon-pollution free power sector by 2035. As a result, new oil and gas leases on public lands or offshore waters will be “put on pause” and there will be a review of existing leases related to fossil fuel development. One of the goals is to double renewable energy production from offshore wind by 2030.
While this may have negative implications for utility companies as well as those in the oil and gas sector which rely on traditional fossil fuel production, the new government guidance does not mean those companies are off the table as feasible investments, according to Takano.
Takano and team invest in three groups of companies: 1) Solution providers, which provide solutions to environmental or social challenges; 2) Balance stakeholders, which balance environmental and social factors, aiming to generate sustainable financial returns; and 3) Transition companies, which are committed to transforming their business models for defined social or environmental benefits.
Commenting on the third grouping, Takano says:
“If you look at them on an MSCI ESG scoring3 database, transition companies might not rank high because they have certain issues around the environment,” she says. “But what makes them different from the really bad actors is they have made a commitment to change and transition their business models.”
As an example, she references a regulated utility in Michigan, which is transitioning its legacy CO2 generation portfolio to low carbon, with incremental investment in renewable energy. In order to evaluate how likely it is to stick to its commitment, past analysis of its actions is necessary, according to Takano. The Michigan utility company has already reduced its carbon profile by 38% since 2005 and is targeting 90% by 2040. In terms of its financial expectations, in our view the company has a long runway of 6-8% earnings growth, according to Takano.
“These types of companies tend to be attractive valuation opportunities because they’re not seen by Wall Street as typical environmental, social and governance (ESG) stocks. We really like that transition phase, where we can get in early and engage with them.” she says.
And it’s not only niche companies in the utilities sector; major multinationals have also pledged to shrink their oil and gas businesses, while ramping up offshore wind power and solar and battery storage development.4 While there may be further acceleration from federal support, these businesses have also considered quantifiable changes from over the past year.
2020 was a record year for wind turbine capacity additions in the US at 23 gigawatts (GW), squashing the prior record of 13.2 GW in 2012.5 Similarly, last year the share of fossil fuel-based electricity generation in the US fell from 62.4% in the first eight months of 2019 to 60.2% in the same period of 2020.6 But while companies with more questionable climate legacy practices are working to change their business models, what about those which are better constructed to align with a sustainable future?
With the government “identifying new opportunities to spur innovation, commercialization, and the deployment of clean energy technologies and infrastructure,”7 solution providers may be positioned best to benefit, Takano says. However, skilled and differentiated security selection will be necessary to uncover opportunities in an area more susceptible to crowded trades.8
“These companies are at the forefront of sustainability in terms of their business models and tend to be innovators in their field,” Takano says. “However, since ESG has become more mainstream over the past two years, a lot of people have crowded into these stocks, creating a bit of valuation scarcity.”
To provide an example of a solution provider, Takano points to a global leader in providing water, hygiene and technology solutions in the food, healthcare, energy, hospitality, and industrials markets in over 170 countries. The company has a goal to cut its carbon emissions in half by 2030 and be net-zero by 2050. It also measures the sustainable impact of its customer solutions alongside operational efficiency achieved and financial performance delivered.
“It distributes cleaning products to healthcare service providers and hospitality companies, like hotels and restaurants, so its customers can promote safe food and maintain clean environments,” Takano says. “I think this is really pertinent in an age where we have Covid and sanitization becomes so much more important.”
While a renewed federal focus could help drive the adoption of sustainable practices, historical data shows Wall Street has already been conscious of increased dedication to environmentally friendly business models. ESG has more or less outperformed and attracted assets even in the face of headwinds.9 The market could see an even bigger acceleration with Biden’s plans in action, Takano says.
“Going forward, there will likely be a lot of stranded assets10 associated with the fossil fuels. Given the way things are going, we believe there will be an increase of unsustainable stocks, not just from an ESG perspective, but also an earnings-stability perspective,” she concludes.
1 BBC: Biden signs ‘existential’ executive orders on climate and environment. January 27, 2021.
2 WhiteHouse.Gov: Fact sheet – President Biden takes executive action to tackle climate crisis...January 27, 2021.
3 Morgan Stanley Capital International (MSCI) Environmental, Social and Governance (ESG) ratings are designed to measure a company’s resilience to long-term, industry material ESG risks.
4 The Washington Post: Big Oil’s green makeover. September 15, 2020.
5 US Energy Information Administration. 2020 could be a record year for US wind turbine installations. November 12, 2020.
6 International Energy Agency: Electricity Market Report. December 2020
7 WhiteHouse.Gov: Fact sheet – President Biden takes executive action to tackle climate crisis...January 27, 2021
8 A crowded trade refers to the deployment of a large amount of capital to purchase or sell an asset or group of assets with similar characteristics, which can result in a significant change in the price of an asset.
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Impact investing and/or Environmental, Social and Governance (ESG) managers may take into consideration factors beyond traditional financial information to select securities, which could result in relative investment performance deviating from other strategies or broad market benchmarks, depending on whether such sectors or investments are in or out of favor in the market. Further, ESG strategies may rely on certain values-based criteria to eliminate exposures found in similar strategies or broad market benchmarks, which could also result in relative investment performance deviating.
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