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Sustainable Equity: focusing on compounding wealth in uncertain times

Hamish Chamberlayne, Head of Global Sustainable Equities, presents his outlook for 2024 and outlines the long-term secular growth opportunities for the asset class.

Hamish Chamberlayne, CFA

Hamish Chamberlayne, CFA

Head of Global Sustainable Equities | Portfolio Manager


29 Nov 2023
7 minute read

Key takeaways:

  • Higher interest rates are proving to be a headwind, causing slowing real growth in many end markets associated with sustainability.
  • Despite this pressure, we are still seeing underlying progress in laying the foundations for clean technologies, electrification, green buildings, and decarbonising electricity. This presents attractive multi-year secular growth opportunities.
  • In uncertain times, we believe it is important to focus on resilient companies exposed to these secular growth opportunities and which offer cash flow generation, balance sheet strength, and valuation discipline.

For the past year uncertainty has reigned, with geopolitical discord, inflation and higher interest rates casting a shadow over markets. Returns over this period have been narrow. Outside of artificial intelligence (AI), some of the best equity market returns have been in weight loss drugs, social media, and smart phones – perhaps a rather sobering reflection of today’s society.

In this environment, the good ship Sustainability has hit some rougher seas. The transition to a more sustainable economy requires investment, and higher interest rates are a headwind. Real growth has been slowing in many end markets associated with the sustainable investment themes that we focus on. Renewable energy projects are being delayed, real estate and construction markets are slowing,  and automotive and many industrial markets related to electrification and digitalisation have come under pressure. Taking the iShares Global Clean Technology ETF as a proxy (see figure 1) it has been a tough period for returns.

Figure 1: Sustainability faced headwinds in 2023

Source: iShares Global Clean Energy ETF, 3 January 2023 to 22 November 2023 in USD. Rebased to 100 at beginning of period. Past performance does not predict future returns.

Despite the current macroeconomic challenges, our message is to stay the course. Over the next few years, we see a period of value creation in many different sectors, some of which are attractively valued in today’s turbulent environment.

In uncertain times, where the cost of capital is higher, we believe it is important to focus on the following attributes in order to compound wealth: secular growth, cash flow generation, balance sheet strength, and valuation discipline. Despite being under pressure, we still see attractive multi-year secular growth trends associated with our sustainable investment themes. We are concentrating on investing in related companies with leading franchises in their respective industries, attractive business economics, good cash flows, and strong balance sheets. This, in our view, enables us to navigate uncertainty and offers us the best opportunity to compound wealth for our clients over the long term.

Decarbonising computing

Innovation in the field of artificial intelligence has been one of the biggest stories of 2023 and will continue to dominate headlines as companies and governments race to harness its power. AI stands to benefit companies across many different sectors by accelerating innovation and increasing efficiencies, and we are excited about the potential opportunities that this presents. However, the digital transformation of the global economy will require significant processing power, and we therefore believe it is imperative to consider the energy implications.

The International Energy Agency has stated that more efforts are needed for data centre technology to become net zero by 2050. Graphics processing units (GPUs), such as those made by Nvidia, are used to minimise the significant energy strain of high-performance computing on data centres and are therefore critical to enabling the smarter use of energy in a digitalised world. A recent study showed that using GPU-accelerated systems when running AI programmes globally could save as much as 10 trillion watt-hours of energy per year – equivalent to the amount of energy consumed by 1.4 million homes in a year.1 Elsewhere, low carbon cloud infrastructure, such as Microsoft’s carbon neutral Azure, enables customers to decarbonise their energy intensive computing resources.

From semiconductor chips to data centres and cloud servers, the breadth of technology means that decarbonisation can come in many forms, offering different avenues to find growth opportunities. We believe that businesses enabling efficiencies within high performance computing and which put decarbonisation efforts at the heart of digital transformation will continue to be a key area of growth in the coming years.

Advancing electric vehicles

Outside of AI there are many other opportunities for growth. The trajectory for electric vehicles (EVs) over the next decade is clear, with government policies and initiatives in place to support development and production. That said, recent demand suggests that appetite for EVs has been mixed, with strong growth in China but slower growth in Europe and the US. As a result, car manufacturers General Motors and Ford have announced a scaling back on their EV spending plans in the near-term. We consider this pullback to be a blip in what we see as an inevitable transformation to the transportation sector.

When we focus on the long-term, the vast amount of capital being invested to transform the industry is telling. This capital will be put to use, for example by increasing battery cell capacity, manufacturing lower-cost EV models, and developing autonomous ride-hail technology. We believe that exposure to this trend – be it through growth advantaged auto suppliers, manufacturers in the battery supply chain or software and system control developers – may offer growth opportunities for investors.

Transforming water

The water industry also offers more predictable growth opportunities thanks to specific dynamics that are less beholden to the external economic environment. Not only does poor quality infrastructure need to be upgraded in many countries but there is growing awareness of the need to invest more in water treatment. PFAS (per-and poly fluoroalkyl substances) are common chemicals which have useful non-stick, water repellent properties often used in cookware, clothing, and firefighting foam. The nature of PFAS mean that they are very resistant to biodegradation. As a result of their widespread use and persistent properties, PFAS are being found in many different places, which may have negative health implications and damaging effects to the environment.

 

In 2023, President Biden’s Bipartisan Infrastructure Law allocated US$2 billion to address emerging contaminants, including PFAS, in drinking water across the US, seeking to promote access to clean water in small and disadvantaged communities by improving water infrastructure. This investment offers a huge opportunity for companies involved in the treatment and management of water, from manufacturers of pipes which carry the water, to firms creating technologies to clean water. Independent bodies in the UK and Europe have also called for greater regulation and a phasing out of PFAS too, so we also expect to see continued momentum in this space outside of the US.

Calm before the storm

The aforementioned themes are just an example of the growth opportunities we see when we look beyond the noise. We are also seeing continued growth across insurance, emerging market banks, ESG data providers, and renewable energy. While it may seem that there is a bit of a lull in many of the trends we are focused on, we firmly believe this is a short-term transitional phase and would encourage investors to look beyond the bow and focus on the long-term horizon.

We look upon this period as analogous to a calm before the storm; the storm in this case being a period of exponential growth and value creation. We see a lot of underlying progress in laying the foundations for a period of accelerated growth in relation to reshoring manufacturing in key, clean tech industries such as batteries and semi-conductors, the electrification of transportation, greening buildings, decarbonising electricity, and transforming industry.  And we continue to follow our proven approach, identifying companies exposed to these growth trends, focusing on cash flow generation, strong balance sheets, financial resilience and exercising valuation discipline.

1 Nvidia, Blog: What’s Up? Watts Down – More Science, Less Energy, May 2023

Balance sheet is a financial statement that summarises a company’s assets, liabilities and shareholders’ equity at a particular point in time. Each segment gives investors an idea as to what the company owns and owes, as well as the amount invested by shareholders. It is called a balance sheet because of the accounting equation: assets = liabilities + shareholders’ equity.

Cash flow is the net amount of cash and cash equivalents transferred in and out of a business. A company exhibiting strong cash flow has persistent positive cash flow into the business.

Emerging market is a developing country that is transitioning to become more integrated with the global economy. This can include making progress in areas such as depth and access to bond and equity markets and development of modern financial and regulatory institutions.

Net zero is state in which greenhouse gases, such as Carbon Dioxide (CO2) that contribute to global warming, going into the atmosphere are balanced by their removal out of the atmosphere.

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References made to individual securities do not constitute a recommendation to buy, sell or hold any security, investment strategy or market sector, and should not be assumed to be profitable. Janus Henderson Investors, its affiliated advisor, or its employees, may have a position in the securities mentioned.

These are the views of the author at the time of publication and may differ from the views of other individuals/teams at Janus Henderson Investors. References made to individual securities do not constitute a recommendation to buy, sell or hold any security, investment strategy or market sector, and should not be assumed to be profitable. Janus Henderson Investors, its affiliated advisor, or its employees, may have a position in the securities mentioned.

 

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The Janus Henderson Horizon Fund (the “Fund”) is a Luxembourg SICAV incorporated on 30 May 1985, managed by Janus Henderson Investors Europe S.A. Janus Henderson Investors Europe S.A. may decide to terminate the marketing arrangements of this Collective Investment Scheme in accordance with the appropriate regulation. This is a marketing communication. Please refer to the prospectus of the UCITS and to the KIID before making any final investment decisions.
    Specific risks
  • Shares/Units can lose value rapidly, and typically involve higher risks than bonds or money market instruments. The value of your investment may fall as a result.
  • Shares of small and mid-size companies can be more volatile than shares of larger companies, and at times it may be difficult to value or to sell shares at desired times and prices, increasing the risk of losses.
  • The Fund follows a sustainable investment approach, which may cause it to be overweight and/or underweight in certain sectors and thus perform differently than funds that have a similar objective but which do not integrate sustainable investment criteria when selecting securities.
  • The Fund may use derivatives with the aim of reducing risk or managing the portfolio more efficiently. However this introduces other risks, in particular, that a derivative counterparty may not meet its contractual obligations.
  • If the Fund holds assets in currencies other than the base currency of the Fund, or you invest in a share/unit class of a different currency to the Fund (unless hedged, i.e. mitigated by taking an offsetting position in a related security), the value of your investment may be impacted by changes in exchange rates.
  • When the Fund, or a share/unit class, seeks to mitigate exchange rate movements of a currency relative to the base currency (hedge), the hedging strategy itself may positively or negatively impact the value of the Fund due to differences in short-term interest rates between the currencies.
  • Securities within the Fund could become hard to value or to sell at a desired time and price, especially in extreme market conditions when asset prices may be falling, increasing the risk of investment losses.
  • The Fund could lose money if a counterparty with which the Fund trades becomes unwilling or unable to meet its obligations, or as a result of failure or delay in operational processes or the failure of a third party provider.
  • In respect of the equities portfolio within the Fund, this follows a value investment style that creates a bias towards certain types of companies. This may result in the Fund significantly underperforming or outperforming the wider market.