Sustainable Equity: focusing on compounding wealth in uncertain times

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.

JHI

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.

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.

IMPORTANT INFORMATION

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.