On 11th May 2021 the TT Environmental Solutions strategy celebrated its one-year anniversary. In the following piece we detail how we added value over the past year, before discussing why we find the environmental thematic so compelling, even after the rally seen in 2020. Finally, we outline some of the key sub-themes that look particularly promising.
2020 was undoubtedly the year that environmental investing came of age. Partly in response to the global pandemic, governments around the world announced truly vast support packages worth trillions of dollars to help facilitate the green transition. This catalysed significant outperformance of ESG/sustainability as a general thematic, and particularly of environmental equities. Early 2021 brought a sharp reversal of fortune after a spike in bond yields left investors questioning the heady valuations in certain environmental sub-themes such as renewable energy and electric vehicles. Many of these high-growth stocks experienced substantial corrections, which punished investors heavily exposed to these areas, but also enabled the TT Environmental Solutions team to demonstrate the value of a well-diversified portfolio with a strong sell-discipline.
Key performance drivers
In its first full year since inception on 11th May 2020, the TT Environmental Solutions strategy generated +117.2% (Gross of fees. Past performance is not necessarily indicative of future results and investors may not retrieve their original investment). Because the strategy is classified under EU SDFR regulation as an “Article 9” fund targeting sustainable investments, it does not have a specific benchmark, aiming instead to significantly outperform global equity markets over the long-term, while adhering to strict environmental investment criteria. However, for context, the MSCI AC World index returned +45.4% over the same period.
Below we have highlighted the top 10 winners since inception as they typify several of the themes that have been key drivers of value add for the fund.
Investor, government and consumer support
Perhaps the most important factor driving the fund's performance has been growing optimism from investors that we have crossed the Rubicon in terms of government support for, and commercial adoption of, environmental technologies. Vast green stimulus programmes have either already been approved or are likely to be forthcoming in China, Europe and the US. Many of our holdings re-rated as a result. For example, Chinese solar inverter and EPC company Sungrow Power traded higher in anticipation of increased government targets for solar installations as part of China’s new Five Year Plan. Meanwhile, TPI Composites rallied ahead of expected increases in US government targets for wind installations following Biden’s election victory.
Such successes demonstrate the benefit of our integrated top-down/bottom-up approach. Indeed, our process begins with our top-down research, which can be thought of as a series of lenses that we apply in order to filter the universe and determine the most attractive areas of the market. This enables us to focus our bottom-up research resources on the areas of the market that we expect to maximise returns for investors. One of the lenses that we apply is macroeconomic analysis. Here we are looking to assess where we are in the economic cycle, countries that are in different stages of that cycle, and the key monetary and fiscal drivers within the major economies. As part of this process, we specifically consider the potential impact of political changes and targeted stimulus efforts such as China’s Five Year Plan, the EU Recovery Fund, and Biden’s infrastructure package.
An even more important lens that we apply is the environmental one. Here we look to assess the most interesting trends within environmental investing from a regulatory, technological and consumer preference perspective. Having additional insights from the Research Advisory Board is especially useful in this regard. Our ability to identify particularly promising environmental themes and technologies is exemplified by Ceres Power, a hydrogen fuel cell company that rallied after announcing several positive manufacturing agreements that helped to validate its technology. Similarly, although Aker Carbon Capture is just outside the top 10 winners, it benefited from growing optimism about carbon capture technology.
Diversification is key
Another notable feature of our biggest winners is that 3 out of 10 are based in Emerging Markets, including the top two contributors. We believe that Emerging Markets will play a key role in the green transition and should therefore represent a large portion of an environmentally focused portfolio. Our team of analysts is highly experienced in researching companies in Emerging Markets, and continue to find fast growing companies that trade on large discounts to their Development Market counterparts. Such experience of performing rigorous company due diligence is invaluable in Emerging Markets, where geopolitical and governance risks can be higher.
Not only is the portfolio diversified by geography, it is also diversified by opportunity set and market cap. Unlike many of our competitors that have a narrow focus on carbon, the fund is not simply exposed to the most popular areas of the market such as renewables and EVs, but rather has exposure to a wide range of themes including agriculture, water, forestry and recycling, which have not yet enjoyed the magnitude of re-ratings seen in some areas. Exposure to companies such as Signify and Weyerhaeuser, which could be considered as ‘value’ stocks, helped to protect the portfolio during the sharp sell-off in high-growth names that was prompted by a spike in US bond yields in early 2021. Moreover, the winners list consists of a full spectrum of company sizes, from large-caps such as Samsung SDI, Vestas and Sungrow all the way through to small-caps such as Alfen, Ceres Power and TPI Composites. Indeed, we often find more significant structural mispricing opportunities in small- and mid-cap companies, partly as fewer analysts cover them. We are highly experienced in exploiting these inefficiencies, and constrain capacity in the strategy to ensure that we will always have the flexibility to invest in such companies.
Volatile markets need truly active management
The final point worth mentioning about our biggest winners over the past year is that we actively manage the portfolio, resizing positions accordingly as they become overbought or oversold in our view. Given the strong performance in a number of our holdings, we took profits in many names such as Sungrow, Vestas and EDP Renovaveis. The proceeds were recycled into some of the more attractively valued names that have lagged such as European paper-based packaging and recycling company Smurfit Kappa. We also used the recent correction in high-growth stocks to pick up what we see as very compelling businesses that offer strong structural growth opportunities over the next decade at discounted multiples.
The continued case for environmental equities
Much of the strong performance from environmental equities over the past year has been driven by a re-rating of stocks rather than earnings growth, and clearly such a re-rating cannot continue in perpetuity. That said, while there has been a significant re-rating of well known, liquid names in Europe such as Vestas and Ørsted, as well as many renewables/EV companies in China, beyond these popular pockets of the market we continue to find environmental solutions companies that we believe have excellent products and opportunity sets, but which haven’t yet enjoyed nearly the same magnitude of stock performance.
Even accounting for the material short-term re-rating that some companies in the space have enjoyed, we still believe that environmental equities are incredibly exciting because they offer an opportunity to invest in companies that can grow and compound revenues at very high rates for a prolonged period of time. There are many areas in our investment universe that we believe will be 10 times bigger in 10 years’ time, including electric vehicles, solar and wind power, but there are also areas that could realistically be 100 times or even 1000 times bigger, including carbon capture, hydrogen, lab cultured meats and recycled clothing. In our view, investing in these disruptive, high-growth industries with huge addressable markets offers an unparalleled opportunity to generate substantial long-term returns.
As can be seen in the graphic below, our portfolio has exposure to many environmental thematics that promise to be transformational, but two of the most exciting in our view are agriculture and clothing.
Data as at 30th April 2021.
Agriculture is responsible for the same amount of emissions as the entire transport sector globally. It is vital that we develop lower emission ways to grow crops, and to produce protein sources that people want to consume – whether they are plant-based or lab cultured – in a way that is lower carbon and that has less of an impact on biodiversity and land use. This is a big area for disruption with a huge potential market, given the aggregate size of the meat industry compared to its alternatives. We have two investments in the space and are actively looking for further ideas.
Within the clothing thematic, virgin cotton production has a particularly bad biodiversity footprint as it is extremely water and pesticide intensive. It is also associated with human rights abuses in many countries. Although cotton production has been partially disrupted by synthetic fibres, many of these have their own drawbacks. We see an excellent opportunity for further disruption and therefore own Swedish textile recycling company Re:NewCell. It has pioneered a solution that can recycle cotton textiles at a fraction of the cost of competing products, which also only yield 20-30% of the pure cotton content produced by Re:NewCell’s technology. Given the environmental and social issues surrounding virgin cotton production, we see this as a huge growth area, with a potential global market of 100m tonnes annually, rising to 160m tonnes by 2030. To put that in perspective, Re:NewCell is building out capacity of 1m tonnes by 2025, so even in 5 years’ time it will still represent less than 1% of the total addressable market.
By investing in highly disruptive companies such as Re:NewCell and many others like it, we hope to generate substantial long-term returns for our clients. If you would like further information on the strategy, please get in touch using the details below.
Nothing in this document constitutes or should be treated as investment advice or an offer to buy or sell any security or other investment. TT is authorised and regulated in the United Kingdom by the Financial Conduct Authority (FCA).