Global equities endured a challenging month, with persistent inflation and some economic strength fuelling market fears that central banks will not ease monetary policy as quickly as previously hoped.  This economic resilience and the danger of an escalation in the Middle East boosted energy prices, which when coupled with lower interest rate sensitivity supported the outperformance of value over growth companies as well as non-sustainable over sustainable companies.

In this month’s commentary, Victoria MacClean delves into the complex mix of issues including climate policy, trade policy and regional protectionism, and the demand environment. With these factors pointing in different directions in terms of whether they are “good” or “bad” for sustainability, Victoria looks at how they are influencing our near- and longer-term thinking.

Top Holdings (alphabetically)

Agilent Technologies Inc

United States

Health Care

Agilent Technologies is a specialist in the development and manufacture of bio-analytics for the life sciences and chemical analysis industries. The company's mission is to advance quality of life. Within healthcare, its analytical instruments are used in the development and testing of healthcare products. Agilent also has a chemical analysis business which makes equipment for monitoring levels of pollutants in the ambient environment and or measuring contaminants in food and the human body.

CSL Ltd

Australia

Health Care

CSL develops medical products for serious and life-threatening diseases. Its core business is as a provider of human blood plasma-derived products to treat bleeding disorders, rare and serious infections and autoimmune diseases. CSL also manufactures vaccines and related products, including for flu and cervical cancer, as well as other products that speed up recovery times for patients that have undergone heart surgery, organ transplants and burns. The company provides these solutions across North America, Europe, Asia, Australia as well as other parts of the world.

Danaher Corp

United States

Health Care

Danaher is a diversified business that designs, manufactures and sells laboratory equipment, consumables and services to clinical and medical laboratories including microscopes, analytical software and imaging and molecular devices. These tools are used in the development of new drugs and for diagnosing critically ill patients.

Ecolab Inc

United States

Materials

Ecolab sells cleaning products and services to restaurants, hotels, hospitals, food and beverage producers and other businesses. The company has a particular focus on energy and water efficiency. Ecolab has developed a range of products and services that help to reduce, and in some cases even eliminate, the use of water in a wide range of industrial applications. In turn, this helps to lower costs through a reduction of energy and water impacts.

ICON PLC

United States

Health Care

ICON is a clinical research organisation (CRO) which provides outsourced development services on a global basis to the pharmaceutical, biotechnology and medical device industries. The company's mission is to accelerate the development of drugs and devices that save lives and improve the quality of life. ICON specialises in the strategic development, management and analysis of programmes to support all stages of the of the clinical development process.

Keyence Corp

Japan

Information Technology

The company's products include machine visions systems including sensors and measuring instruments that are primarily used in the automation of factories. These components help customers achieve higher levels of efficiency, energy-savings, improved material utilisation and reduced wastage and quality management.

Linde PLC

United States

Materials

Linde Plc produces and distributes industrial gases. The company operates globally supplying oxygen, hydrogen and other gases to a very wide range of downstream markets including into manufacturing industries, petrochemical and electronics industries. The gases are used in a variety of applications including in making manufacturing processes more efficient and in reducing harmful emissions. The company is establishing a strong presence in the green hydrogen market and also sells oxygen and other gases into the healthcare sector.

Schneider Electric SE

France

Industrials

Schneider Electric is a leading global provider of low- and medium-voltage electrical products and systems as well as automation control equipment. It specialises in digital automation and energy management, serving customers in the home, building and infrastructure industries. Its products and services promotes sustainability and energy efficiency through driving digital transformation in manufacturing processes and energy technologies.

Thermo Fisher Scientific Inc

United States

Health Care

Thermo Fisher Scientific is one of the largest suppliers of analytical instrument, equipment, consumables and software for healthcare and environmental research, analysis, discovery and diagnostics. The company offers a very wide range of products and services including the equipment needed to analyse samples as well as the variety of containers and other consumables needed to handle them.

Xylem Inc/NY

United States

Industrials

Xylem manufactures a wide range of products and provides services to the water industry. The company's water infrastructure business provides a range of pumps, filtration and testing and treatment equipment to water utilities. The company also supplies commercial, residential markets with water and wastewater systems, and provides measurement and control solutions. Xylem's strategy is characterised by the application of intelligent technology to improve water efficiency, in products such as smart meters and intelligent monitoring equipment.

Market Review

April was a challenging month for global equity markets. The MSCI World Index was down -3.2%.

Persistent inflation, and some economic strength, fuelled market fears that central banks will not ease monetary policy as quickly as previously hoped.  That economic resilience and the danger of an escalation in the Middle East boosted commodities prices.  A combination of rising energy prices and lower interest rate sensitivity also supported value stocks, which outperformed their growth counterparts.

The US was the weakest performing region as valuations came under pressure from rising bond yields. UK equities were the best performing, supported by their high exposure to commodity and energy companies.  Energy was the strongest sector in the global market, followed by Materials and Utilities, while Consumer Discretionary and Technology were the weakest.

Fund Review

The fund delivered negative performance over the month of -4.3%.

The Cleaner Energy theme detracted, including specific weakness in solar tracker maker Nextracker.  Concerns about growth in the US solar market weighed on the stock.  We think this is misplaced, not least because of the company’s global footprint. The Safety theme further hurt performance with both Steris and MSA Safety making negative contributions, on no particular news.

On the other side of the ledger, Trane in the Resource Efficiency theme was the largest positive contributor. The company delivered another beat-and-raise quarterly results driven by strong demand for its highly efficient commercial heating and cooling systems in Americas. The growth was broad-based across market verticals including data centres, healthcare, and education.

At a thematic level, Water Management was the largest positive contributor, with holdings including Veralto performing well. Veralto reported positive results in the company’s second quarter as a standalone company, after its spin out of another portfolio company, Danaher.  Better than expected margin expansion resulted in a raise of their full year guidance.

Outlook

Following the fall in inflation, sentiment in global equities is more positive with markets expecting that the central bank tightening is nearing its end. This environment should be more supportive for the generally smaller and more growth-orientated impact stocks we invest in.

Meanwhile, several of our key sustainability markets have cyclical challenges to overcome, as well as repositioning around China’s changing role in global manufacturing.  We remain convinced that the companies we invest in retain the competitive edge to deliver the transition to a more sustainable economy.

Navigating policy uncertainty in sustainable investing – why stock selection matters

By Victoria MacClean

There have recently been negative sentiment towards electric vehicles (EVs), headwinds facing Clean Energy companies and a risk that Trump would try to repeal elements of the Inflation Reduction Act (IRA) in the US if he comes into power later this year.

Underneath the surface of those topics is a complex mix of issues including climate policy, trade policy and regional protectionism, and the demand environment. Some of these factors are pointing in different directions in terms of whether they are “good” or “bad” for sustainability and for companies in our portfolio.

In this article, we will look at those issues and how they are influencing our thinking, both in the near-term and over a longer time horizon. While the picture may be complicated, we believe that there is still significant support for the structural sustainability drivers that underpin our investments.

Climate policy

Over the past few years, we’ve seen the launch of several high-profile climate package policies. The US introduced the Inflation Reduction Act (IRA) and the Infrastructure Investment and Jobs Act (IIJA), Europe announced its Green Deal, and China formalised its “dual-carbon goals” with 2030 and 2060 emissions targets.

These packages support growth across multiple themes and sub-themes within the portfolio. As an example, the IRA and IIJA cover renewable energy, electric vehicles, hydrogen, water infrastructure, and buildings. Together they invest over $1 trillion to address climate needs.¹

Last year, more solar panels were installed in China than the US installed in its entire history² and the government is likely to exceed its renewables installation and non-fossil energy targets.³ China is also the world’s largest EV market with sales expected to account for half of all car sales this year.⁴ This compares to an expected penetration rate of around 11% in the US and 28% in Europe.

Against that backdrop, it may seem surprising that Clean Energy and Sustainable Transport returns have lagged within the portfolio, but we believe there are three reasons for this. First, the risk that policy may change. Second, protectionist trade policies around the world are complicating the impact of climate policies. Third, there is a question about which companies will be able to generate positive equity value from addressing climate change.

Policy risk

We wrote about the growing trend of watered-down environmental policies in a previous blog.⁵ Since then, we’ve seen the EU making concessions to farmers following protests,⁶ the Scottish government scrapping its ambitious net-zero targets after a damning report by its independent advisers who warned that they were no longer credible,⁷ and the US Environmental Protection Agency (EPA) watering down tailpipe emission limits to allow a slower adoption rate of EVs.⁸

Despite the headlines, things are nonetheless moving in the right direction. The International Energy Agency (IEA) predicts that demand for coal, oil and natural gas will peak this decade even without any new policies.⁹ A study by Ember released in early May goes even further, anticipating that global power sector greenhouse gas emissions will peak as soon as 2024.¹⁰ Once up and running, currently announced manufacturing capacity additions in solar and batteries would be enough to meet demand by 2030.¹¹ In April the G7 countries, which together account for 20% of global emissions, also reached a milestone agreement to phase out the unabated use of coal by 2035. This sends a clear message to the rest of the world.

It seems clear that the tide has turned. The issue now is one of speed not direction. The potential for repeal of the IRA under a Trump administration is a good example. Emissions would still decline but they would fall at a much lower rate than under Biden’s policies. But both of those scenarios still fall short of what’s needed.¹²

Green trade tensions

Policy support is uncertain and needs to improve. However, we see increasing positive momentum from companies setting their own climate and nature-based targets which drives demand for our investments. Trane Technologies and Schneider Electric are two examples in heating, ventilation, and air conditioning (HVAC) and electric components and software respectively which are benefiting from this in their results.

One complicating factor in the current environment is the way that climate policy is interacting with trade policy. For example, the US has introduced several measures to severely limit the import of Chinese solar panels. China on the other hand has excess supply because their weak economy is supressing demand. That excess can’t go to the US and so Europe has to absorb a lot of it, resulting in pressure on pricing.¹³

The EV supply chain is another example of this complicated dynamic. EVs contain more semiconductor content than traditional vehicles so they are a great opportunity for semiconductor companies. However, there is a big push in China to grow the local value chain which means Chinese EV manufacturers are under pressure to use as much Chinese content as possible.

In Europe and the US there is also an increasing focus on creating a more regional supply chain. The US CHIPS Act and the EU Chips Act both have the aim of increasing supply chain resilience and protecting against Chinese technology advancements for security reasons. As a result, the US is projected to triple its manufacturing capacity by 2032, the fastest rate of growth globally.¹⁴

What does it mean for investment opportunities?

The answer is: it depends. There are a lot of moving parts to this complex landscape. That’s why we think bottom-up analysis and a fundamentals-driven approach to investing is so important in the sustainability space.

One area of focus for us is technology innovation creating a defensible moat around the business. If a company has technology that others can’t replicate this can help protect against some of the protectionist measures. Infineon is a good example – it’s the number one player in Micro Controller Units (MCUs). While Chinese companies are catching up in some technologies, they are significantly behind in MCU technology with a very small market share. Infineon’s head start and continued focus on product development stands the company in good stead to defend its position.

Another consideration is end-market exposure. In Clean Energy, First Solar is US-focused and a clear beneficiary of the shift to more US manufacturing. Many of our environmental themes also have diverse industry exposures, including exposure to commercial customers where the economic case is more compelling and less sensitive to interest rates.

In Sustainable Transport we have no direct original equipment manufacturer (OEM) exposure. We believe our holdings should benefit regardless of which car brands are the winners and the geographic mix of growth. Aptiv is a good example. It’s a tier one supplier of electrical components and software which has been announcing increasing design wins with Chinese OEMs as those companies take share in the global market.

There will be winners and losers in the transition. We think the companies that can capture the opportunities in the shift to a green economy will be well placed to outperform over the coming years.

¹ https://www.brookings.edu/articles/why-workforce-development-is-crucial-to-new-infrastructure-and-clean-energy-investments/
² https://www.vox.com/climate/24139383/climate-change-peak-greenhouse-gas-emissions-action
³ https://www.carbonbrief.org/guest-post-why-china-is-set-to-significantly-overachieve-its-2030-climate-goals
⁴ https://www.ft.com/content/5b8a02ab-2d0d-4459-85fb-4ae500de494f
⁵ https://www.whebgroup.com/our-thoughts/environmental-policies-vs-economic-realities-unravelling-the-conundrum-amid-a-cost-of-living-crisis
⁶ https://www.politico.eu/article/france-tractors-farmer-protests-gabriel-attal-emmanuel-macron/
⁷ https://www.politico.eu/article/scottish-government-abandons-flagship-climate-goal-mari-mcallan-says/
⁸ https://www.reuters.com/business/autos-transportation/biden-administration-relax-ev-rule-tailpipe-emissions-ny-times-2024-02-18/
⁹ https://iea.blob.core.windows.net/assets/ac433d3a-3f9e-482e-b8bf-17653b1c4024/NetZeroRoadmap-2023Update-ExecutiveSummary.pdf
¹⁰ https://ember-climate.org/insights/research/global-electricity-review-2024/#about
¹¹ https://iea.blob.core.windows.net/assets/ac433d3a-3f9e-482e-b8bf-17653b1c4024/NetZeroRoadmap-2023Update-ExecutiveSummary.pdf
¹² https://www.vox.com/climate/24139383/climate-change-peak-greenhouse-gas-emissions-action

¹³ https://www.ft.com/content/2ea6bf6d-04e9-453b-a35f-cd6431cfc7bf
¹⁴ https://www.semiconductors.org/america-projected-to-triple-semiconductor-manufacturing-capacity-by-2032-the-largest-rate-of-growth-in-the-world