We have seen global stock markets start to run out of steam amidst the second wave of COVID-19 in Europe. Fears of a tighter lockdown and increased restrictions, coupled with the political chaos in the US, have made hopes of a global economic recovery by the end of the year unlikely. While some sectors of the market have struggled during 2020, others such as hydrogen have experienced significant growth. In this month’s commentary, Ty Lee shares his views on the new hydrogen era, exploring whether it is just hype or whether there are more substantive reasons to get involved.

We are delighted WHEB has been shortlisted for the Boutique of the Year (below £1bn AUM) category in the Specialist Investment Awards 2020 from Investment Week (UK).

Top Holdings (alphabetically)

Agilent Technologies United States Health Care

CSL Australia Health Care

Daifuku Japan Industrials

Icon Ireland Health Care

Keyence Japan Information Technology

Koninklijke DSM Netherlands Materials

MSA Safety United States Industrials

Roper Technologies United States Industrials

Steris United States Health Care

Thermo Fisher Scientific United States Health Care

Global stock markets ran out of steam in September amid the second wave of COVID-19 in Europe. Fears of tighter lockdown and restrictions on economic activity dampened hopes of a rapid economic recovery for the rest of the year. The benchmark MSCI World Index ended the month down -0.38%.

Meanwhile, the Fund meaningfully outperformed that benchmark in September, rising +3.73%. The outperformance was mainly driven by the Resource Efficiency and Health themes. It was partly offset by weaker performance in the Education and Cleaner Energy themes.

Resource Efficiency was the best performing theme in the month. The stocks of two Japanese advanced manufacturing companies, Daifuku and Keyence, did well. Daifuku is a leading material handling system supplier. Its products enable warehouse and factory automation and reduce energy and resource use in these activities. Keyence is another technology leader, this time in machine vision. Its sensors and measuring instruments help customers save energy and reduce waste.

COVID-19 highlighted the risks in supply chains and logistics for many companies. These companies began to look for ways to automate their supply chains to improve efficiency, resiliency, and safety. This potential growing demand has helped drive the strong performance of these stocks so far in 2020. After a short lapse in August, they regained momentum in September.

Our Health theme was another strong performer. Steris was the strongest positive contributor to the theme. It is a leading provider of infection prevention and control equipment. It serves hospitals, medical device manufacturers, and pharmaceutical companies. The company is well-positioned to benefit from the increasing focus on infection prevention and control as a result of the pandemic.

The weak spot in the month was the underperformance of the Education theme. Both of our holdings in the theme, Grand Canyon Education and Strategic Education, are US higher education providers. This sector is typically seen as very politically exposed and has been under pressure ahead of the US presidential election. We are happy to hold both companies despite this political noise.  They are making a meaningful positive social impact. They help to address a serious skills gap problem through providing high quality accessible online education. They also both focus on underserved populations.

Our Cleaner Energy theme also performed poorly, due to a weak performance from TPI Composites. It is an outsourced manufacturer of blades for wind turbine manufacturers. It also produces lightweight composite structures for electric buses. The stock has benefitted from the positive sentiment around the renewable energy sector since the beginning of the pandemic. It gave up some of these gains this month.

COVID-19 continues to dominate the stock market as it does all other aspects of life in 2020. Companies that outperformed this month mostly operate in sectors that have seen growing demand during the pandemic. These sectors include warehouse automation, logistics, factory automation, and infection control. This once again validated our conviction that several sustainability trends have been accelerated by this pandemic. The Fund is well placed to benefit from these enhanced trends.

Is it time to jump on the hydrogen bandwagon?

In the first half of 2020, investors were piling money into hydrogen-linked stocks. During the second quarter, the stock price of hydrogen-powered car company Nikola shot up 535%. Other shares related to the technology were also very strong. ITM Power jumped 123% and Ballard Power rose 96%. These companies don’t just share an interest in hydrogen. They are all loss-making and are expected to be so for several years yet. In the third quarter, this momentum waned, and their share prices slumped. The easy conclusion to draw is that this is just another example of hydrogen hype. We saw a similar cycle 20 years ago.

So, is the new hydrogen era just a hype or are there more substantive reasons to get involved? Looking at the stock markets, some investors clearly believe that hydrogen is the next big thing. And there are some good reasons to believe this is the case.

Strong policy support in some regions

Several countries have renewed their interest in hydrogen as part of their strategy to decarbonise their economies. The European Commission recently set a target to produce up to 10 million tonnes of renewable hydrogen by 2030. Japan was relatively early to embrace hydrogen technologies. It adopted a “Basic Hydrogen Strategy” as early as 2017. The aim is to decarbonise key sectors such as transport and power while strengthening energy security. China plans to have 1 million fuel cell vehicles on the roads by 2030.

Substantial corporate interest

The renewal of interest in hydrogen is not limited to the policy level. We have also seen companies putting money into hydrogen projects. For example, Johnson Matthey has been engaged in hydrogen production and fuel cell development for decades. Its automotive fuel cell sales went from zero 18 months ago to 25% of its total fuel-cell sales. The number of companies joining the Hydrogen Council has more than quadrupled to 81 companies since the inception of the industry initiative in 2017.

How to invest in hydrogen

As impact investors, we are excited about the potential of growing hydrogen use to reduce carbon emissions. However, not all hydrogen is produced in the same way. Today, hydrogen is still largely produced from fossil fuels, which is either referred to as “brown hydrogen” or “grey hydrogen”. “Blue hydrogen” combines grey hydrogen with carbon capture and storage. ”Green hydrogen” is produced by electrolysing water using electricity from renewable sources. We would only be interested in blue or green hydrogen given its greater potential to cut carbon emission. However, a global rollout of these technologies is not possible without steep price decreases.

Looking across the investment opportunities, we have found very few investable companies so far. Some are too small. Some are heavily loss-making and not yet commercialised. At the moment, we believe that the best way to gain exposure to the growth of hydrogen in decarbonising downstream sectors is by investing in established companies that have a footprint in this space.

Linde, one of our investee companies, is a good example. It is the largest industrial gas company in the world. Linde is about to begin construction of the world’s first hydrogen refueling station for passenger trains in Germany. It also recently formed a partnership with Scottish Power Renewables and ITM Power to build a 10MW green hydrogen production facility in Glasgow. The project aims to supply hydrogen to the commercial market within the next two years.

Kion is another example in our portfolio. It is a leading forklift manufacturer. Kion has been running hydrogen projects involving a wide range of vehicle types since 2013. While fuel cells are not a big part of its business today, they are well-placed to expand their use of fuel cells. According to the Hydrogen Council, the total cost of ownership of fuel cell forklifts today is already cheaper, compared to diesel. With cost coming down for hydrogen, fuel cell forklifts have the potential to penetrate more than 65% of the market by 2050.

As with a lot of emerging trends, forecasting demand accurately is not enough. With supporting government policy, the competition will intensify. Companies without sustainable competitive advantages in a nascent industry can easily be devoured by competition. We have seen this in the solar and wind industries over the years. We would prefer to invest in well-run high-quality companies – companies with relevant technologies that can be leveraged in hydrogen applications as exemplified above.