Daniela Dorelova (left) and Alex Rowe (right), of Nomura Asset Management
Over the past year, markets have focused obsessively on the impact of higher inflation and soaring energy prices.
The focus on the need to tackle global, societal and environmental challenges has shifted somewhat down the priority lists of investors and broader society.
However, in fact, the need to address many of these challenges has only increased in importance - for example the need to transition away from fossil fuels and increase energy efficiency, reducing reliance on Russian gas, while governments globally announce huge increases in funding to accelerate progression towards a cleaner, more sustainable world.
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Over the coming years, it is believed that investors will be forced to refocus on sustainability, the challenges faced and the investment opportunities this creates.
In the United States, two key Federal acts are the Infrastructure Investment and Jobs Act (IIJA), which will provide in excess of $220bn of new funding for water resiliency, legacy pollution remediation and clean energy/ grid resilience; and the Inflation Reduction Act (IRA) that will provide almost $370bn of increased funding for addressing energy security and climate change over the next ten years through loans, tax incentives and grants.
The IRA includes for example, $139bn of funding for renewables, storage and grid reliability, $40bn for sustainable infrastructure, $14bn for home energy efficiency and $10bn for supporting domestic manufacturing of key components.
Speaking to the companies that the team invests in, the benefits of the IIJA (signed into law late 2021) are only expected to start flowing through to earnings from late 2023, while initial investor excitement for the potential benefits appear to in many cases have dissipated.
Recent huge increases to the budget of the Environmental Protection Agency and updated company expectations of the impacts provide further confidence in the benefits that will soon start to flow through.
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Not wanting to be left behind and in fear of increased competition from the US, Europe will be releasing its own version of the IRA. While details are currently being developed it aims to lower the burden for building out renewable infrastructure and allow more subsidies for clean energy through relaxing state aid restrictions.
The EU's Green Deal Industrial Plan is expected to focus on four main areas:
- Simplified regulatory environment - accelerating industrial manufacturing of key technologies, enhanced predictability and duration of permitting processes.
- Access to funding - this pillar includes the use of the NextGenEU funding (availability of €250bn, however skewed towards EU periphery countries), as well as InvestEU, which refers to the mobilisation of €373bn of private capital. The funding will be deployed through the use of tax credits, accelerated depreciation and subsidies.
- Necessary skills to enable a speedy transition.
- Resilient supply chain - this pillar would probably address the concerns of Europe's competitiveness vs the US given IRA's substantial support and could aim at netting off the effects between two value chains.
However, strong tailwinds from being aligned with such mega trends does not in itself make a good investment. The last two years have been a sharp wake up call for investors and a reminder that the companies invested in must be capable of executing on these advantages and stock prices paid must not reflect over exuberance as to the economic benefits that will accrue.
As a result, there has been a huge derating in a number of sustainability ‘darlings'. For many, this has been justified, however the team are seeing more and more opportunities to invest in companies that are exceptionally well positioned to benefit from an acceleration in the need to tackle huge societal challenges and this not being fully reflected in current stock prices.
Ways to play this theme include, for example, those companies that are involved in the early stages of the design and planning of water and sustainability projects, which are starting to see attractive opportunities appearing as states and municipalities grow more concerned about droughts and access to water.
The US has made huge commitments to ramping up infrastructure spending to support access to water and a cleaner grid (through Federal Acts such as the IRA and IIJA) and this spending will start to come through from the end of this year.
Alex Rowe CFA is lead portfolio manager and Daniela Dorelova is sustainable investment specialist of Nomura Global Sustainable Equity fund
