The fastest Bear market in history?

The US market bottomed (at least initially) on the 23rd of March 2020 following a 31.9% decline from its peak 5 weeks ago. Modern financial history only goes back about 120 years, so if we take that as our guide, the table below from William O’Neil & Co. shows that this was the quickest and most intense (-7.2% per day) bear market in history. Only 1929 (part 1 of the great depression) and 1987 come close in terms of velocity.

To read more download the full article The fastest Bear market in history

About the author

Craig Bonthron is an investment manager in the Equities team, responsible for actively co-managing high conviction global equities portfolios. He focuses on analysing disruptive and sustainable investment trends within the technology, healthcare, industrial and consumer sectors in order to identify high conviction stock specific investment ideas.  He joined us in 2014 from SWIP, where he was an investment director in global equities. Prior to SWIP, he was a portfolio manager at Kleinwort Benson Investors. Craig has a 1st Class honours degree in Building Surveying and an MSc with Distinction in Business Information Technology Systems from Strathclyde Business School. He has 18 years’ industry experience.  *As at 30 November 2019.

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Renewable energy growth – the wind of change

In the same week that a disastrous meeting between OPEC and Russia hit the price of oil, the UK government announced it would lift a ban on onshore-wind and solar from competing in subsidy auctions.

The approximate 30% slide in the oil price was a reminder of how vulnerable the commodity can be at times, when supply is dictated by a few oil rich nations. The argument to de-carbonise energy production is well past its tipping point – it’s now cheaper for the majority of the world (and continues to get cheaper) with almost no negative side effects for the environment. Compare that to burning fossil fuels. 

The decision in the UK to lift the ban will encourage more renewable projects as the government guarantees a minimum price the developer will receive for the energy produced. Since the decision to ban onshore projects from competing for subsidies in 2017, unsubsidised projects have still gone ahead and proven they are feasible without government help. However, to reach the UK’s ambitious climate targets, support is needed to speed up investment.

On paper, we have one of the world’s most progressive climate policies. The net zero target by 2050 was signed as legally binding in June last year. This type of announcement was the first from any major economy.


The UK has been advised by the independent body, Committee on Climate Change (CCC), that clean energy production will need to quadruple in order to achieve the net zero target.  

Onshore wind is currently the cheapest form of energy to produce in the UK, so opening this market back up to subsidies is an encouraging sign and will benefit the likes of Orsted and SSE (plus some landowners in the Highlands!)


Currently there is about 8.5GW installed around the UK’s coastline. So there is ample investment opportunity to reach the 40GW of offshore wind by 2030 that has been pledged, alongside the CCC’s recommendation of building 1GW/year of onshore wind until 2050.

It’s the first time, in a long time, that we have had utilities analysts claim that this is now a growth sector. With more renewable-friendly regulation, the UK’s abundance of wind is likely to become one of our major assets.

About the author

Euan Ker is a Sustainable Investment Analyst. He is responsible for analysing and monitoring environmental, social and governance factors within the Global Sustainable Equity Strategy. Euan joined us in 2014 as an investment implementation analyst with responsibility for implementing macro investment decisions across a number of fund-of-fund mandates, totaling some £13 billion under management. Prior to moving to the ESG Research team in 2018 his responsibilities also included asset class, regional and currency hedging overlays through derivatives. Euan has a 1st Class Honours degree in Management with Economics from Robert Gordon University. He has the IMC professional qualification and has 6 years’ industry experience.*  *As at 30 November 2019.

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50 shades of green…

The EU Taxonomy is a legal classification framework being introduced in stages, to help define what is (and isn’t) a sustainable economic activity. It will require companies to make new disclosures on the extent to which their activities are associated with taxonomy-aligned activities and it will require fund providers to describe the extent to which their products are also taxonomy aligned. Yawn…..yes, it is as dull as it sounds (591 pages but hey, there is a handy 67 page summary…..). However, because of the impact it could have on sectors, companies and share prices, every investor (not just the ESG guys) will need to get to grips with it. And by the way, the timing for its implementation is by the end of 2021 (assuming it gets sign-off from the European Parliament).

Why bother?
Two reasons, both of which required the taxonomy to be science-based. Firstly, the investment required to address the challenges of climate change is huge; the European Investment Bank (EIB) estimates that to address transport related climate issues needs Euro80bn, water and waste Euro90bn and energy Euro100bn. To close the gap, the EU needed to define ‘green’ in order to direct capital towards it.  The second reason is fund green-washing. ESG is very popular right now. The taxonomy will blow a hole in some of the claims that some fund providers are making.

What does it actually mean for corporates and investment firms?
It all hinges on corporates reporting the right stuff that investors can use. For corporates, financial and non-financial companies will need to disclose, in their annual accounts (or dedicated sustainability report), any turnover and capital or operational expenditure associated with taxonomy-aligned activities. At the fund level (or other financial products), fund providers will be required to disclose the extent to which the portfolio is aligned (if they have sustainability as an explicit investment objective) or for those funds which don’t have a sustainability objective, it’s comply or explain.

Do companies even report this information?
No….nope…not even close. Or rather they may do some to regulators e.g. for purposes of the EU Emissions Trading Scheme (ETS), but certainly not currently to investors. The statement, ‘In cases where full disclosure is not made, the TEG acknowledges the hurdles involved in assessing compliance’ somewhat understates the problem.

What is defined as ‘green’?
In its first iteration, the Taxonomy is focused on climate change. In due course, it will be broadened out to address other environmental concerns e.g. ‘sustainable use and protection of water and marine resources’ and ‘transition to a circular economy, waste prevention and recycling’. In the first round, activities are classified as ‘green’ (already low-carbon), ‘transition activities’ (that contribute to net-zero emissions in 2050, but aren’t themselves there yet) and ‘enabling activities’ (that enable low-carbon performance or substantial emissions reductions). Things like low carbon transport or battery storage are included in the latter category. Manufacturing of batteries for electric vehicles is taxonomy eligible, but lithium mining isn’t. Go figure. So-called ‘brown’ activities aren’t currently included, although the taxonomy is open to considering this area in the future (think oil & gas transition).

 It’s part of a whole bunch of other green regulatory stuff
The EU is at the forefront of global financial system reforms that aim to incorporate sustainability. As such, the EU taxonomy shouldn’t be viewed in isolation, but as one part of a series of actions, which it could provide a framework for, including new capital requirements for taxonomy-aligned projects, a green quantitative easing program from the European Central Bank, or a haircut for brown assets in the European Central Bank’s collateral policies.

Well done for reading this far
Will it work? We have said before that ‘perfect is the enemy of good’. There is a strong element of idealism in the very comprehensive technical recommendations made by the taxonomy, like there is only one shade of green. Given that no corporates currently report in this way, the new regulation will be both challenging and potentially burdensome. Will there be sufficient end-user (investor) demand to make companies report this stuff? Does its complexity mean it will simply get ignored? Will the easiest way to conform be to invest in pure-play climate solution providers (;0)? Time will tell.

About the author

Ryan Smith is Head of ESG Research at Kames Capital. He joined Kames Capital in October 2000 as an SRI analyst and was appointed to his current position in September 2002. He has 19 years’ industry experience. His role involves managing the team that conducts the ESG screening process for our Responsible Investing funds. Ryan’s team also provides corporate governance screening and research for all equity investments, and conducts research into environmental and social issues. Before joining us, he worked as an environmental chemist for Severn Trent Water. Ryan has an MSc in Environmental Chemistry from Nottingham Trent University.  *As at 30 November 2019.

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Impact Calculators: Informative, exaggerated or mis-selling?

“Everything should be made as simple as possible, but not simpler” Albert Einstein

 You may have come across impact calculators in your search for a sustainable fund to invest in. These neat tools usually take the form of a simple text entry box on a website that turns your £/$/€ invested into a precisely quantified reduction of bad things… and increase in good things.

They usually look something like this:

So what happens when you enter the amount that you want to invest? There are usually nice infographics which accompany the “statistics” combined with an array of feel good outputs – not to mention a surprising lack of disclosure regarding the assumptions or error ranges around the calculations. For example, it might tell you that you will save thousands of tonnes of CO2 or millions of plastic bottles by investing. It might claim your investment is the equivalent of taking thousands of cars of the roads or planes out of the sky. I might suggest that your investment provides millions of litres of clean water or provides treatment for hundreds of sick people. What’s not to like?


But perhaps I’m being too cynical. Aren’t these claims broadly accurate? Surely encouraging investment in such funds should be encouraged? I mean, they might be over-reaching a bit, but the ends justifies the means in this case. Right?

No, no and no. These claims are not fact. They are unsubstantiated and unverified. In fact, they are unverifiable! They are, to a large extent, unmeasurable. The impacts that companies have on the world around us via their products and practices are complex, multi-faceted, nuanced, highly variable across sectors and range from source materials or labour through to the second and third order impact of the products in use. The inter-relationships between the companies within a portfolio can offset each other. I genuinely don’t know where to even begin to think about how to reduce that down to a few simple numbers.

“Not everything that counts can be counted. And not everything that can be counted, counts.” Albert Einstein

All of which begs many questions.

Why is this allowed?
Who is regulating it?
Who can we trust?
Oh no not again (head in hands emoji, exasperated emoji)… do we learn nothing in this industry?

Very good questions. We’re asking the same ones on a regular basis, with the same level of exasperation. This sort of behaviour sows the seeds of future consumer mistrust. It (quite rightly) leads to regulatory clamp down which restricts everyone, including the best actors. It starts small with genuinely good funds with positive impact trying to capture a bit of market share and ends with some large cynical corporation taking it to extremes. If you think I’m being alarmist about this particular slippery slope, we don’t have to look far to see how quickly the terms “greenwashing” and “rainbow-washing” have gained traction. And it’s hard to argue that our industry doesn’t have form in terms of colossal, commercially motivated F&*& ups.

From the perspective of the retail consumer and the rise of the collective consciousness regarding sustainability, positive impact is one of – if not themain reason retail investors will buy funds in the future. So the commercial motivation is clear… can we be sure that the organisational integrity is highly tuned? We should judge that on a company-by-company basis, but the general consumer perception of our industry is not good. Trust and goodwill are fragile. They take a long time to build and just one isolated scandal to destroy.

Source: PWC

To sum this rant up, I believe this is worse than the standard forms of “greenwashing” which are fairly transparent in their disregard for genuine sustainable investing. Or “rainbow-washing”, that involves randomly attaching UN SDG badges to every company in the fund to prove how wonderful it is. We have internally coined the phrase ‘woke-ulators’ for these impact calculators. This is dark humour to help us deal with the seriousness with which we take this. It’s not good. Positive impact fund managers need cut it out before it damages all of our reputations.

But perhaps this is finally coming to a head. The 2 Degrees Investing Initiative (2DII) is beginning to resist the currently loose definitions of impact and has quit the Science-Based Targets initiative (SBTi) over how companies set ambitious and meaningful GHG reduction targets. The definition of impact must be the one understood by the general public and retail investors.

See here: 2DII “Science Based Targets” for financial institutions

Yes. It’s complicated. Communicating what we do as impact managers to the public is tough. It can require patience. But no matter how commercially tempting it is and how important the end (you believe you are justifying) is, we need to resist the urge to compromise our integrity.

“Doubt is not a pleasant condition, but certainty is an absurd one.” Voltaire

For over 30 years we have ardently resisted green washing, rainbow washing and magic green buttons.… and for the last two years or so we have had to resist the “woke-ulator” too. We may have lost out on market share as a result. That’s not particularly pleasant to think about, but then the alternative is absurd.

Other soapboxes on closely related topics can be found below:
Positive (second-order) impacts
The carbon footprint of your investment
Supply Chains: Materially materialising
Everything is awesome
Why it can be good to look bad

 

About the author

Craig Bonthron is an investment manager in the Equities team, responsible for actively co-managing high conviction global equities portfolios. He focuses on analysing disruptive and sustainable investment trends within the technology, healthcare, industrial and consumer sectors in order to identify high conviction stock specific investment ideas.  He joined us in 2014 from SWIP, where he was an investment director in global equities. Prior to SWIP, he was a portfolio manager at Kleinwort Benson Investors. Craig has a 1st Class honours degree in Building Surveying and an MSc with Distinction in Business Information Technology Systems from Strathclyde Business School. He has 18 years’ industry experience.  *As at 30 November 2019.

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“I don’t care if it rains or freezes, as long as I got my plastic Jesus”

Plastic waste has BOOMED from the 15 million tonnes we lobbed over the fence in 1964 to approximately 360 million tonnes in 2019(1).   The CO2 emissions from plastic waste are around 80% of the aviation industry’s total footprint (2).

The challenge for humankind is not only environmental pollution but also how to mitigate the impact on our health; plastic has health implications for our continued wellbeing at every stage of our lifespan. It’s estimated that 32% of it ends up in our oceans and rivers each year.

Single use plastic has, understandably, been given all the focus, given there is the least justification (or most guilt) for its continued use. Mechanical recycling rates are low and at best it ‘down-cycles’ rather than displaces the need for virgin resins. The process of ‘plastic pyrolysis’, which is basically a chemical reaction, breaks down plastic to its original naphtha state (a mixture of hydrocarbons). While pyrolysis is a good scrabble word it is not much use for solving our problems yet. There are significant challenges; it produces, for example, lots of diesel – not the favourite hydrocarbon child.  It also requires a very efficient collection mechanism. Therefore the process remains quite expensive compared to cheap virgin feedstock, particularly as commodity prices remain low.

Rain or shine we’ll need our plastics but it seems unlikely that this is enough to prop-up our extractive industries at their current scale. Currently, 69% of a barrel of oil is used in transportation industries (4). As more and more oil demand is displaced from the continued shift to clean modes of transport, the input costs will increase for plastics. On a relative basis other materials may become more attractive, the chemicals industry will therefore have a challenge to retain the relative attractiveness of its product to all its customers.

Even if all the challenges of chemical recycling are surmountable, companies are not investing fast enough. Why would they? I expect the economics look terrible. Currently many refineries, such as those on the US Gulf coast, enjoy geographic cost advantages. They are located, for example, close to supply or shiny new pipelines. The return on investing is likely lower for new projects to invest in recycling where their output will have no such advantage.

All the while the US keeps building pipelines to the Gulf with 20-year payback periods, enabled by loosened environmental controls.

“Cause Jesus’ plastic doesn’t hear
‘Cause he has a plastic ear
The man who invented plastic
Saved my soul.”
Source: ‘Plastic Jesus‘: song by Ed Rush and George Cromarty

Sources
1) J.P.Morgan Petrochemicals – Peak Plastic
2) https://www.mckinsey.com/industries/chemicals/our-insights
3) Ellen MacArthur Foundation
4) https://www.eia.gov/energyexplained/oil-and-petroleum-products/use-of-oil.php

About the author

Jonathan Parsons is an Investment Manager in the Equities team with responsibility for North American equities. He also manages a global technology portfolio and contributes to the idea generation process for our global equity portfolios. Prior to this, he worked as a Quantitative Analyst, also in the International Equities team. Jonathan joined us in 1996 straight from university and has 24 years’ industry experience*. Jonathan studied Mathematics & Computation at Loughborough University of Technology and is a CFA charterholder.  *As at 30 November 2019.

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“You don’t own enough windmills!”

It’s a comment that was made to us recently in a meeting with a prospective client. It’s also occasionally inferred in some commentary from other clients. So first, let’s set the record straight……. We like windmills!

But. It’s a tough business to be in right now (see recent profit warnings from Siemens Gamesa and negative commentary from GE). Vestas are the clear sector leader, and have better managed unit pricing and cost pressure, but even they struggle to consistently execute (especially offshore). Project risk is significant, delays can be costly and unit economics often dependant on variables outwith company control. As we have said previously, just being exposed to a theme is not enough. In renewables, long-term competitive advantage requires cost and technology leadership plus price discipline.

We won’t invest in anything just to appear virtuous! And we believe there are other ways of having a positive impact. The positive sustainable impact of technology might not be so obvious as a wind turbine, but we strongly believe it is no less important. Don’t get us wrong, technology alone can’t sort all our environmental ills, but we are more wizard than prophet. So called Fourth Wave Technologies, including artificial intelligence, automation, blockchain, data analytics and sensors are allowing businesses to lower resource consumption, decrease pollution, carbon emissions and waste AND boost their bottom line. Boom! They are functionally better and virtuous!

 


Nearly every CEO and VP we surveyed agrees that emerging technologies have at least some potential to improve their organization’s environmental impact, and 92% of all leaders agree that these technologies can help businesses improve their bottom line as well as their sustainability.’
Source – Business and the 4th wave of environmentalism, Findings from Environmental Defense Fund’s 2019 Fourth Wave Adoption Benchmark Survey.
Source – Making things better: Advanced Analytics and Manufacturing, Oct 2019, Bloomberg New Energy Finance

Energy reduction from software analytics, by industry (case studies)

And whilst the rate of adoption varies, companies across every industry are employing technology to drive efficiencies. Business leaders ignore at their peril. With benefits to retailers (data analytics to predict online purchasing trends), suppliers (blockchain to better track products and transactions for improved efficiency) and manufacturers (artificial intelligence for safer, more precise output), uptake of Fourth Wave technologies is surging.  Previous industrial revolutions have radically improved our standard of living but they have also borrowed from the future. Today’s technological revolution might just help break this pattern.

About the author

Ryan Smith is Head of ESG Research at Kames Capital. He joined Kames Capital in October 2000 as an SRI analyst and was appointed to his current position in September 2002. He has 19 years’ industry experience. His role involves managing the team that conducts the ESG screening process for our Responsible Investing funds. Ryan’s team also provides corporate governance screening and research for all equity investments, and conducts research into environmental and social issues. Before joining us, he worked as an environmental chemist for Severn Trent Water. Ryan has an MSc in Environmental Chemistry from Nottingham Trent University.  *As at 30 November 2019.

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