Exploring why contributing new capital and improving assets is crucial to meet Net Zero and sustainability goals.
The investment required to reach net zero is vast. The global consultancy, McKinsey, estimates $275 trillion needs to be spent on physical assets to meet sustainability and water goals by 2050. That’s an average of $9.2tn a year with spending currently $3.5tn a year short of that1. A recent Economist article outlined just how far behind we are – the headline „the world is going to miss the totemic 1.5°C climate target“ – doesn’t need any elaborating; although climate pledges (if achieved) would result in a 1.7°C temperature rise according to the Guardian2. At Fulcrum, we have made sustainability a core firm value and part of our purpose as a business, committing significant resource to become a leader in macroeconomic climate research. Signing up to the Net Zero Asset Managers Initiative (NZAMI) is part of that commitment, permeating much of what we do as a firm. We can create real change through our investments by funding the creation or improvement of sustainable assets and companies instead of just passively owning existing ones. We believe this is most impactful through our illiquid investments.
The ownership and maintenance of pre-constructed, existing assets like solar and hydropower facilities is, of course, crucial to meeting sustainability goals, and is where many ESG-focused funds concentrate. But it’s not enough. We need to build new renewable power generation facilities, new battery storage sites, install new home heating systems and improve the efficiency of our buildings at a much faster rate. These investments will, we believe, come with a substantial tailwind in terms of investment returns. Recent moves by the Biden administration via the Inflation Reduction Act as well as nineteen European countries announcing they are accelerating their decarbonisation targets following the Ukraine war3 are clear evidence of an ever-increasing momentum.
Listed Equity Markets
Many companies in the listed markets are contributing to the cause by building new assets to meet net zero. FTSE Rusell4 analysed 16,000 equities, 3,000 or so were found to have green products and services (or ~7% of 2021 market cap). This number has been growing at a CAGR of 24% from 2018-21, evidencing progress. That being said, the green economy is still only a small proportion of each sector with varying levels of saturation, e.g. only 5% of the Real Estate sector is ‘green’ versus 10% of the Technology sector. We co-lead the engagement with BP in conjunction with Climate Action 100 and they are a good example of change, having made, in our view, one of the most ambitious commitments to reduce emissions (and curb production) in the Oil & Gas sector. The company has pledged to “increase the proportion of its capital expenditure in transition growth businesses to more than 40% by 2025”5. We are pleased with the progress this engagement effort has made so far, while recognising they should go further and faster6.
Syndicated Debt and Private Debt
Primary debt issuance, both direct and syndicated via the banking sector, offers an opportunity to influence company management and direction. Banks are facing increasing pressure from shareholders and politicians to stop funding projects like new coal power plants. This is starting to yield results and should continue. Green/impact bonds are a welcome new development but remain a nascent asset class. Low rates haven’t helped – abundant capital has favoured debtors, weakening financial covenants and extending debt terms on lower and lower rates. Why would the average company want the hassle of adding green covenants too? The hawkish moves by central banks of late puts power back in the hands of the lender to design covenants that assist with the energy transition; for example, we are seeing some private debt managers look to incorporate carbon emission targets into all their loans. Infrastructure debt is often used to provide capital to sustainable projects at scale, although the yields are usually very low coupled with long bond durations. Therefore, these investments tend to only be suitable for liability hedging by insurance companies or defined benefit pension schemes.
Private Equity & Real Assets
Infrastructure and Real Estate
MSCI7 estimate ~90% of UK institutional investors that invest in real estate do so through ‘core’ mandates – this is akin to an investor holding a pre-existing asset mentioned at the start of the article. While core+ managers will make some improvements to their holdings (versus core investors who mostly maintain assets), they are small in nature, with the majority of returns still coming from asset operation. Moving up the return/risk spectrum to value-add, a smaller part of the market, involves the development of new assets or the large-scale improvement of existing ones. In the case of infrastructure, this is often done through buying land with planning permission and then funding construction, usually at a fixed price, reducing risk.
Within real estate, value can be added through improving energy efficiency or re-purposing a building, putting it to better use. This type of small-to-medium-sized development is vital to meeting net zero goals and is an area we allocate to within our illiquid portfolios. We don’t just need the largest offshore wind farms built by the likes of Orsted. We need solar panels on our local supermarkets and heat pumps replacing gas boilers in residential property. Net zero has to permeate our daily lives.
This asset class is somewhat less homogenious compared to infrastructure and real estate, often getting less attention by private market investors. Our chosen value-add focus here is on improving resource efficiency and driving toward a circular economy.
Forestry is a great example. Much of the world’s timber comes from smaller forests that are not run to the latest sustainability standards and lack efficiency, standing to benefit from better management. Buying small lot timber farms and improving them over time can have a host of potential advantages – higher carbon capture, yield, soil quality and increased biodiversity being some.
Precision agriculture and closed-environment farming are also budding areas for investment. Farming in its current form cannot continue – an ever-increasing requirement for farmland, the huge loss of topsoil via runoff and a growing use of pesticides and antibiotics are case in point. The institutionalisation of the greenhouse ‘closed environment farming’ sector is already underway, pioneered by the Norwegians. A greenhouse can be built on poor-quality soil and needs much less of it (output gains can be some 25x field farming), leaving space for renewable energy to be installed on any spare land to provide power to the greenhouse, or it can be rewilded. There are efficiency gains across the board, often only 10% of the water is required compared to field farming and pesticide use is dramatically lower too.
Private Equity and Venture Capital
The venture capital and lower-to-mid-size private equity markets are the bedrock of innovation and daily economic life. From a sustainability perspective, it is vital that we provide capital to those companies that are able to make the largest efficiency gains to their operations and to those creating goods or services that accelerate sustainability goals such as reaching net zero. We have a multi-sector approach and encourage clear sustainability plans.
Fulcrum invest across private and public markets and incorporates sustainability and ESG innovation across both areas. In the private markets, we believe that having a small-to-mid-market value-add investment programme gives us the best ‚bang for buck‘, both in return per unit of risk and across sustainability metrics. Our hybrid-liquidity offerings provide highly diversified exposure to each of these areas to create a real-world impact for the generations to come without sacrificing return.
Fulcrum Asset Management LLP. This document represents a marketing communication (non-independent research). It has not been prepared in accordance with legal requirements designed to promote the independence of investment research, and it is not subject to any prohibition on dealing ahead of the dissemination of investment research.
Fulcrum Asset Management LLP (‘Fulcrum’) defines marketing communication as market commentary consisting of illustrative, critically educational explanatory notes written to discuss or equally support an article or other presentation previously published. This document is also considered to be a minor non-monetary (‘MNMB’) benefit under Directive 2014/65/EU on Markets in Financial Instruments Directive (‘MiFID II’). Fulcrum defines MNMBs as documentation relating to a financial instrument or an investment service which is generic in nature and may be simultaneously made available to any investment firm wishing to receive it or to the general public. The following information may have been disseminated in conferences, seminars and other training events on the benefits and features of a specific financial instrument or an investment service provided by Fulcrum.
Information provided does not constitute investment advice and should not be relied upon as a basis for investment decisions, nor be considered a recommendation to purchase or sell any particular security or fund. In addition, the views expressed do not necessarily reflect the opinions of any investment professional at Fulcrum, and may not be reflected in the strategies and products that Fulcrum offers.
This document does not represent valuation judgments with respect to any financial instrument, issuer, security or sector that may be described or referenced herein. It is being provided merely to provide a framework to assist in the implementation of an investor’s own analysis and an investor’s own views on the topic discussed herein.
Any views and opinions expressed are for informational and/or similarly educational purposes only and are a reflection of the author’s best judgment, based upon information available at the time obtained from sources believed to be reliable and providing information in good faith, but no responsibility is accepted for any errors or omissions. The information contained herein is only as current as of the date indicated, and may be superseded by subsequent market events or for other reasons. Charts and graphs provided herein are for illustrative purposes only. The information in this document has been developed internally and/or obtained from sources believed to be reliable; however, Fulcrum does not guarantee the accuracy, adequacy or completeness of such information.
Nothing contained herein constitutes investment, legal, tax or other advice nor is it to be relied on in making an investment or other decision. Some comments may be considered forward-looking statements; however, future results may vary materially. By accepting this document, the recipient acknowledges its understanding and acceptance of the foregoing statement.
Australia: All information in this communication is intended to be accessed by ‘Wholesale Clients’ as defined by the Corporations Act. No offer or advice: Nothing on the website should be construed as a solicitation, offer or invitation, or recommendation, to acquire or dispose of any investment or to engage in any other transaction. Fulcrum is not providing any personal advice or recommendation regarding any financial products within the meaning of section 766B of the Corporations Act. No consideration has been made of any person’s investment objectives, financial situation and/or needs. Prospective investors should make their own enquiries and should seek all necessary financial, legal, tax and investment advice.
UK & EU: For professional investors and eligible counterparties as de each as defined in Directive 2014/65/EU, as amended (“MiFID II”), which UK which has been transposed into domestic law by the Financial Services and Markets Act 2000 (Regulated Activities) (Amendment) Order 2017, the Financial Services and Markets Act 2000 (Markets in Financial Instruments) Regulations 2017 and the Data Reporting Services Regulations 2017 (together “UK MiFID II”).
Japan: QII means a qualified institutional investor as defined in the Cabinet Ordinance Concerning Definitions under Article 2 of the FIEL (Ordinance No. 14 of 1993 of the Ministry of Finance of Japan, as amended).
Switzerland: For qualified investors (the „Qualified Investors“), as defined in Article 10(3) of the Swiss Collective Investment Schemes Act („CISA“) in conjunction with Art. 4(4) of the Swiss Federal Act on Financial Services („FinSA“), i.e. institutional clients, at the exclusion of professional clients with opting-out pursuant to Art. 5(3) FinSA (“Excluded Qualified Investors”).
United States: this document is not intended for distribution in the United States or for the account of U.S. persons (as defined in Regulation S under the United States Securities Act of 1933, as amended (the „Securities Act“)) except to persons who are „qualified purchasers“ (as defined in the United States Investment Company Act of 1940, as amended), „accredited investors“ (as defined in Rule 501(a) under the Securities Act) and Qualified Eligible Persons (as defined in Commodity Futures Trading Commission Regulation 4.7).
Redistribution or reproduction of this material in whole or in part is strictly prohibited without prior written permission of Fulcrum Asset Management LLP, authorised and regulated by the Financial Conduct Authority (No: 230683) © 2023 Fulcrum Asset Management LLP. All rights reserved.