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Schroder Global Energy Transition - New addition

Energy transition is a multi-decade theme where capital will be reallocated on an unprecedented scale.

| 9 min read

The potential impact of climate change is well known, and the scientific consensus is that urgent and drastic action is needed to prevent potentially catastrophic effects. In response, governments are stepping up their ‘net zero’ commitments to drastically reduce carbon dioxide emissions from fossil fuels. The European Green Deal, China’s 14th 5-Year Plan and policy developments in the US all support significant investment to limit a global temperature rise to “well below 2°C” – as agreed in the 2015 Paris Agreement.

As a result, investment in climate solutions has rapidly moved from the periphery into mainstream. To achieve climate goals, how we produce, distribute and consume energy will have to change significantly and will require monumental investment – as much as $120 trillion has been estimated. From a purely economic perspective, renewable energy also makes sense – it is now the lowest cost form of generation in most markets. However, it can be less reliable than traditional sources, which means storage and management are key components of the energy transition.

It’s clear that companies have a key role to play in the battle against climate change and the evolution of a more sustainable energy system, and the huge investment required will likely create significant opportunities. Businesses delivering products or services that are part of the solution should be well placed to deliver growth to shareholders.

Structural changes are necessary

To meet targets the energy system needs to undergo three structural changes, which are currently in their infancy.

Firstly, the decarbonisation of power generation. The share of electricity generated from renewables is expected to increase from 20% to almost 85% by 2050 in order to reduce carbon emissions, which should offer opportunity to utilities companies who specialise in renewables, electrical equipment companies, and energy storage companies who can help iron out the peaks and toughs of supply and demand.

Second, further electrification of energy use through the adoption of electric vehicles. The share of electricity in energy consumption is expected to increase from 20% to nearer 45% and most countries will require significant upgrades to their electricity grid and infrastructure.

Finally, increased efficiency is necessary to offset the growth in overall power consumption, which presents opportunities for businesses with intelligent or energy saving technology.

One option in the sector - Schroder Global Energy Transition Fund

There are broadening number of funds investing specifically in the transition towards lower carbon sources of energy and more sustainable forms of consumption. One is Schroder Global Energy Transition, which aims to outperform the MSCI Alternative Energy Index, the MSCI AC World Index and peers over a rolling 3-year period.

The fund was launched in December 2020 but adopts the same strategy as an offshore version that commenced in July 2019. It invests across the entire sustainable energy industry from production to end use, classifying investments into five activity groups:

  • Renewable energy equipment
  • Renewable energy generation
  • Transmission and distribution
  • Energy storage, batteries and other solutions
  • Electrical equipment

Although investing across the sustainable energy industry spectrum provides some diversification, this is a higher risk and specialist investment. It has a high weighting to small and medium sized companies (around 80% of exposure is presently to companies with a market cap less $10bn) which can be less resilient that larger firms, plus the portfolio comprises a relatively small number of constituents (30 to 50) which increases risk as each holding has a bigger impact on returns. In addition, many companies in the area are already priced for high growth and any setbacks or inability to keep up with expectations could lead to significant falls.

Table: Schroder Global Energy Transition top ten holdings

Vestas Wind Systemswind turbines4.4%
First Solarsolar panels/ plants4.0%
Red ElectricaSpanish & South American grid operator3.1%
TernaItalian & South American grid operator3.1%
Ormat Technologiesgeothermal energy3.0%
Umicoreprecious and specialist metal products3.0%
Nexanscable and fibre optics2.6%
Falck RenewablesEuropean renewable energy generator2.6%
Hydro OneCanadian utility2.4%
Schneider Electricenergy management and automation2.4%

Source: Schroders – as at 31.12.20

Geographically, the opportunity set is global and tends to lead a bias towards Europe and China, and away from the US.

Manager credentials and philosophy

The fund’s lead manager is Mark Lacey, Schroders Head of Global Resource Equities, who joined Schroders in 2013 initially to run their global energy strategy. He is the former manager of Investec’s global energy funds and the former Head of Global Energy at Goldman Sachs, among other roles.

Portfolio manager Alex Monk joined the team in September 2018 as a sustainable energy analyst, having started his career with Schroders in 2016. Felix Odey, also portfolio manager, joined the team as an energy equity analyst in June 2017. The team make use of Schroders’ global research platform and can interact with regional or sector specialists to enhance their own research. This is particularly important in regions such as China where corporate governance can be more variable.

The managers seek to capture the growth on offer in the energy transition space without paying too much in terms of valuation. Specifically, they focus on finding companies within the energy transition space that can generate sustainable, long-term growth and earnings and are resilient in terms of balance sheet strength. A differentiating feature is the manager’s willingness to run up some cash (up to 20%) when attractive opportunities are in short supply.

Managers’ current outlook

With significant investor interest in the sector finding reasonable value shares is an increasing challenge for the managers. In particular, they have grown progressively more cautious on various sub-sectors in the energy transition universe including energy storage, renewables and hydrogen. They warn valuations are looking fairly stretched, but still see an acceptable balance between risk and reward in other areas, particularly in the regulated utility and electrical equipment markets.

They are focused on attractively priced high-quality companies, strong balance sheets and sustainable business models and are vigilant surrounding heightened valuations and market exuberance. Presently, the fund holds around 13% in cash.

Our view

Energy transition is a multi-decade theme where capital will be reallocated on an unprecedented scale, creating investment opportunities across a multitude of sectors and industries. However, there has been a surge in interest in renewable energy stocks recently and consequently valuations have become more expensive.

There have been some genuine drivers behind this: Fundamental resilience during Covid 19, a positive change in US leadership, loose monetary policy, enormous public fiscal support, and the shift in capital towards sustainability and environmentally themed investments. However, there is a danger that a large wave of money is seeking a relatively small number of opportunities in the area.

We believe a selective, disciplined and active approach such as the one adopted by this fund is a sensible means to access the space. The combination of a well-resourced team and competitive charges for a fund of its type add to the attraction. However, even among the more established businesses in the energy supply chain there will likely be significant losers as well as winners. The combination of the strong recent track record of the area and the positive environmental outcomes should not distract from the high risk involved.

For patient, longer term investors it could be worth considering as a more adventurous, satellite holding in a broad portfolio. It is also worth noting that it excludes companies involved in fossil fuels and nuclear energy, as well as applying ESG screens, so it could be of interest for many socially responsible investors too. We welcome it to our

Direct Investment Service Preferred List our curated list of investments for new investment in their respective sectors.

Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.

Schroder Global Energy Transition - New addition

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