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2023: Time to generate positive impact and performance

 

The beginning of 2023 is marked by a strong rally in both equity and bonds. The main drivers of this rally are the worldwide decrease in inflation expectations as well as the re-opening of the Chinese economy. Put together, these two factors led market participants to anticipate a soft-landing of developed countries’ economies together with friendlier Central Bank policies. There are many reasons why we don’t share these optimistic expectations. First, because the current valuation level of equity markets (especially in the U.S.) is not attractive enough compared to government bonds to justify the current equity rally. Second, because earning expectations are still too high and thus do not reflect the expected growth rate of the economy.

 

By Guido Bolliger
Chief Investment Officer, Asteria Obviam                       

 

Impact investing is a long-term investment story, which relies on the fact that companies providing products and services that can accelerate both the environmental and social transition will experience higher capital gains than their peers. After the war in Ukraine and the closure of the Chinese economy, developed countries’ governments took actions to 1) strengthen their independence across the entire renewable energy supply chain and 2) develop the infrastructure required for the climate transition. The most important decision in this regard was the adoption of the Inflation Reduction Act in the U.S. The main beneficiaries of this law are the members of the renewable energy value chain (solar, wind and batteries) as well as the actors involved in soft mobility (electric vehicles, biofuels, etc.). In the meantime, the state of the economy and the level of interest rates can have a significant short-term influence on the various impact themes. At the moment, our quantitative stock selection model prefers highly profitable, low risk companies with reasonable valuation multiples.
 

Exhibit 1: Median value of fundamental ratios by impact thematic


Source: Asteria, S&P Capital IQ

 

Renewable energy

The renewable energy opportunity set is quite wide and heterogeneous going from semi-conductor manufacturers to renewable energy producers. It is mostly split across industrials, information technology, and utilities. This thematic is the most exposed to the benefits of the US Inflation Reduction Act (IRA). Valuation multiples contracted significantly in 2022 but some of its segments (consulting and engineering firms) still trades at high valuation multiples. Semi-conductors’ valuations improved in 2023 and the supply-chain issues with Taiwan and China are largely solved. However, due to their cyclical nature (high cash-flow volatility), we tend to be more optimistic for utility companies (renewable energy producers and distributors) that will also benefit from 1) the IRA, and 2) high energy prices.

 

Clean and smart water

The thematic is split across utility companies (water providers and sewage), life science companies (water quality and water treatment), industrial companies that produce pumps, pipes, and plumbing, and companies that provide software and equipment aimed at improving water efficiency. As we can see from Exhibit 1, we expect this thematic to under-perform. This is mainly due to companies’ valuation. Our preferred investments in this opportunity set are industrial companies with very stable and resilient cash-flows. In the short-run, we tend to be less optimistic for life science companies, which outperformed the market in 2023 and still trade on relatively high valuation multiples.

 

Decarbonization

The bulk of the opportunity set is made of public transportation companies (rail and ground), battery manufacturers (industrials), as well as forest products producers (materials). As reflected by its cash-flow volatility, this is probably the most cyclical theme within impact investing, and it will certainly suffer if the economy slows down further. The exception is the public transportation segment. It has the highest alpha of our entire universe. U.S. railroad rolling stock providers will benefit from the IRA. Finally, note that even if the thematic is extremely trendy, it is still very difficult to get exposure to battery manufacturers because most of them are Chinese small-cap companies with either very bad ESG scores or no listing on an accessible stock exchange (ADR or Hong-Kong).

 

Pollution reduction

The pollution reduction theme contains companies that are active in waste management and remediation services (industrials), organic chemical manufacturers (materials), and environmental control software and equipment manufacturers (mostly IT and industrials). Due to the stability of their cash-flows and higher commodity prices, waste management companies performed very well in 2023. Despite their relative high valuations, we remain very optimistic for companies that are active in pollution reduction. With a very few exceptions, waste management companies continue to have fundamentals (low cash-flow volatility and high profitability) that shall enable them to navigate well during this period of high macro-economic uncertainties. We tend to be less optimistic for environmental control companies that are still expensive with shrinking profitability. 

 

Conclusion

In summary, we are very optimistic for the performance of high environmental impact companies that both in absolute (positive alpha) and relative terms. We do not foresee a significant price drop in energy prices, which could trigger a significant drawdown in the energy giants of the index. However, we would be extremely surprised to see oil companies outperforming the market to the same extent as they did in 2022. 

 

 

Biography

Guido Bolliger has more than 25 years of experience in managing and developing systematic investment strategies. He is joining from SYZ AM, where he held multiple roles as Chief Investment Architect and Head of Quantitative Strategies. Prior to that, Guido served as CEO of the Olympia Capital Alternative Investment Fund. Guido is the Chief Investment Officer of Asteria Obviam, managing the Asteria Funds – Planet Impact Global Equities and Asteria Funds – People Impact Global Equities and is one of the members of the Executive Committee.