COP26 this lot!

With this year’s report from the UN’s Intergovernmental Panel on Climate Change (IPCC) heralded as a ‘code red’ for humanity, there is rapidly increasing anticipation about and expectation for November’s COP26 Conference in Glasgow.

The IPCC’s latest report was very clear on the science behind this transition in that we need to reduce emissions from human activity materially within the next decade to limit the global average temperature rise to a rate that does not seriously limit our future quality of life. Reducing emissions to the necessary extent will affect the whole economy while the transition will impact our energy system and how we heat and cool buildings. In addition, it will also drive transformations in transport, industrial processes, agriculture and land use. It will also have a massive impact on investment returns. Companies contributing to this shift should prosper while those on the wrong side of the energy transition, or simply not confronting its ramifications, are at risk of secular decline and underperformance over the next decade and beyond.

Regardless of what COP26 achieves, the ongoing energy transition will leave no company untouched and is something no investor looking for long-term returns can afford to ignore.

How will sustainability effect my portfolio?

This is a key issue for all investors and, if you have not already considered this, you should now as markets change their stance on ethical, social and governance (ESG) criteria. ESG investing is no longer a ‘niche’ activity undertaken by tree hugging, hippy fund managers. ESG is a core activity for every fund management group and individual manager. If you are not on the ESG page already, you are a long way behind the curve.

As climate change and other environmental and social impacts become growing concerns, we believe the custodians of capital (fund managers) have an increasing role to play as we adapt to this changing world. As investors, we need to be able to establish how this is potentially influencing risk and returns, as well as considering the wider impact our investments have on society. We need to recognise, as part of our responsibilities as human beings, we can engage and push for positive change as opposed to merely buying or selling funds without tackling any underlying issue. As such, we launched a range of ESG portfolios formalising the integration of ESG considerations into our investment risk framework and we have built this into the naturally collaborative, regular engagement with our investment teams as part of our investment process.

Hydrogen -The Fuel of the Future?

Amid ongoing debate about reducing emissions, there is growing excitement about hydrogen’s potential as an ultra-low carbon fuel of the future. The beauty of hydrogen is that when burned, the main by-product is water. The critical factor from an emissions standpoint, however, is how hydrogen is produced. At present, virtually all hydrogen comes from using natural gas as a feedstock (known as ‘grey hydrogen’). ‘Blue hydrogen’ is when this process captures and stores most of the resulting emissions and ‘green hydrogen’ is made by electrolysing water (using electricity from ultra-low carbon sources such as wind and solar).

From an environmental and investment perspective, our ESG portfolios will only be interested in ‘green hydrogen’. The wider market has yet to see carbon capture and storage technology make ‘blue’ economically viable while the emissions in producing ‘grey’ are worse than burning natural gas. In heating homes, replacing natural gas with hydrogen will take time before grids are capable of carrying high proportions of the latter. From what I have read, electrically driven heat pumps will gain traction as we move towards 2035 before we see this ‘green’ hydrogen gas network scaling up, which is likely in the late 2030s or early 2040s. Investing in those companies developing their technology must be good for the investor and the planet.

Growth v. Value

We hear a lot about ‘growth and value’ stocks and I think it is worthwhile explaining what this means.

Growth investing focuses on companies expected to grow faster than the market while value investors look to buy stocks trading at a discount, expecting them to reveal latent value in the future i.e. over the longer term. Growth stocks tend not to pay dividends as these companies are keen to reinvest earnings to accelerate expansion in the short term. It would make sense that growth stocks can typically be found at the smaller end of the market but many of the fastest growing businesses in the world are actually among the largest.

Given the increasing dominance of certain companies in the US (Facebook, Apple, Netflix, Amazon, Google), growth has become broadly synonymous with technology.

Value stocks tend to be larger, more well-established companies where, for a variety of reasons, the shares are trading below what they are fundamentally ‘worth’. The theory is that when these temporary factors pass, the shares will move back towards their intrinsic value and make money for investors.

But with the emergence of the FAANG (Facebook, Amazon, Apple, Netflix and Google) giants, growth has dominated overall ‘equity’ returns for the bulk of the last decade and this led to a protracted period in the doldrums for value. As the disparity in favour of growth got ever larger over the two or three years to 2020, investors began to question whether value as a style was less effective. However, in recent months, we have seen a rotation in markets, with vaccine breakthroughs in late 2020 sparking a performance resurgence in traditional value sectors, many of which had been beaten down during Covid lockdowns.

Ultimately, the decision on growth versus value is determined by an investor’s key criteria dictating any investment, such as risk tolerance, investment goals, and time horizon. As investors, we always want to prepare rather than react. The latest run for value after such a long spell of growth dominance shows how quickly things can turn, as does the more recent growth/quality resurgence. Funds that are able to tilt between these while ultimately keeping a foot in all camps offer a compelling and diversified risk/reward balance.

Our investment teams constantly monitor such positions and many of our clients will notice some changes to their portfolios to reflect these market conditions.

Summary

Our investment teams remain positive on risk assets and stock markets in general but acknowledge ongoing challenges, particularly countries struggling with their recovery predictions, future Covid-19 mutations, ongoing supply chain blockages and spiralling raw material prices. There are plenty of positive signs to be comforted with and we can see pent-up corporate and consumer demand still being released, vaccine distribution continuing and monetary and fiscal policy still supportive. While central banks are discussing tapering asset purchases (reducing their QE), many have stressed interest rate rises are still some distance away and higher levels of inflation remain transitory. However, it is fair to say, most market commentators are expecting interest rate hikes by the end of 2022.

Assuming vaccination efforts continue and the pandemic recedes, observers see the global economy moving into a mid-cycle expansion, with the focus shifting from recovery to more sustained growth. This should result in seeing global GDP moderate to above-trend levels next year. Investors should expect more active stock selection in such an environment as the broader stock market rally thins out.

Speak to your Prosperis adviser on 01423 223640 or email us below if you want any more information on these portfolios.