Barclays Private Bank investment experts highlight our key investment themes and strategies for the coming twelve months.
19 November 2020
15 minute read
By Damian Payiatakis, London UK, Head of Sustainable & Impact Investing and Olivia Nyikos, London UK, Responsible Investment Analyst
With returns from traditional approaches looking challenging in the short term, it may be time to concentrate on longer term options. Addressing climate change, with renewed focus from governments and companies likely in 2021, can offer attractive growth opportunities, while protecting the planet.
Until COVID-19, climate change was central to the agenda for many governments, companies and people – and increasingly investors too. Rightly, attention has shifted to manage the human and economic hardship facing many as a result of the pandemic.
The immediate crisis and related economic shock, however, takes place in the shade of a long-term environmental challenge. The climate breakdown continues to worsen and will be a critical global challenge in the coming decades. As the pandemic persists and markets struggle, investors shouldn’t disregard the need and opportunities to transition to a low-carbon economy.
For investors, focusing on opportunities with a longer time horizon may help them to endure short-term volatility and find growth prospects too.
Climate change seems an inevitable trend in an uncertain world. Greenhouse gas (GHG) emission levels are increasing. Once a distant concern, climate change is now an existential threat and one of the most significant challenges facing current and future generations.
In 2015, countries pledged to transform their development trajectories to set the world on a course towards sustainable development, aiming at limiting global warming to 1.5 to 2 degrees centigrade above pre-industrial levels. Through the Paris Agreement, parties also agreed to a long-term goal for adaptation and outlined their post-2020 climate actions, known as their Nationally Determined Contributions (NDCs)1.
Since then, many efforts have been made to fulfil their pledges and achieve their NDCs as agreed. Overall, the current trajectory is still not in line with keeping global warming well below 2 or 1.5 degrees.
While during initial lockdowns carbon emissions precipitously fell as global output shrank, a rebound towards their pre-pandemic levels seems to have begun. Even if emissions do remain suppressed for some time, higher levels are likely without structural change.
Addressing climate change doesn’t require a smaller economy or a decade-long depression. Instead, transition to a low-carbon economy means primarily less emission- intensive growth; by decoupling growth and emissions. Though pace remains slow, this is occurring.
Adaptation and mitigation efforts are becoming more deeply embedded in governmental efforts as the profile of climate action raises on national political agendas. Furthermore, and as a response to COVID-19, “greener” stimulus measures have been seen, particularly in Europe. In turn, this may be a sign of things to come in other economies such as India, China or the US.
In December 2019, the European Commission (EC) unveiled the European Green Deal, laying out the blueprint for the bloc to achieve carbon neutrality by 2050. While the European Green Deal was laid out before the global pandemic, many followed the course set in using the crisis as an opportunity to enable transition to a low-carbon economy through the introduction of “green” stimulus packages.
In May 2020, the European Commission presented a €750bn economic stimulus plan and a revised proposal for the EU’s 2021-2027 budget to help mitigate the shock from COVID-19 and pave the way for a sustainable future2. In particular, the funds will partly be used to reach the EU’s objectives of climate neutrality and digital transformation.
Part of the package involves strategies to help incentivise private investments – such as the Strategic Investment Facility built into InvestEU to generate investments of up to €150bn in boosting the resilience of strategic sectors linked to the green and digital transition3.
Among individual EU countries, Germany introduced £36bn climate-cutting and economy-boosting measures, and France pledged £13.5bn at tackling the climate emergency4. As part of the package, the allocated green measures include investments into the sustainable transport sector, further development of green technologies (such as hydrogen) to support decarbonisation measures, energy-efficiency improvements for public buildings, efforts to promote the digital and circular economy, nature-based solutions to restore biodiversity and greening the food sector by developing shorter supply chains.
In the UK, an additional £3bn of energy efficiency measures were announced as part of a broader coronavirus stimulus aimed at boosting the economy. The package includes £2bn towards a Green Homes Grant scheme and another £1bn for public buildings to improve energy efficiency4. The measures are also aimed at helping the UK meet its ambitious 2050 target for net-zero carbon emissions.
In other parts of the world, China is aiming for its carbon dioxide emissions to peak before 2030 and then to move to carbon neutrality by 2060. The specifics of how the country will reach these goals are not yet clear. Still, it inevitably has to include not only deep cuts in fossil fuel use but ways also to pull carbon out of the atmosphere – for example through afforestation activities and growth of sustainable land carbon sinks.
In the US, the 2020 presidential election outcome may accelerate decarbonisation initiatives. According to the campaign, a Democratic administration would rejoin the Paris Agreement, expand upon it and redirect elements of US foreign policy to encourage other countries to adopt climate-related policies and targets, such as including climate targets in trade agreements. The platform also targets 100% clean energy by 2035 in the power sector.
Tools for achieving faster decarbonisation include extensions of tax credits, scaling-up best practices at the state level and providing government support in research.
The next year offers a crucial window for countries to capitalise on current frameworks and build on existing climate change momentum. Foremost, the twenty-sixth United Nation Conference of Parties (COP 26) will see governments report on the Paris Agreement’s efforts and set new targets. While the conference had to be postponed until 2021, its commitments have not been.
Given its November timing, the full agenda and outcomes of COP26 will arrive late in the year. However, as the NDCs were made “by 2020”, we can expect announcements of progress and plans throughout the year. Ongoing discussions around topics such as carbon pricing, greenhouse gas reporting and carbon taxes hint at potential related risks and opportunities.
In addition, the COP26 Private Finance Agenda has been established to ensure that all decisions in private financial systems (not only government-backed) are made considering climate change. The initiative focuses on how climate reporting, risk management and returns can help drive the transition to a net-zero carbon economy.
While most environmental focus has been on climate breakdown, various global efforts are accelerating around biodiversity. The EU has committed to significant biodiversity policy measures. Meanwhile, China expressed the need to balance economic growth with biodiversity policy at the last UN Summit on Biodiversity.
COP26 also has the potential to be a pivotal moment for biodiversity. Delegates will be reviewing progress made towards the Aichi Targets of 2010, setting new goals and standards for nature management for the next decade, which should govern biodiversity under the following three pillars: 1) conservation; 2) sustainable use; and 3) the fair and equitable sharing of benefits from the use of genetic resources.
Investors who want to use their capital to make a positive contribution to a more sustainable future have a range of investment opportunities. Given the scale of environmental challenges, these tend to also be growth markets for companies with effective solutions. Aligned with our sustainable world structural theme, we highlight three trends with many entry points for investors.
Reducing GHG emissions from energy production remains a focus for all involved transition efforts. The pandemic- induced slowdown may, in turn, slow the transition to a world mainly powered by clean energy; but the direction of travel is one-way.
Clean energy and associated value chains that accelerate the low-carbon transition are growth markets. Moreover, stimulus to develop green infrastructure not only addresses environmental issues but also helps to support a green recovery and growth. On top of that, cleaner energy players and associated renewable technologies and equipment companies have had a positive year, as investor sentiment appears to shift further towards them. The sector has profited from a push for cleaner fuels from Europe to China; targeting net-zero emissions by 2050 and 2060 respectively.
Investors will have options across the value chain. Even as solar and wind power become the “new normal”, offshore wind, emerging technologies and fuels such as battery storage, biofuels, geothermal and hydrogen seem to be increasingly part of company and state energy transition plans. Even traditional fossil fuel companies are seeking to offer an integrated approach to supplying energy – including renewables, backed up by natural gas with carbon offsets.
Hydrogen is also set to become an important part of this energy mix, offering further opportunities in supply, transport and distribution. Delivering complex solutions at scale will also involve road transport design, digital solutions, procurement and construction management. According to Barclays Research, hydrogen has the potential to transform hard-to-decarbonise parts of the economy and support electrification, helping save up to 15% of annual carbon dioxide emissions by 2050. In addition, the market is forecast to grow eight times over the next 30 years.
Construction and heating and cooling buildings account for approximately 36% of global final energy usage5 – which as temperature bands become more extreme is set to increase with climate change. Finding ways to use less energy, or existing energy more efficiently, is key to achieving climate targets.
Green buildings or greening of existing buildings will reduce or eliminate negative impacts or even create positive impacts on the climate and natural environment. Through design, construction or operation they can preserve precious natural resources and improve our quality of life through improved energy efficiency, materials efficiency and waste reduction. According to the International Energy Agency (IEA), realising the potential of such buildings could save $1.1 trillion by 2050.
Beyond upgrading buildings or constructing more efficient ones, there are further opportunities to improve energy efficiency in industrial processes or technology companies, as well as providing devices and sensors that enable this change.
With green stimulus packages being rolled out in response to the pandemic, green building programmes could not only stimulate economic activity and create jobs, but simultaneously achieve environmental and social goals.
According to the World Bank, urban areas concentrate around 80% of global economic activity. By 2050, two- thirds of the world’s population is expected to live in city environments6. Fast-paced urbanisation likely increases both social and environmental pressures. Issues such as water stress, waste management and air pollution increasingly create associated health and economic risks.
To keep pace with the challenges presented by the pandemic, the escalating sustainability commitments and the ongoing urbanisation will require unprecedented investment and innovation. Smart cities and smart city infrastructure, therefore, offer various investment opportunities. Within cities, not only do the buildings need to become smarter, but the infrastructure and economic production (both manufacturing and services) need to evolve. This revolution, sometimes referred to as the “Industry 4.0”, will likely have far-reaching implications: fully automated factories and production lines (changes in the workforce), increasingly digitised consumption, on-demand energy and healthcare services.
Beyond consumer-facing smart homes, energy, water and waste management in buildings are increasingly being prioritised to help bridge the existing infrastructure gap. Driven by emerging business models and leapfrog technologies, developments in “edge computing”, or a distributed computing paradigm helping to manage data, and 5G are expected to further accelerate smart infrastructure opportunities; particularly in intelligent building management systems, digital twins, clean energy, smart grids and real-time usage monitoring. While Asia seems to be doing better from an innovation perspective, “older” cities in the West are under pressure to upgrade as well.
Traditional linear economic models of take-make-use- dispose are becoming neither sustainable nor economical — for consumers, producers and the environment. This has created both an increasing range of organisations utilising circular economy principles and business models to generate new economic value.
In a truly circular economy, economic activity may use natural capital, but also restores overall health of the system. Moving to a more circular economy isn’t only about reducing negatives or recycling. Rather, it represents a systemic shift to generate growth and abundance, while providing environmental and societal benefits. A more circular economy can also help reduce the environmental impacts of production and consumption, reduce waste, drive greater resource productivity and address emerging resource security/scarcity issues in the future.
While these principles apply universally, investors can look to sectors which are most resource and waste intensive for the highest potential. This includes electronics and information communications technology; batteries and vehicles; packaging; plastics; textiles; construction and buildings; food; water and nutrients.
In Europe, as part of the European Green Deal, the European Commission’s new Circular Economy Action Plan unveiled this year7 is calling members to shift to a circular economy and adopt the use of incineration and landfill taxes. The initiative presents opportunities along the entire life cycle of products, targeting their design, promoting circular economy processes, fostering sustainable consumption and aiming to ensure that the resources used are kept in the local economy for as long as possible.
According to the OECD, the world is highly dependent on rich and varied biodiversity, extracting $125 trillion in benefits from the ecosystems each year8. Before the current trends in population growth and increasing dependency on our ecosystems, much of modern society’s growth has been achieved through the use of natural resources.
Today, biodiversity is declining at unprecedented speeds, with soil and land degradation rising and available land decreasing. As a result of human activity, 75% of the global land surface has been significantly altered; 66% of oceans are experiencing cumulative deterioration; and over 85% of wetlands have been lost9.
In the 2020 World Economic Forum’s Global Risks Report, biodiversity loss and ecosystem collapse were named as one of the top five risks in terms of likelihood and impact in the coming ten years. Abundant biodiversity is necessary for many components of life, including the provision of food and medicines. With biodiversity in decline, traditional land economics is quickly being reconsidered and natural capital is increasingly factored in decision-making.
Maintaining biodiversity is quickly moving from being ethically motivated towards becoming an economic and regulatory imperative. While the primary reason for considering biodiversity issues is risk management, understanding sectors (such as palm, soy, cattle and timber) and activities (like excessive land and sea use, land exploitation, climate change, pollution and invasive alien species) most associated with biodiversity loss can help investors identify companies with solutions to these issues.
In part, legislative drivers and changing consumer demands are creating new markets for organisations to attempt to profit from biodiversity-related goods and services and biodiversity conservation. Extended policies, company pledges to use-certified commodities (in some cases avoidance of particular commodities) and net-zero deforestation commitments reinforce the rationale for considering investment in alternate-land management practices.
As a theme, there is a growing set of opportunities in nature that benefits biodiversity such as reforestation, regenerative agriculture, supply-chain monitoring and product certifications. According to the World Economic Forum, the focus on biodiversity is significant, at an estimated at $3.6 trillion a year10. Focusing on natural capital (commodity certification, regenerative ag-tech and sustainable production and consumption) investors can deploy capital in various commercial opportunities.
Alternatively, sectors such as tourism and recreation have direct links and value associated with addressing biodiversity risk and investing in nature. Agricultural value chains, covered more fully below, provide another range of opportunities. Finally, marketplaces are available, or being established, in areas such as carbon sequestration, maintenance of water quality and supply, pollination, or biomass production.
As the world’s largest sector, the World Bank estimates the food industry to account for over 10% of global gross domestic product, employing billions of people. With growing populations and expanding economic development and consumption, the natural environment and its limited resources are under increasing strain.
While much of our economic development has been achieved through the mass industrialisation of the global food system, the gains have resulted in declining biodiversity, soil and land degradation, food waste and water scarcity. Eventually, the system will have to change, creating significant opportunities in the sustainable agriculture investment space.
For companies and investors whose goal is to make the global food and agriculture system more sustainable and to create better connectivity between producers and consumers, there are various opportunities available. These include advanced ag-tech, reforestation, regenerative agriculture (such as precision farming, alternative fertilisers), biodiversity-friendly practices (like vertical farming and lab-grown produce), long-term biotech advances and sustainable production and consumption methods. Companies aiming to reduce greenhouse gas emissions through the use of sustainable agriculture practices by leveraging technology should create further investment opportunities.
With land management and conservation becoming increasingly important, regenerative or circular farming practices (or ag-tech) should provide great opportunities. For instance, the development of alternative green fertilisers and products that enable the restoration of degraded ecosystems and vegetation. Furthermore, supporting the very beginning of the supply chain with innovative technology and ways to improve profitability and optimise costs should also be of importance. Agriculture’s future lies in harnessing intelligent technology and precise farming methods that sustainably enhance climate-resilient, higher quality food production.
Due to COVID-19, there has been significant growth in demand for health and wellness products, including food and non-food items. While numerous consumer-ready products exist, other meat-free options (like cell-based meat) still need to gain scale. According to the World Economic Forum, the focus on “planet compatible consumption” offers great investment opportunities; over $1 trillion by 203011. Companies that invest proactively in sustainable production methods can appeal to consumers and investors that are increasingly aware of biodiversity.
With a variety of stakeholders seeking to support planetary health, companies offering commercial solutions to (unfortunately) growing sustainability issues should expand too. This may make such options appealing for investors seeking portfolio opportunities to explore more actively in 2021, while recognising the long-term nature of most of these investments. In the end, the opportunity to deploy capital in a way that not only can grow assets but also positively contribute to society and the environment could be attractive for many investors.
Barclays Private Bank investment experts highlight our key investment themes and strategies for the coming twelve months.
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