This article is authored by MOI Global instructor Alex Gates, director of research at Clayton Partners, based in Berkeley, California.
Alex is an instructor at Best Ideas 2022.
It has become evident that the public and private sector are now remarkably aligned to achieve the goals of the Paris Climate Accords and a zero carbon economy by 2050. Investment strategies focused on carbon reduction will have a tailwind for the next thirty years. This prompts the question:
Outside of expensive renewables pure plays, and ill-conceived or suboptimal ETFs, how can investors participate in the decarbonization transition?
We found the options to be lacking in both return potential and direct impact to carbon reduction. In response, we created the Clayton Partners Sustainability Strategy (CPS). CPS will invest in a portfolio of companies focused on achievable carbon reduction and value creation based on those initiatives.
A major reason for starting CPS is that the current options for climate investing are not focused on profitability or where the greatest benefit is being created. For most investors, ETFs are the main way to participate. This leaves two options: (1) Environmental, Social and Governance (ESG) focused ETFs and (2) Clean Technology ETFs.
ESG focused ETFs utilize exclusionary criteria to eliminate companies with larger carbon footprints. That results in them being overweight asset-light businesses, like technology companies, and underinvested in heavy industry where the most meaningful change is happening. For example, one of the largest “ESG” mandated ETFs, has a 29% weighting to large cap technology stocks, more than the S&P 500. Most technology companies are inherently low carbon, so supporting them with investment capital is not very impactful.
Clean Technology ETFs focus specifically on environmental or renewable technologies. While a seemingly obvious choice, most of these ETFs are concentrated in unprofitable, unproven, and expensive companies. In fact, the second largest clean tech ETF by market value, has nearly half of its investments in unprofitable companies.
CPS uses an entirely different approach. Our strategy is focused on carbon reduction for the benefit of climate change. We do NOT have a formulaic approach that excludes certain industries or includes them regardless of valuation.
CPS focuses on profitable companies enabling dramatic carbon reductions using quantifiable methods. The companies will become more profitable and valuable as a direct result of their emissions reductions.
Our focus is on key areas of emissions reduction where valuations generally have not caught up with the opportunity.
A few examples:
Utilities in “Transition”: The need to decarbonize the electric grid and electrify sectors like transportation will require the current world electricity supply to triple by 2050. Utilities will be the ultimate change agents for this thirty-year transformation. Green, or 100% renewable utilities, trade at high prices relative to their peers with diversified generation sources. CPS will focus on the utilities that are making the fastest pivots to 100% renewable power because they offer the highest appreciation potential and the most impact from a net carbon reduction standpoint.
Solar, Wind and Storage: Considered the workhorses of the new electric paradigm, these technologies drive the decarbonization of the world’s electric grids. Although they have grown quickly in the past, wind and solar will need to be deployed at over three times the current pace to reach a decarbonized US grid by 2035. CPS will focus on supporters of these technologies including energy storage, which makes renewable energy projects more viable.
Low and Zero Carbon Fuels: Decarbonizing the transportation sector is a universal goal for all governments focused on net zero emissions. Electric vehicles will play a massive role in this transition, but sectors like heavy trucking, shipping and aviation are decades away from full electrification. CPS will focus on companies enabling scalable biofuels that are ready to deploy today.
Carbon Capture and Waste Solutions: The transition will require large amounts of CO2 removal and storage in the coming decades. This will create opportunities for direct carbon capture and storage (CCS), as well as new recycling and waste infrastructure needs. CPS will focus on companies investing in profitable projects with proven technologies involving CCS, biomass, digesters and waste-to-energy.
Conclusion: A great way to contrast the CPS approach with the alternative options is to compare one of our large holdings, AES Corp, and a large holding of the more popular strategies, Google. AES and Google are both committed to sustainability; however, the magnitude of their impact is quite different.
Google plans to use 10.5GW of green energy to power its data centers by 2030. AES produces over 11GW of green power TODAY and has a pipeline to produce 37GW more, almost five times the amount Google intends to deploy. AES has a market cap of $16B vs. GOOG at $1.9T, more than 100x larger. An incremental dollar invested in AES will clearly have a larger climate impact compared to Google. Regardless, Google is in many sustainable ETFs and AES is not in any. Yet!
Our focus on profitable value creation and the magnitude of environmental benefit positions us to participate in a strong secular trend and support companies making the greatest contributions to the sustainability transition.
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About The Author: Alex Gates
Alex Gates is the Director of Research and Chief Compliance Officer at Clayton Partners LLC. Founded in 2003, Clayton Partners is an opportunistic value investment firm. Clayton manages a private investment partnership and individual separate accounts. We take a private equity approach to investing in the public markets and look to align ourselves with shareholder friendly management teams that focus on long-term value creation. Alex leads our effort to find compelling public and private investment opportunities in sustainable businesses which have a positive impact on climate change. The current focus is on investments in renewable energy, bio-fuels, recycling and water infrastructure. He holds a Masters Degree in Business Economics from the University of California at Santa Barbara. Prior to his graduate education, he completed a dual major BS in Economics and Statistics from Cal Poly State University. At both institutions, Alex concentrated in finance and economic modeling. He earned the Chartered Financial Analyst designation in 2015.
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