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Magazine Issues » November 2021

The $2.5 trillion window for diversification and opportunity

John_Cook_and_Greg_PayneAn aversion to hype and commitment to value continue to drive performance at a pioneering environmental thematic manager.

You could say Mackenzie Greenchip Team portfolio managers John Cook and Greg Payne were satisfied with their early days in the investment industry, but not overly impressed by what they witnessed.

In 2007, Payne concluded that to stave off the worst effects of climate change and other environmental challenges, a massive global shift was necessary from fossil fuels to renewable energy, liquid fuels to electrons, and inefficient processes to efficient ones. About $2.5 trillion of new capital investment each year by 2030 would be required to finance the transition, Payne calculated.

Today, the Mackenzie Global Environmental Equity strategy they oversee is pure, specialised and focused on a small subset of companies selling environmental products. It’s the farthest possible thing from greenwashing, and because of how they select companies, the strategy is ideal for diversification via a growing niche segment of the market.

What’s the difference between your strategy and what we’ll call a “basic” ESG investing strategy which might just look at companies’ ESG scores?
John Cook
: We look at the revenues of businesses, and specifically whether those revenues are driven by selling environmentally superior products and services. We have a universe of over 800 businesses. If you want exposure to the drivers of environmental challenges or opportunities, then you need environmental thematic investing because investing in banks and healthcare companies and FANGs that have nice ESG scores doesn’t give you that. When a lot of institutional investors think about environmental investing, they think of their private equity portfolios filled with, for example, clean tech infrastructure at one end of the risk continuum – say, a renewable utilities project – and at the other end of the scale basic ESG type equities strategies. What they have generally missed are opportunities in listed solutions providers in the middle.

In the context of your investment philosophy and strategy, has the pandemic revealed anything new or reinforced any your existing thoughts?
Cook: That capital still isn’t going to the right places, that in general the world and investors don’t think sufficiently long term or manage risks particularly well.

That said, what should asset owners be investing in that they currently are not?
Greg Payne: Infrastructure, transportation, clean water production and distribution, and the way we use energy in food and water production. A lot of capital is chasing price momentum in companies that don’t need capital. In our strategy, we’re building something that we believe has the potential to result in actual prosperity.

Cook: Here’s how it plays out in the renewable energy space when capital is just looking for rent off its money rather than growing profit streams: Renewable power producers globally are sort of like utilities, spinning off dependable cashflow streams. When we first researched the sector, they looked to us like they fit into two buckets – those playing a high-yield game targeted at investors and offering a healthy dividend, and others that did not pay dividends. It was very clear that the market was pricing these buckets differently. The bucket with the dividend payers was getting a much higher price in the market. But the yield that CEOs and management were spinning out forced them to go back to the market and raise very expensive money to fund their growth., We were finding companies that didn’t have to do that, and which were able to take the free cash they had and develop more renewable energy. That’s what we and our investors really wanted.

How did you develop that sense of value and avoiding the hype around some companies?
Payne: Since we started the strategy, by all broad metrics value has had a very difficult time of it and momentum has been the only way to play. Sticking to our guns has paid off, however.

When we started the firm, the hype was all about solar. First Solar had a market value of about $30 billion at the time, and there were a few other companies – all US and European – enjoying lofty valuations. The market was tremendously excited and saw that solar had a cost curve in front of it. Today solar now installs well over 100 gigawatts per year, so that’s thirtyfold growth over slightly more than ten years.

However, the market was wrong in assuming that Western companies, with high costs and high margins, and a lot of government subsidies, would last forever and that there wouldn’t be competition, or a shift in market shares and margin. And that’s exactly what happened. Commodity tech is typically the domain of giant Asian manufacturers, and this was no different. In fact, the market is now 80%-plus supplied by Chinese production.

And what was Mackenzie Greenchip’s position while all of that played out?
Payne: We stayed out of solar at that time, and if we hadn’t, we wouldn’t be here talking to you today. Finding the value opportunities has a positive side, but it also helps you avoid the disasters. The renewable energy space at large dropped by more than 80% between 2008 and 2012 – in other words, it flipped from euphoria to revulsion when investors who’d lost their shirt didn’t want anything to do with solar. However, by 2012, we saw companies that were dirt cheap by any metric that we could find. We’ve been invested in solar and in those companies to varying degrees since then, and they are the companies that have contributed the most to our performance over the history of the strategy. Investing in those companies separated us from our peers while some other environmental thematic shops closed. Among the few of us who remain still, none played solar like we did.

Speaking of global, let’s talk a bit more about the companies in your strategy.
Payne: The basic criteria for inclusion in an environmental thematic strategy is the question of what they do, not how they behave. That’s the distinction between ESG and thematic. Beyond that, we are inclusive, and for that we mean a small company – up to $100 million in revenue – that’s just getting started should be a pure play. Between $100 million and $1 billion, we want it to be at least half-dedicated to our sectors. Over $1 billion in revenue, we slide that down to 20%.

How do you think the future might unfold in your space?
Cook: Climate change is creating physical and transition risk for assets and investors. Institutions have to manage that risk. Beefing up their infrastructure investments alone isn’t going to get them there. They are going to have to reinvest in some of the businesses that make the manufacturing equipment and infrastructure necessary to build a more sustainable economy.

• The above are excerpts from an interview in October 2020. To read more, visit https://mackenz.ie/3pBkCSv. This material is for marketing and informational purposes only and does not constitute an offer of investment products or services (or an invitation to make such offer). This material, including examples related to specific securities, is not intended to constitute investment advice or any form of recommendation.

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