271. Why saving money is a greater driver than cutting back on CO2 emissions

17 August 2023 (pre-recorded 9 August 2023)

Below is a transcript of the episode, modified for your reading pleasure. Please check the corresponding audio before quoting in print, as it may contain small errors. Please remember we’ve been discussing individual companies to bring investing to life for you. It’s not a recommendation to buy or sell. The fund may or may not still hold these companies at your time of listening. For more information on the people and ideas in the episode, see the links at the bottom of the post.

[INTRODUCTION]

Staci West (SW): Welcome back to the ‘Investing on the go’ podcast brought to you by FundCalibre. Climate change is one of the biggest challenges we face as a society – and is spurring rapid innovation across sectors. Today’s guests seek to invest in this wave of innovation by investing in key themes such as sustainable food & water, sustainable construction and electrification. I’m Staci West, and today I’m joined by Francesco Conte and Sara Bellenda, co-managers of the JPM Climate Change Solutions fund. Thank you both for joining me.

Francesco Conte (FC): Thank you, Staci.

Sara Bellenda (SB): Thank you.

[INTERVIEW]

SW:  Now, I just want to start with a quick overview of the strategy because this fund has launched recently – June 2021 – so it’s probably still new to a lot of our listeners. So, if we can just start with a little bit of an overview. This fund actually combines artificial intelligence and human insight to identify the companies developing innovative solutions, which is in itself interesting. So, can you briefly, just tell us more about this? How does it work in practice and translate into the fund?

FC: Yeah, so perhaps if we stand back a little bit and just say, what is the aim of the fund? The aim of the fund is really to invest in those companies that provide, should we say the tools that the world will need in order to decarbonise in large part. And hence, the emphasis is really on the solutions to the problem of climate change. So, the question then is, you know, how do we go about finding these companies because it’s, you know, companies do not report solutions for the problem of climate change. And so, the question is how do we go and scour the world and look at thousands of companies to try and find these companies? And what we use is an internally-developed artificial intelligence data tool which allows us to do that. It allows us to scan 15,000 companies worldwide and come up with a sort of probability, a ranking by probability, that these companies are likely to be involved or have a solution for the problem of climate change.

We obviously do a lot more work, so in practice, once we look at these, let’s say we focus on the top 300, we will then, of course, look at each single one in much greater detail, initially ourselves, but also with our sustainable investment team, together also with about a hundred analysts that we have worldwide, to really understand whether these companies really are providing a solution to the problem of climate change – and to what extent, because obviously in what extent is an important part of the question.

So, that’s roughly the process. You know, once we’ve identified these companies, then obviously we move on to the second component, which is, let’s call it financial: is this a good investment? And there, you know, we make use of our internal research in order to come up with a portfolio, and this is our best ideas portfolio. So it’s roughly 50 to 60 stocks, somewhere thereabouts.

SW: And when you’re looking at this list of companies, are you looking to target decarbonisation specifically, or are you looking for companies that are looking to adapt to this changing world through perhaps research and technology, or is it a mix?

FC: So, it’s largely a mix of different things. So, I think one thing that came out of both the IRA [Inflation Reduction Act] and the EU green deal is that efficiency – energy efficiency, resource efficiency, really more widely, you know, if we don’t consume a plastic bottle, but we don’t have to worry about recycling it – so, companies that help us to become much more efficient feature very highly in our fund. You know, so companies that, for example, in the electrification [space] you know, we need spades and shovels in order to take that renewable energy from the offshore field [for example], so that we can use it on our electric hob at home. So, things like companies involved in providing software for the grid, high voltage cables, micro inverters, all the things that you need in order to either produce that renewable energy or to be able to transport it and finally use it. So, we use that kind of approach. It’s really the spades and shovels that we need in order to replace fossil fuels on the one hand, but also to use less of them on the other hand.

SW: So, all of these ideas are then grouped into what you have as your five main themes. So, we don’t unfortunately have time to go into all of these themes, so I’m just going to highlight two that I personally find interesting, because that’s one of the joys of writing the questions – I get to pick. And the first one that I wanted to talk about is sustainable food and water. I believe that this encompasses both food and clean water, but also agriculture. And looking through your presentation, agriculture was something like a quarter of global greenhouse gas emissions. So, maybe tell us more about this theme, what it looks [like] in practice and perhaps the agriculture side of things.

SB: Yes, so perhaps sadly, food, water and agriculture is one of the big pillars in the themes that we take care of, that we look at. And so, starting with water, this is obviously a resource that is scarce, and that we need to preserve, and we’re really interested in finding the companies that take care and are developing the technologies and innovate in order to preserve every cycle and reuse water. One of the companies that we found early on pretty much, we’ve been involved in since the launch of the fund, is Evoqua [Evoqua Water Technologies Limited]. And this is a company that basically focuses [on] purifying water to a great fine detail that is required across a number of industry applications. It can be in pharmaceutical, in the consumer goods, in the food industries, in the chemical industries and so on. So, the spread of clients for this solution is very diversified. This company has actually been, earlier this year, taken over by another water infrastructure player called Xylem [Inc.]. And so, we’ve also generated alpha by holding onto this company. And the features that we really like here, is the visibility of the contracts [inaudible] that allow us to generate steady returns.

Moving on to agriculture, here there are a variety of industries and technologies that are really exciting, and basically, it’s all about helping the farmer to work more efficiently with the use of their land, but also across all the tools that they have. So, the companies that I’m thinking about are Deere [& Company] and CNHI [CNH Industrial N.V.] that are at the front of investing in future technology called prestige of agriculture, to allow the farmers to essentially make more money and working more efficiently, by using less labour, which is obviously very hard to resource, using less pesticide, because with this machine, you can precisely aim at the plant or the crop that definitely needs pesticide but not the whole land. And therefore it just makes a lot of sense for the utilisation, better use of efficiency, for the farmers. And it makes a lot of sense also because these companies are leaders and they’re cashflow generative, so they make money today and they can invest in the future technologies. And AI here will actually catapult the innovation even further. So, we’re quite excited about this space.

SW: That’s not necessarily something that we hear about a lot, pushes in agriculture. Is that still in its kind of infancy or is it just people aren’t talking about it as much, or is it still kind of a new area of this technology that you’re seeing?

SB: I think that obviously the companies are talking about it, but it’s still in the infancy in terms of kind of like the rollout into the business.

SW: Another unique area that again, we don’t really get to talk about a lot, is sustainable construction. Now, governments are really embracing this idea of net zero buildings, so, can you just tell the listeners a bit more about the innovation in this area, but then also where the opportunities come through for the fund within the construction sector?

SB: Sure. Obviously indeed, buildings consume a lot of energy throughout the cycle, and so the biggest opportunity in terms of decarbonising building lies into retrofitting, which is where a lot of capex can go towards a good cause. But also, I’m talking about insulating building. I’m talking about the overall infrastructure for cooling and heating – so ventilation and heat pumps – and, you know, we can further develop it into commercial as opposed to residential, there’s different technologies that goes all around the building. We don’t really classify solar panels also in the sustainable construction, but it also goes all around electrifying the building, building management systems are also key. So, all of these are technologies and innovations that are already existing and are easy to implement. Of course, retrofitting buildings can be time consuming and it requires building permits, et cetera, but it is all very doable within a timeframe that is, if you like, required by the policy makers.

The part that is perhaps a little bit more challenging, that does require time, is in the overall construction when it comes to building new buildings. Obviously, these consume energy but also the materials that are required for new buildings are still having to be completely decarbonised. So, there are certain companies that are already at the forefront of this. So, for example, we like Sika [AG], which is developing if you like, additives for making cement less carbon intense. And so, there are already ways to improve the overall building system, which we call modern methods of construction, but definitely there’s more to do. And, of course, the great connection with the buildings is what’s key to make a building completely net zero. So, more and more to do, but also a lot of technologies and a lot of companies that are already kind of like in existence and making a difference today.

FC: It is maybe worth adding at this point that what Sara is describing are really companies that are providing products that, at the end of the day, save their customers money, because either your tractor’s producing more on the land or, for example, you know, you can save 30% of your energy bill in a building. So, a lot of these solutions at the end of the day, they’re not selling them because people’s priority may be to reduce their CO2 footprint, but really people’s priority is to save money. By saving money in areas like energy efficiency, you are effectively having a very beneficial impact in terms of your CO2 emissions

SW: And also a real overlap of the themes in this fund. I mean, I know we don’t have time to talk about all of them, but you know, you have recycling, you have energy efficiency, for example, which has come up in the two other themes that we did highlight. And so, when you are looking at these as a bigger picture, there is this overlap of the themes and how they interact with each other, which is potentially something we can get into in a different interview. But one of the things that I did really want to talk about, and we touched on a little bit already, is that an interesting part of the climate change solutions is that they’re typically in their early stages or potentially don’t even exist yet. So, how do you approach these early-stage companies and technologies? And then does this mean that the fund has a bias towards small and mid-cap?

FC: That’s a really good question. You know, it’s a question that we confront on a daily basis. And I think the way we kind of think about it is, in technology, you often refer to the S-curve, so, the rate of adoption. And clearly, when you launch a new product, the rate of adoption is very low, and then it’s like an S, it speeds up and demand goes vertical. You know, like for example, artificial intelligence at the moment, you know, it’s just ramping up really fast.

And we can say that in our sector, right? So, you know, if you look at, for example, a solution like hydrogen or a solution like carbon capture, a solution like vertical farming, you know, they really capture the imagination. You know, and we could probably find startups that have a hundred percent exposure to the theme. And this is very often people say, oh, you know, what is your exposure to the theme? And it’s actually not a hundred percent, and the reason it’s not a hundred percent is because if it were a hundred percent, it would probably mean that we’re investing in companies like hydrogen, that today have such tiny markets. You know, hydrogen companies usually have sales of  a few million dollars. So, even though we’d have a hundred percent compliance with the theme, we’d actually have virtually no impact on environment.

Where we really want to make an impact, and you said it in the question, is really to say, well, in an ideal world, you know, we would not use the heating in the house; you know, we would not use cars. In an ideal world, there are many things we would not do ideally in terms of climate change solutions, but we live in the real world and people are going to live in a building and they want to be heated and they want to have [their] creature comforts and so on.

So, what we’re looking for really are those companies that are at the forefront of their technologies. Again, whether it’s in agriculture, whether it’s in electrification, whether it’s building technologies, et cetera, they’re really pushing the boundaries of the R&D and making those heat pumps more and more and more efficient. So, products that perhaps 10 years ago … for example, solar energy 10 years ago was quite expensive technology. Today’s the cheapest source of energy in the world and will keep getting cheaper.

So, the majority of our investments really are, I would say, in these companies that are global companies dominant, and the reason that they’re dominant is because they are making the best technologies for saving the most energy, enabling the farmer to produce 30% more crops with the same cost base, et cetera. Those are the companies that we’re investing in and, you know, you may say, well, hang on, but a hundred percent of their sales are not dedicated climate change solutions, but it’s a very large portion of their sales, and because their sales are big, it’s making a huge impact on the environment today. So, that’s really what we’re looking for.

We are keeping an eye out on these newer technologies that, by the way, will make a huge difference in the years to come, like hydrogen, [which] is probably going to be a very big player at some point. But, at the moment, you know, they’re still loss-making, they’re still burning a lot of cash, and we need to see manufacturing costs really reduce in order to sort of commit capital to these industries.

I should perhaps make one caveat that obviously government policies, both sides of the Atlantic, both in the US and in Europe, are really going to be trying to encourage these new technologies going forward, as well as some of these more established technologies, to encourage us to, you know, make our buildings more efficient, et cetera. So, there is going to be government support that will hopefully speed up the technological progress of these technologies even more, making them, you know, investible in a few years’ time.

SW: One of the technologies that you mentioned and I wanted to touch on as well, was carbon capture technology. Can you just give us a little bit of a background, tell us more about it, where you see that going in the future? Because I believe it’s on the upward scale – that ’S’ that you mentioned earlier – and being integrated. So, can you tell us more about that?

FC: So, carbon capture is still in the early part of the S-curve in the adoption. And the reason is because it’s quite expensive technology. Now, carbon capture will play an important role in climate change strategies. And the reason is that there are certain industries, for example, like the cement industry that are going to find it really hard to decarbonise. 1) They use a huge amount of energy, but of course some of this energy can become [inaudible], et cetera. So, that’s part of the equation, is not the major problem. But the major problem is you actually produce greenhouse gases are being let out of the concrete as it’s produced. And therefore the idea of carbon capture is, as the name says, is you’re actually capturing the carbon. And then it would be stored presumably in deep wells under the sea floor, for example or it could be in mountains, et cetera. But again, the costs today are really quite expensive. And so, there’s still a lot more to be done on the R&D side before these products reach what we might call grid parity*, so they’re competitive.

[Grid parity occurs when an alternative energy source can generate power at a levelized cost of electricity that is less than or equal to the price of power from the electricity grid. The term is most commonly used when discussing renewable energy sources.]

SW: Thank you. Now, I wanted to finish on the weather, which is very British, but my parents were over visiting, and they told me that the ocean temperature in Florida hit over a hundred degrees, which is about 37 Celsius. And, in fact checking them – because I thought they were just trying to wind me up – I actually read that the month of July was hotter for four out of the five people globally – despite not having them here in England, there have been loads of heat waves, <laugh>. And I guess my question is that these heat waves, are they evidence that climate change is speeding up and do we really just need to adapt that life is changing? Because I don’t know about you, but a hundred degree water doesn’t exactly seem refreshing, when it’s equally as hot outside.

SB: I perhaps I can answer that. I’m from Italy, I was raised in the Italian Alps, so for me the metric is not so much the water temperature but the degree of the pace of melting of the glaciers. And so, every time I go back home, every summer, I can actually see the difference from previous years, and I compare pictures from 20 years ago and so on. And it’s frightening to see that, even this year we did have at 3,800 metres high, the zero degree, meaning that this has been zero or a higher temperature for the glaciers to melt. This is kind of like, obviously frightening [and] has been happening for a number of years. It has accelerated somewhat. And I think it’s just not just something that we should bluntly accept. We can do something about it; we can adapt, and we can kind of like improve the lifestyle as consumers and we can adopt all these solutions and we can change to be more prepared for the future, both as consumer, as I said and as an investor.

So, it’s actually quite exciting and it’s not all about accepting, but being ready for it.

SW: Well, unfortunately, we have to leave it there. But thank you both so much for joining me today and talking through so many different facets of the portfolio and what’s happening in climate change solutions. Really appreciate you taking the time.

FC: Thank you.

SB: Thank you.

SW: The JPM Climate Change Solutions fund is a high conviction thematic portfolio. One notable advantage of this fund lies in its freedom from geographical, sectoral, and market capitalisation constraints. This unique

flexibility empowers its managers to explore a broader spectrum of opportunities, as we heard in this

interview. To learn more about JPM Climate Change Solutions, please visit fundcalibre.com

Please remember, we’ve been discussing individual companies to bring investing to life for you. It’s not a recommendation to buy or sell. The fund may or may not still hold these companies at the time of listening. Elite Ratings are based on FundCalibre’s research methodology and are the opinion of FundCalibre’s research team only.