Essex Global Environmental Opportunities Strategy (GEOS) July 2023 Update
There was a lot going on in the second quarter of 2023 across our capital markets. Early in the quarter, the markets were absorbing continued banking stresses amidst the din from the media and strategists alike regarding their anticipation of a global recession. Such headlines catalyzed a risk-off environment that continued to drive extreme valuations and returns for the largest of the large cap technology stocks – especially if AI was referenced. As the quarter progressed, there was some mild broadening of the market yet the flight to large growth equities versus smaller company shares is at decade high extremes currently. We believe smaller companies are ignored currently because of the continued “indexation” of US stock investing coupled with an aversion to what is deemed “risky”, which might stem from the credit or capital markets needs of faster growing businesses. While these are valid concerns (and addressed in recent reviews), the valuations relative to growth rates for the equity shares of our holdings are very attractive currently, based on our 14-year track record for the Essex Global Environmental Opportunities Strategy (GEOS, Strategy) composite as of June 30. On an asset allocation basis, we see significant opportunity for our undervalued and inefficient segment of the market. This is gravy as the fundamental case for GEOS resonates soundly. Polluted air from Canadian wildfires? The need for back-up power generation in Houston? Drought in the UK affecting hydro power and crop yields? Reshoring manufacturing in the US? PFAS pollution in our drinking water? Battery fires in electric vehicles (EVs)? Extreme heat in Europe and the Southwest US stressing power grids? We could go on. The companies represented by the portfolio holdings in GEOS solve each of these dire economic, environmental, and social problems, among many others. And AI? Machine learning and artificial intelligence are applications driving future growth opportunities for many of our GEOS holdings, from factory automation to fleet tracking and sensors for electric vehicles. AI is a technology exhibited across several GEOS themes that can continue to further our definition of clean technology, doing more with less.
While many investors have interest in companies setting net-zero targets and reducing operational emissions, GEOS invests in companies enabling a net-zero society. We identify and invest in companies offering differentiated products and services that help accelerate the transition to a net-zero economy. Many of the “net-zero enablers” we invest in also have decarbonization or net-zero commitments for their own operations, as 14 current GEOS holdings have a net-zero or carbon neutral commitment that covers scope 1 and 2 emissions, as well as scope 3 emissions in select cases. Although we do not invest in companies simply for having a net-zero commitment, (see previous blog for additional insights) we view positively the steps that companies take to address their value chain emissions footprint.
Not only do decarbonization commitments strengthen brand value and minimize company risk from carbon pricing schemes and other regulatory action, but in high carbon industries like metals and mining, steel, or cement, companies are expected to have a decarbonization strategy. Due to the high emissions footprint of these industries, companies without decarbonization commitments are at a competitive disadvantage, while climate leaders have an advantage, since their customers demand green or low carbon products. For example, auto companies are trying to decarbonize the lifecycle emissions of electric vehicles, including upstream emissions from purchased goods and services. Lithium, a key input into batteries, can be emissions intensive during production and OEMs are pushing suppliers to decarbonize the production process. We own a lithium company which has committed to becoming carbon neutral across scope 1, 2, and 3 emissions by 2040, including using 30% renewable energy by 2030. Their decarbonization strategy will enable them to produce low-carbon lithium to secure customer business and help auto OEMs meet net-zero targets.
Our highest conviction GEOS theme currently is power technology, which extends from electricity delivery to technologies that store electricity where it is needed, at the “edge of the network.” Distribution – which means to spread evenly translates to power deployment where it is needed. This trend can be compared to the computing transformation of the last 30 years, where data management was transformed from mainframe computer to laptop. We believe the electric grid transformation will be bigger than the computing transformation regarding the data and capital requirements. Our electricity grid is currently experiencing the greatest transformation since the Rural Electrification Act of 1936, which enabled coal-fired electricity delivery to rural customers – a more linear technology. Coal plants were constructed to deliver power, so lights could be turned on across the US using the most greenhouse gas intensive source of energy.
Our electric grid is now changing in all facets. Grid reliability is needed, as well as safety given increasingly severe weather, whether storms or extreme heat. Residential and commercial customers are investing in technologies to limit risks, from financial to environmental. Electricity customers want reliable power and limitations from price inflation, whether natural gas prices in the EU, or electricity pricing in the US which is increasing an average of 10% per year. While wind and solar energy are now cheaper than legacy fossil fuels, their attributes require a smarter grid, to manage the intermittency of solar, and the variability of wind power. While utilities have been slow in most regions to recognize the disruption occurring on their networks, this is rapidly changing now. The grid edge installation of technologies that can generate, store and use electrons when needed are rapidly increasing, requiring utilities to observe and manage these now “digitized electrons”. Data management is now required for this smart grid. Lights can now be turned on with electricity delivered from the grid, or locally from the point source of demand, using an EV, battery, or solar array. The move to electrify everything, from home stoves to EV charging and heat pumps will drive this trend much further. As we home shore more industrial manufacturing, commercial facilities will continue to adopt more grid-edge solutions, from fuel cell power to solar arrays coupled with storage and inverter technologies. In several regions now, new data centers are not allowed to plug into the grid, given already peak power capacities amidst the huge electricity requirements for cooling. Data centers are now the most rapid adopters of fuel cell power.
We believe we are early in the first inning of this power technology revolution, and our current GEOS investments include:
-advanced battery technologies, such as improved cathodes for enhanced performance and safety
-battery materials, from lithium to safety gels
-utility labor services for construction and maintenance
-utility data services and grid development
-virtual power plants, aggregating grid edge solutions to sell power back to grid
-advanced substation solutions
-hydrogen fuel cells for powering off grid datacenters and manufacturing facilities
-improved semiconductor technologies for EVs, vehicle to grid (V2G), storage and VPPs using silicon carbide to drive cycle life and improve performance and safety
-smart EV charging solutions
-solar inverter technologies for DC-AC power conversion
At this writing, GEOS has passed its 14-year track record – we believe to be the longest thematic and environmental solutions track record with a consistent investment team and investment process. We spent many years describing thematic equity investing to the marketplace, and now thematic investing is increasingly recognized as differentiated amidst large cap ESG approaches. We are very proud of the GEOS track record built on a consistent investment philosophy and process managed from a firm founded on dynamic equity investing over 47 years ago. The case for environmental solutions grows stronger by the day, as well as our GEOS team experience.
This commentary is for informational purposes only. It does not constitute investment advice and is not intended as an endorsement of any specific investment. The opinions and analyses expressed in this commentary are based on Essex Investment Management LLC’s (“Essex”) research and professional experience and are expressed as of the date of its release. Certain information expressed represents an assessment at a specific point in time and is not intended to be a forecast or guarantee of future results, nor is intended to speak to any future periods. Accordingly, such statements are inherently speculative as they are based on assumptions that may involve known and unknown risks and uncertainties.
This does not constitute an offer to sell or the solicitation of an offer to purchase any security or investment product, nor does it constitute a recommendation to invest in any particular security. An investment in securities is speculative and involves a high degree of risk and could result in the loss of all or a substantial portion of the amount invested. There can be no assurance that the strategy described herein will meet its objectives generally or avoid losses. Essex makes no warranty or representation, expressed or implied; nor does Essex accept any liability, with respect to the information and data set forth herein, and Essex specifically disclaims any duty to update any of the information and data contained in the commentary. This information and data does not constitute legal, tax, account, investment or other professional advice. Essex being registered by the SEC does not imply a certain level of skill or training.
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