Candriam: why Esg investments are not a passing trend

Although they have slightly negative performance, David Czupryna (Candriam) does not stop believing in green stocks. “Public projects and megatrends will drive the sector while valuations offer entry point”. But a focus on quality is needed

by Giulio Zangrandi

In today's complex and multidimensional environment, investors are wondering if the sustainable investment trend will continue. Especially considering that, over the past two years, stocks of so-called ‘green companies’ have had slightly negative market performance. According to David Czupryna, senior fund manager at the Thematic Global team of Candriam, there is no danger. FocusRisparmio caught up with him to delve into the topic and to understand what the trajectory of one segment will be: the circular economy.

How can investors become more aware of the effects of the SDGs on the real economy??

In the real economy, the green agenda and green investments are progressing, and in some cases even accelerating. For example, since 2015 every year the world spends more on clean energy than fossil energy. In 2023 we spent $258bn more on clean energy than in 2022, an increase of 18% vs 2022. Of these $258bn, 35% went to renewable energy, and 69% was from Europe and the US. And talking about the US, partly thanks to the Inflation Reduction Act, we are seeing a positive momentum building up with $387bn spent in 2023 vs $284bn in 2021 pre-IRA. Another key indicator of the progress on green investments can be found in EVs numbers. In 2023 30% more EVs were sold than in 2022, representing over 3m cars. China comprises 60% of that market, but the trend was evident also in EU, US and China. The average price of EVs sold globally has declined 21% over the last 12 months, which puts it now just 8% higher than the overall market average, therefore increasing its competitiveness, not to mention the lower cost of using an electric car vs petrol car.

How can the future of green investments be shaped in light of the new geopolitical environment? Is the season for fossil fuels, for example, really coming to an end, or has the war in Ukraine brought them back into the limelight?

While companies in the so-called dirty sector have performed well in the last couple of years, on the long run the future is green. If we look at solar energy, its cost has collapsed, increasing its competitiveness against fossil energy. Futhermore, green investments are here to stay, since in several green sectors?we have reached a point where, no matter the future regulation, the appeal is now economical as well as environmental. In fact, while the possible re-election of Donald Trump could possibly translate in efforts to water down the IRA (thus creating short term volatility), we think it is very unlikely that Trump, if reelected, will want to, or be able to, repeal most of the IRA as many of US states benefiting the most from the IRA are Republican states.

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One of the most interesting and tangible dimensions is investments in green solutions that help decarbonize the economy and make it more circular. What is it about and why should investors care?

Circular economy represents an alternative to the current linear economic model (“extract, manufacture and dispose”) and aims to reduce the need to extract raw materials while reducing waste generation. This includes those companies involved in activities which contribute to recycling, replacement, repurpose and rationalization of products and resources. These companies are implementing this in a variety of ways, depending on their business sector and the circularity challenges they face. This may involve integrating a greater proportion of biodegradable or recycled materials into their production processes, developing waste treatment solutions, enabling the extension of the lifespan of manufactured products, or reducing the need to produce new equipment by making it easier to share.

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Over the past two years, the share price performance of green solutions companies has been quite negative. Why did it happen and how long will it last?

There are several rational explanations for the poor performance of the green sector, but certainly not because of a lack of investment in the green transition. The market environment over the last two years has been very unfavourable for small and midsized companies and many clean tech companies belong to that category. Futhermore, many green sectors are still very young: with the end demand booming, the risk of overinvestment, oversupply, followed by a collapsing margin, high-cost producers leaving the market and then the market readjusting is high. Another reason is that green tech companies are typical growth companies, with their cash flows expected to grow into the future: with interest rates going up massively over the last two years, the present value of these future earnings has dropped accordingly. All these elements have to do with the fast and decisive rise in interest rates. Now that central banks are flagging likely rate decreases, we would expect this headwind to recede.

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Wich instruments to invest in this segment and according to which approach?

We believe that the current market weakness in clean tech is a rare opportunity to gain exposure to these companies, as they suffered short term share price weakness for reasons that do not impact their mid-term growth potential. In Candriam, when we select companies, we look at capital preservation, as we want to invest in companies with a proven business model and and if not positive free cash flows, at least a credible path to get there. Clean tech has been appealing for the fact that it benefits from strong support through subsidies and incentive programs in all major regions. But regulations can change, we are therefore very prudent to invest in companies that can stand on their own two feet.

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What strategies to offer to intercept this trend? What are their characteristics?

Our strategy on circular economy aims to invest in companies that have their core business positively aligned with circular economy principles. To do this, we have developed an internal model to analyse a company's contribution to the circular economy which aims to create a body of evidence for each company to support its degree of circularity. Moreover, each company is assessed, takin into account ESG factors, through a financial framework according to five fundamental criteria: quality of management, business growth, competitive advantage, value creation, financial leverage. The strategy also takes into account each company's overall contribution to the Paris Agreement objectives, based not only on carbon emissions, but also on avoided emissions, as well as a forward-looking assessment of a company's investment plans, credibility of greenhouse gas emission reduction targets and strategy. The analysis and selection process is also accompanied by active involvement, in particular through dialogue with companies and, as a shareholder, through voting at general meetings.