As the number of investors eager to jump on the Sustainability Express grows, there is still a reticence to invest in sustainability-related products.
They shouldn’t be.
For these investors, the slick marketing and exciting destinations has done little to allay fears over how high the businesses are being valued. But the sustainability revolution has only just started and companies on the journey should expect to see strong and steady growth in earnings in the years and decades to come.
Much of these companies’ earning potential is down the track in the future, so it is natural shares will be bought and sold at high multiples relatives to their current earnings. This is common for growth stocks.
Recent volatility in some sustainable investments, such as green tech stocks, spooked investors already wary of jumping on the bandwagon. But this volatility should be welcomed as the ticket for investors looking to buy into sustainability-related themes at a reasonable price.
One of the main drivers behind this is the market putting some of the green tech stocks in the growth stocks camp, together with more traditional technology firms. Growth stocks sold off when bond yields spiked, due to market concern over rising inflation, and the corresponding uncertainty around central banks’ reaction pondering if they will start to tighten monetary policy to address inflation.
In the short term, inflation may continue to rise, and volatile bond yields could continue to lead to some volatility in growth and green tech stocks. But central banks have repeatedly stressed their intentions to pursue very gradual policy normalisation, and we believe they should manage to calm bond and stock markets in coming months.
For the world to become more sustainable, as Governments and companies scramble to hit net zero targets, the investment needed is staggering. But so is the opportunity.
To reach net-zero carbon emissions by 2050 or 2060, as many countries have pledged, we will need to completely change the way we live and find ways to cut our net emissions to levels close to those before the first industrial revolution. So, companies that ride this train of investment and demand for sustainable products should see plenty of scope to grow their earnings, now and over the long term.
The journey to net zero will be long and fraught with execution risk. But the level of global commitment for an investment theme is rare.
We are now at a pivotal junction, where the take-up of sustainable products and services is rapidly accelerating; not just because people care about the environment, but also because sustainable products are now competitive with traditional versions. With so much growth ahead for these businesses, the earnings in their price/earnings ratio should be well supported, and many stocks therefore warrant their high valuations.
Of course, typically, when investors mention the high valuations of sustainability focused holdings, their concerns often centre on pure-play firms which solely focus on sustainable products and services. But the number of quoted pure-play companies is limited. This is why capital flow into such stocks has naturally driven up their price and why we think investors looking for slightly cheaper options can diversify into companies that are not pure plays but have growing activities in sustainability.
Traditional car companies have different levels of activity in electric vehicles for example; some utilities are more advanced than others in green energy; and some industrial companies have growing green hydrogen activities. By differentiating between ‘traditional’ companies, and selecting companies with growing sustainable activities, investors can build up their exposure to sustainability. If this is replicated across the portfolio, total exposure to sustainable investments will quickly add up.