Three themes’ investors cannot afford to miss over the coming decade
Impax's Ian Simm discusses how the last decade has influenced the market today, and the three themes’ investors cannot ignore.
If the last few years are anything to go by, the next decade will be intense and volatile for financial markets. "Normal" market pricing was thrown out the window in 2022 and this led to severe falls across almost all asset classes. So will the volatility stick around?
How will the next few years compare to the last decade in markets?
I think what we've seen in markets for the last 10 years is a rising tide of valuations, to some degree underpinned by quantitative easing, which has been a feature of central bank policy for a long period of time. And now that's stopped, and we're probably going to be reversing QE and having quantitative tightening, or the equivalent for quite a long period of time.
I'm not sure that markets will return to what people think of as normal with a 10-year hindsight perspective.
What we're likely to have is quite significant volatility for the next decade, with geopolitical risk being a significant factor. We've also got the issues around more disruptive weather patterns and climate change related issues, which on a local level, have really been very disruptive to real assets, infrastructure and real estate, etc. So in that context, the other factor, of course, is inflation.
And 18 months ago, the market consensus was inflation was going to plateau quite rapidly, and then fall as supply chains post-COVID sorted themselves out. What we've actually seen is that has happened to some degree, but then we've had a problem with labour markets with a lot of people retiring permanently from labour markets and China remaining closed.
The supply situation is going to be a problem for the foreseeable future, and that's probably going to underpin higher than previously seen inflation, which is obviously going to then raise discount rates for assets. So I think we're into a much more choppy period compared to the experience for the last decade.
When it comes to investing, is it better to be a short or long-term investor?
There are two schools of thought in investment management. Long-term investing, where you buy assets and then wait for certain trends to play out, or short-term investing, where you are chopping and changing and trying to time the market and assess where sentiment is about to go in the near future, and then trading accordingly.
From our perspective as active investment managers, the optimal strategy does appear to be a blend of the two. For example, in the UK, we've had a policy commitment that beyond 2030, it'll be illegal to sell vehicles with internal combustion engines. That's one product cycle away for the original equipment manufacturers who are having to adapt very rapidly. So that's a good backdrop in which to be making investments in the transportation sector from a long-term perspective.
But on the way, there are going to be bumps in the road for companies up and down that value chain. There's going to be money to be made from buying and selling companies that long term are going to be winners, but maybe short term are overvalued or perhaps are misunderstood and cheap. So yes, a nice combination of the two is the right way to play it.
What does a sustainable economy look like to Impax?
So Impax Asset Management's whole business is based on the idea of the transition to a more sustainable economy being an excellent area for investment outperformance. There are a number of industrial revolutions or sectoral transformations underway in the areas of energy, transportation, materials, healthcare and financials.
All are underpinned by this idea that we all live on a finite planet and that with a rising global population and rising standards of living, there has to be some constraint on economic activity and strong incentives to improve the efficiency with which resources are used. Otherwise, human habitation can't continue.
Underneath that is a number of market changes. The most obvious of which is in the switch from fossil fuel based power generation to renewable energy like wind and solar. But it's also the incredible acceleration of market penetration for electric vehicles. Over the last 20 years, they have come from very, very small levels of penetration to become the majority of vehicle sales now across the whole economy in parts of Northern Europe.
So these central transformations are producing very high rates of economic growth, and they're also quite often misunderstood by the average investor, because understanding the way that regulations change or the way that technology affects valuation is quite technical challenge.
The transition to a more sustainable economy is fabulous place for making money. It's underpinned by very strong economic rationale on a global basis. And that rationale really is based on the mis-pricing. So what we're trying to do as investment managers is exploit that mis-pricing.
Which three themes will drive returns over the next decade?
I think the most obvious is energy. This rapid adoption of renewables, battery storage, the creation of more sophisticated power grids, decarbonisation, and decarbonising both power and heat. That's probably the biggest investment opportunity that the world has seen maybe for a hundred years.
In the water space, there is an acute and growing need for more reliable water, and new water supply to new populations, many of which are increasingly moving to urban areas. And then, of course, there's a huge challenge around water quality. The requirement to invest in the resilience of water infrastructure to make it robust against more extreme weather, but provide new infrastructure and higher quality infrastructure is a very powerful theme.
And then the third theme is food. So at the moment, one-third of food is wasted between the field and the fork, between the place where it's grown and the point of consumption, which is just extraordinarily inefficient. So there's a massive amount of money to be made from improving the efficiency with which food is grown, distributed, and provided through retail outlets. And then I think the potential for moving away from meat-based diets to increasingly plant-based diets, maybe not entirely. Flexitarian-type diets are increasingly preferred by people in their twenties, and suddenly my kids, in their teens, are showing a lot less interest in eating meat. So business opportunities to provide new food-based products in that dimension as well are very exciting.
How long will it take for the energy transition to actually happen?
There is a lot of debate about the pace of change and the timing of this transition. People point to 2050 and expect that things will all immediately happen then, but we don't need to do anything in the meantime. But we've seen from COVID just how quickly these transitions can happen beyond expectations, the move to home working, video conferencing, etc.
I think with the Russian invasion of Ukraine, we've seen probably a 10-year acceleration or compression of the timeframe to adopt energy efficiency measures, because Europe's just been desperate for energy supply sources and reducing demand over the last 12 months.
And also, renewable energy is seen in Europe as a way to create energy resilience. So the technology adoption is really accelerating now, not just in renewable power, but in electric vehicles. In the UK, it's going to be illegal beyond 2030 to sell vehicles based on internal combustion engines. This market structuring is going to create demand for cleaner products and services much more rapidly than expected.
That's going to bring down price points for consumers all around the world, including Australia. There's going to be cheaper clean power and more clean vehicles than ever before. And therefore, the transition is going to be taking place this decade, not in the 2030s and 2040s.
Article courtesy of Livewire