By Velislava Dimitrova, Portfolio Manager & Cornelia Furse, Assistant Portfolio Manager, Fidelity Sustainable Water & Waste Fund at Fidelity International
The recent flurry of political announcements highlights to good effect the increasing focus on creating a more sustainable and greener global economy. In the US, for example, President Biden has announced a US$2tn deal to fund sustainable infrastructure projects, while the EU Green deal has set out €1tn towards sustainable investments and China has targeted net zero carbon emissions by 2060.
This points to a significant expansion of a global green market and has fuelled investor appetite for sustainable technologies and environmentally friendly companies like renewables, electric vehicles and many others. This has been reflected in the recent run of ‘green’ stocks, with the renewables sector reaching record highs at the beginning of 2021.
However, the more recent correction of renewables presents the question - is this a ‘green’ bubble bursting or are there signs of a fundamental future opportunity? We believe that the ‘green’ premium is driven by improving and superior fundamentals and ‘green’ stocks are vital in creating a step change towards the decarbonisation of the world.
The driving factors behind current valuation premiums for ‘green’ stocks
In addition to the strong economics of some green technologies, there are two other important key drivers behind the valuations of ‘green’ stocks:
1. Acceleration of ESG flows
A key driving factor behind the ‘green’ premium is the dramatic acceleration of flows into ESG focused investments. As highlighted in the chart below, 2020 was by far the most successful year for ESG flows, totalling US$45bn (nearly five times that of 2019). This momentum continued into the first two months of the year, having already exceeded flow levels as of 2019. Furthermore, a recent Fidelity study has shown a positive relationship between ESG ownership and stock performance.
2. Decarbonisation global regulation has shifted investor focus towards clean energy
As a result of the ongoing climate change debate, zero carbon targets have been set globally to decarbonise the word (as highlighted in the graphic below). This trend can also be identified at a company level, as according to Fidelity analysts, almost a quarter of all companies will be carbon neutral by the end of this decade. Innovative technologies for decarbonising the world are clear beneficiaries from this regulation.
Our research has shown that the ‘green’ valuation premium is justified due to visible, structural growth drivers which will span for decades to come as a result of the decarbonisation of the world. Stocks that are exposed to these trends, while at the same time benefit from favourable competitive dynamics and high barriers to entry, will be in the best position to offer superior and sustainable earnings growth and returns, and therefore outperform the market.
Renewables are a prime example. We need more than 20 times the renewables we have today if we are to fully decarbonise by 2050. Renewables costs have declined more than 80% over the last 10 years and this reduction in cost will further accelerate wide scale renewables adoption. The investment opportunity is huge.
Conclusion
The current ‘green’ premium for many stocks exposed to the green economy transition are justified due to several key structural drivers and improving fundamentals. The decarbonisation trend is currently at the early stage of penetration and will be driven by a combination of innovation, improving economics, accelerated governmental support and changing consumer behaviours; all in response to climate change. It is the stocks exposed to these themes, but with the superior technologies and favourable competitive dynamics, that will drive superior investment opportunities for investors.
For more information on Fidelity's approach to sustainability, click here.
Important information
This information is for investment professionals only and should not be relied upon by private investors. The value of investments (and the income from them) can go down as well as up and you may not get back the amount invested. Past performance is not a reliable indicator of future returns. Investors should note that the views expressed may no longer be current and may have already been acted upon. Changes in currency exchange rates may affect the value of an investment in overseas markets. Currency hedging is used to substantially reduce the risk of losses from unfavourable exchange rate movements on holdings in currencies that differ from the dealing currency. Investments in emerging markets can be more volatile than in other more developed markets. Reference to specific securities should not be interpreted as a recommendation to buy or sell these securities,but is included for the purposes of illustration only. A focus on securities of companies which maintain strong environmental, social and governance (“ESG”) credentials may result in a return that at times compares unfavourably to similar products without such focus. No representation nor warranty is made with respect to the fairness, accuracy or completeness of such credentials. The status of a security’s ESG credentials can change over time. Investments should be made on the basis of the current prospectus, which is available along with the Key Investor Information Document, current annual and semi-annual reports free of charge on request by calling 0800 368 1732. Issued by Financial Administration Services Limited, authorised and regulated by the Financial Conduct Authority. Fidelity, Fidelity International, the Fidelity International logo and F symbol are trademarks of FIL Limited. UKM0521/34436/SSO/NA