Harry Thomas on the integral role of emerging markets in financial transition

Ahead of the Sustainable Investment Forum Europe, Harry Thomas from TT International talks to Climate Action about the integral role of emerging markets in financial transition. The need for responsible investors to mitigate against biodiversity loss and the importance of channelling capital towards companies protecting against ecosystem destruction.

Why do you think Emerging Markets play such an important role in the environmental transition?

Many of the most exciting environmental technologies are being developed in North Asia, particularly in China, Korea and Taiwan. China is in the midst of a major government push to develop its green technologies, most notably in the fields of electric vehicles and renewables. For example, it has committed to having 1 million hydrogen vehicles on the road by 2030. The Chinese government’s upcoming Five Year Plan is likely to double-down on these efforts, precipitating a significant acceleration in the build-out of renewables infrastructure.

This is despite the fact that the global renewables value chain already consistently leads back to China. In a typical solar panel, it is highly likely that the polysilicon, the glass, the module and the cell will all have been manufactured in China. Korea is also at the forefront of many green technologies, particularly those related to transportation. 60% of the world’s batteries are currently made in Korea, which means that much of the battery materials supply chain is also being localised in the country. The Korean government has mandated a big push in hydrogen technologies and has set an ambitious target of building out 8 gigawatts of domestic hydrogen fuel cell capacity.

Taiwan meanwhile, by virtue of its leading expertise in the semiconductor and electronics industries, is a key beneficiary of the electrification of the planet. If you were to distil the green transition into its simplest form, it is essentially a shift from hydrocarbon molecules – coal, gas and oil – to electrons. Taiwan is home to numerous companies in the supply chains for the electrification of homes and vehicles. As such, its economy is one of the most geared to the accelerating shift towards electrification.  

In a more general sense, Emerging Markets are where the most extreme risks and opportunities associated with the environmental transition will play out over the coming decades. The ironic reality is that, despite the Global South having a relatively limited contribution to climate change thus far, many developing countries there will feel the effects of climate change most acutely. Be it heat death, hunger, water shortages, sea level rises or intensifying natural disasters, an increasingly hostile environment will motivate countries in South-East Asia, Latin America and Africa to create environmental solutions in order to protect their citizens and economies.

Thankfully, the same geographic features that have left many countries in the Global South most vulnerable to climate change have also endowed them with some of the world’s most valuable solar, hydro and wind resources to help them meet the challenge. Meanwhile, burgeoning demand in fast-growing developing countries for energy and western lifestyle privileges such as meat and air travel will present significant opportunities for businesses to design more environmentally friendly alternatives.

Crucially, TT’s Environmental Solutions strategy is a genuinely global approach. Whereas many of our competitors have portfolios that are dominated by companies in Europe and the US, our world-class team of analysts have many years of experience researching companies across the globe, including in Emerging Markets, where TT has a market leading strategy. Consequently, our portfolio contains many exciting companies in Asia and Latin America.

Given the exceptional run the asset has had do you believe now is a good time to invest? If so why?

A popular Chinese proverb states that: “The best time to plant a tree was 20 years ago. The second best time is now.” We believe the same can be said of environmental investment. Structurally we believe that environmental equities as an asset class is likely to be a segment of the market that will see secular outperformance for many years to come, given the growing recognition of the vital importance of helping to solve the problems of climate change and ecosystem destruction around the world.

We believe that the market has yet to appreciate the scale of the transition required, given that it will impact a huge number of areas, including energy generation, travel, building, diet, agriculture and clothing. Many competitor funds are focused solely on carbon and other greenhouse gases, whereas our approach considers all harms to nature and is particularly focused on biodiversity.

Environmental equities have clearly rerated significantly, particularly after Biden’s election victory. However, it is important to note that, while there are undoubtedly areas of the market where valuations are stretched such as EVs and renewables, it is still very early days for many environmental technologies including solar, hydrogen and carbon capture, all of which have a long growth runway ahead of them. Moreover, we are actively managing the portfolio to ensure that we are taking profits in our best performing stocks and recycling the proceeds into relative laggards.

We are also ensuring that the portfolio remains well diversified. It is not simply exposed to the most popular areas of the market, but rather has exposure to a wide range of themes including agriculture, water, forestry, and recycling, which at this stage remain relatively underappreciated in our view.

What role can responsible investors play in resolving the biodiversity crisis?  Can investors mitigate biodiversity loss through incorporating robust risk assessments and opportunities in their investment analysis and directing capital to firms to minimise biodiversity loss?

We believe that responsible investors have a vital role to play in helping to mitigate the biodiversity crisis. By channelling capital towards those companies helping to solve the crisis and away from companies that are complicit in it, investors can help to lower the cost of capital for certain companies and increase it for others. However, we note that many responsible investors have a narrow focus on carbon and therefore limit their investment exposure to electrification trends, often ignoring biodiversity loss.

While we invest in companies that are facilitating the transition towards a lower-carbon world, we are also explicitly looking to channel capital towards companies protecting against ecosystem destruction. Indeed, our investments in areas such as responsible consumption and the circular economy aim to address issues such as waste and the excessive use of raw materials, which are contributing to ecosystem destruction and biodiversity loss.

Investors can also help to persuade companies to minimise biodiversity loss through their engagement efforts. To this end, in conjunction with one of our Research Advisory Board members – a world-renowned expert in biodiversity – we have developed our own tailor-made lists of questions on biodiversity to ask companies in various sectors when we engage with them.

Finally, investors could seek to make an even greater impact by using some of their profits to help promote biodiversity. We give one-third of the management fees received for the TT Environmental Solutions strategy to charities that plant trees and ‘rewild’ habitats as research demonstrates that these are the most effective ways to mitigate the existential threats of climate change and ecosystem destruction.

How important is it to have a defined repeatable environmental process as well as an investment process and how does this work in practice?

Having a well-defined and repeatable environmental process is vital because it provides clarity to the investment team regarding which companies to focus on, and to our investors in terms of what they should expect from us. At the core of our process is a proprietary 5-step environmental screen that we use to assess whether companies are legitimately providing environmental solutions, and therefore whether they qualify for potential inclusion in the fund. We believe that this hurdle for inclusion is demonstrably higher than many of our peers. Moreover, when undertaking our top-down research, we assess the most interesting trends within environmental investing from a regulatory, technological and consumer preference perspective. Our long-term environmental trend analysis includes:

• Consumer trends – responsible consumption, green mobility, diet
• Technological trends – battery storage, electric vehicles, low cost renewables, hydrogen economy, smart grid and electrification
• Regulatory trends – recycling, building refurbishment, emissions targets, renewable energy targets, industrial efficiency requirements, water consumption, EU Taxonomy
• Climate trends – heat stress, unpredictable rainfall, diseases and pests

After implementing these environmental aspects of our process to determine whether a company complies with our overarching environmental philosophy, the strategy employs TT’s broader VVC-ESG investment procedure. This rigorous process requires us to examine the Valuation case for every investment, Verify our assumptions using a wide range of sources, identify clear Catalysts to realise the outperformance, and make an integrated assessment of ESG issues. TT’s VVC-ESG process has been proven to generate strong long-term returns across multiple business and market cycles.

Why is TT International’s relationship with environmental charities so important?

One of the key differentiating features of the TT Environmental Solutions strategy is that we give one-third of our management fees to environmental charities. When designing the product we wanted to ensure that it had a genuine tangible benefit to the environment by supporting carefully selected charities, and also that our support for these charities would increase materially as the product scaled up. But our relationship with these charities goes beyond simple donations; we are looking to partner with them, sharing expertise wherever possible. For example, one of the Analysts on the strategy, Ross Sterling, sits on a committee created by UK-based rewilding charity Heal to advise them on their capital structure.

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Harry Thomas will be speaking at the Sustainable Investment Forum Europe in April, bringing together asset owners and managers, ratings agencies, banks, UN and Government policymakers, investors, development banks, think tanks, and NGOs committed to driving forward the sustainable finance agenda. Register your place for free here.