Tapping into sustainability and green energy—part 2

Decarbonisation, renewable energy, and ethical investing are increasingly urgent issues for asset managers and investors alike. But how do you play it? Finding pure-play ASX-listed companies that tap the theme is tricky, but there are more and more funds, both active and passive, that offer exposure.

In the second part of our feature on investing in sustainability and green energy, we examine some local and international ideas, including some narrow-moat companies as rated by Morningstar analysts, and three examples of ETFs available to local investors. And finally, we end the discussion with a note of caution and why investing in sustainability, like any trend of theme, isn’t entirely free.

Read part 1.

Anatomy of a leader in sustainable investing

The Australian sustainable funds market remains quite concentrated, with the top 15 funds accounting for 52 per cent of total assets in the sustainable fund universe. Australian Ethical and Vanguard remain the dominant Australasian providers of sustainable funds, each with a 20 per cent market share. 

Estimated Top 10 Managers of Australasian Sustainble Investment Funds

Source: Morningstar Direct. Data as of 31 December 2020. Excludes fund of funds.

Australian Ethical Investments

Australian Ethical Australian Shares fund carries a Morningstar Bronze rating. It has a portfolio of 15 to 30 stocks with a large cap bias; it has no exposure to tobacco, gambling and fossil fuel companies, and invests in clean energy, sustainable products, medical solutions, innovative technology, responsible banking, healthcare, recycling, energy efficiency, education, and aged care. Its screening procedures, based on Australian Ethical Investments' Ethical Charter, which was remained unchanged since 1986. Over the past five years, the fund has posted a return of 15 per cent versus 11 per cent for the broader S&P/ASX Small Ordinaries. The investable universe of stocks is constantly monitored by the ethics research team led by Dr Stuart Palmer and two dedicated ESG analysts.

Fire, wind and rain: US and international names in sustainability and renewable energy

Narrow-moat NextEra Energy’s (NEE) regulated utility, Florida Power & Light, distributes power to roughly five million customers in Florida. Florida Power & Light contributes roughly 60 per cent of the group's operating earnings. The renewable energy segment generates and sells power throughout the US and Canada.

Since its initial public offering in April 2008, narrow-moat American Water Works (AWK) has increased earnings at a low-double-digit pace, topping most regulated utilities. The earnings growth has rewarded investors with a total return over 180 per cent the past six years, more than double the Morningstar US Utilities Index.

First Solar (FSLR) designs and manufactures solar photovoltaic panels, modules, and systems for use in utility-scale development projects. The company's solar modules use cadmium telluride to convert sunlight into electricity. This is commonly called thin-film technology. First Solar is the world’s largest thin-film solar module manufacturer. It has production lines in Vietnam, Malaysia, and Ohio.

Narrow moat Duke Energy (DUK) is one of the largest US utilities, with regulated utilities in the Carolinas, Indiana, Florida, Ohio, and Kentucky that deliver electricity and gas to more than seven million customers. Duke operates in three major segments: electric utilities and infrastructure; gas utilities and infrastructure; and commercial renewables.

Danish narrow-moat company Vestas Wind Systems (VWS) is the largest manufacturer of wind turbines with the highest installed capacity in the world. The firm operates two business segments: power solutions and services. The power solutions segment designs, manufactures, and installs onshore wind turbines. The services segment performs operating and maintenance service work on wind turbines. The US accounted for approximately 32 per cent of sales in 2019.

Denmark-based narrow-moat company Orsted (ORSTED), because it has successfully made the transition from being one of the most fossil fuel intensive energy companies a decade ago to being a leading green energy company today. It operated 7.6 GW of offshore wind farms at the end of 2020. The UK is the biggest country of operation, ahead of Germany and Denmark. The group intends to develop its footprint outside Europe with projects in Taiwan and in the US.

A selection of US and international companies

Source: Morningstar Direct. Data as 25 March 2021

Gaining exposure through ETFs

Locally, research from BetaShares, an ETF provider, and Investment Trends has found climate change is among the top ESG concerns for Australians. More than 40 per cent of investors put it down as a primary concern, according to the Investment Trends Report 2020. However, as nabtrade’s Gemma Dale, notes, “the Australian share market offers relatively slim pickings for investors who wish to invest in the global decarbonisation trend. Additionally, overweight positions in emissions-intensive sectors may prove a drag on portfolios as the decarbonisation trend accelerates.”

There are several ETFs that name look to offer exposure to companies specialising in sustainability and clean energy. Investors are advised to check the holdings to avoid overlap as these funds contain many companies that appear in other broader ETFs. 

BetaShares Global Sustainability Leaders ETF (ETHI)

ETHI tracks the Nasdaq Future Global Sustainable Leaders Index, a benchmark co-developed with BetaShares in November 2016. ETHI comprises 200 stocks that have above-average ESG characteristics. It uses a float-adjusted market-cap-weighted approach, starting with a universe of 6,000 stocks listed in North America, Europe, or Asia (ex-Australia). It carries a Morningstar Bronze rating. Since its inception in 2017, it has returned 20.64 per cent a year versus 21.11 per cent for the index.

VanEck Vectors MSCI International Sustainable Equity ETF (ESGI)

ESGI gives investors exposure to a diversified portfolio of sustainable international companies listed on exchanges in developed markets around the world (ex-Australia). ESGI aims to provide investment returns before fees and other costs which track the performance of the index, which is the MSCI World ex Australia ex Fossil Fuel Select SRI and Low Carbon Capped Index. Top holdings include Microsoft, the Home Depot and Amgen.

Vanguard Ethically Conscious Australian Shares Index ETF (VETH)

Vanguard Ethically Conscious Australian Shares ETF seeks to track the return of the FTSE Australia 300 Choice Index. Since its inception in October 2020, it has returned 6.96 per cent versus 6.97 per cent for the index. Its holds 235 stocks. Top holdings include CSL, the big four banks, and Wesfarmers. It does, however, invest in Fortescue Metals Group and gold miner Newcrest.

Exhibit: ETHI, ESGI, VETH v Morningstar Australia Index - Growth of $10k over five years

Source: Morningstar Premium. Data as of 25 March 2021.

“As government and private investment in clean energy is accelerating, divestment away from fossil fuels is also gathering pace,” Neiron says, citing the case of Norway’s sovereign wealth fund and its decision in 2019 to withdraw from fossil fuels. In Australia, superannuation funds are following suit. Aware Super for instance invests in local and global renewable energy projects. In Australia, it invests in the Snowtown 2 wind farm as well as Powering Australia Renewables, which funds four Australian renewable energy projects. Aware’s global renewable investments include the Darby Servtec Energy Fund, which supports renewable energy projects and skill-building in Latin America. These renewable investments sit in Aware’s Infrastructure and real assets asset class. Aware says this asset class has delivered a return of 13 per cent over the past five years to 31 January 2021.

‘Sustainability isn’t free’

As in any investment, investing in sustainability, renewable and ESG-focused funds and stocks is not without risk. Emissions targets can change; countries can withdraw from international pacts; wind turbines can face community resistance, not to mention breakdown. The social component of ESG poses risks too. Efforts to do right by employers—by increasing wages, for example—can backfire. “Sustainability isn’t free,” say Robert M. Wilson and Robert M. Almeida jr, of global equity manager MFS. “In our view, efforts to become more sustainable will challenge many companies and perhaps even bankrupt some of them.”

A sharp rise in the US minimum wage, for instance, would no doubt challenge business models.  Wilson and Almeida argue. “Certain retailers would face particular challenges. If companies in this sector are going out of business at an alarming rate while paying the US federal minimum wage of US$7.25 an hour, how can they possibly hope to survive if the wage increases to U$15?”

“Some retailers will be able to adapt, but many will find that sustainability concerns pose major challenges to their profitability.”

“The move toward sustainability is a disruptive force akin to the industrial revolution or the advent of the internet. It will define society and the investment landscape for decades. But it won’t be free.”

Morningstar's Global Best Ideas list is out now. Morningstar Premium subscribers can view the list here.

See also Morningstar Guide to International Investing.