Global equities reimagined: structural growth, diversification, impact

Achieving net zero and contributing to the United Nations Sustainable Development Goals comes with a hefty price tag. However, this presents a massive structural opportunity for investors to bridge the funding gap between current and future needs. Environmental impact strategies may not only help to bridge this gap but also enhance a global equity portfolio by offering both diversification and the potential for smoother performance throughout the cycle. This article encourages global equity investors to rethink the role of environmental impact strategies in their portfolios. 

Don’t miss out due to misconception!

A common barrier to incorporating environmental impact strategies in global equity allocations is misunderstanding their benefits. Let’s debunk some common myths about investments in environmental solutions providers: 

1. Environmental solutions extend far beyond renewable energy and power grids. They encompass a diverse array of investable companies and technologies. Vontobel’s impact investing team constructs equity portfolios ready to capitalize on consumer shifts and corporate innovation fuelling the transition to net zero and sustainable development investments. Our environmental impact strategies target companies tackling challenges in clean energy infrastructure, clean water, building technology, low-emission transportation, resource-efficient industry, and lifecycle management.  
2. Small- and mid-cap companies are not the sole focus of an environmental impact strategy. At Vontobel, we often find that large-cap companies deliver the growth, profitability, and competitive advantage our portfolio seeks. Our focus is not on company size, but on identifying companies with proven solutions – capable of being scaled and monetized – that can deliver competitive risk-adjusted equity returns over a full market cycle and aim to create a measurable positive effect on the environment.
3. The notion that environmental strategies only fit into dedicated sustainable, impact, or ethical portfolios is false. In fact, they’re being increasingly seen as a complimentary allocation to “traditional” global equity. We'll delve into the diversification benefits later in this piece.

A robust and resilient market opportunity

In 2023, investors funnelled record-breaking funds into energy transition technologies. As shown in graph one, global energy transition investment (ETI) outpaced fossil-fuel (FF) supply investment by nearly USD 700 billion. 

Despite ongoing funding for traditional energy supplies, the shift towards cleaner, more resource-efficient sources is evident. Investment in the low-carbon energy transition surged 17 percent to a new annual record of USD 1.77 trillion in 2023¹. Achieving this record amidst a year of geopolitical and economic tension underscores the overall resilience of the energy transition ¹.

Why the massive structural opportunity?

Despite the positive momentum, capital directed towards the energy transition needs to increase significantly. Enhanced infrastructure, especially in areas like clean energy and sustainable urban planning, is vital for modernization and substantial economic growth. As governments and private entities commit to targets like those in the Paris Agreement, demand for such advanced infrastructure is set to skyrocket, offering fertile investment opportunities in a global environmental impact strategy. 

Net zero is a commonly referenced climate target. To achieve it, the record investment level of 2023 needs to triple by 2030¹, as shown in graph two. This graph also shows the funding requirements for three additional commonly referenced climate targets, revealing an average increase of at least USD 2 trillion is needed. In one scenario, that amount rises to nearly USD 4 trillion. These forecasted investment levels suggest substantial inflows into the target universe of our environmental impact strategy.

Profitable and persistent

Investors should note that many emerging clean solutions are viable investments, irrespective of policy support, incentives, or subsidies. Vontobel’s impact investing team builds equity portfolios from a blend of established and disruptive companies that leverage long-term structural shifts such as climate change, providing innovative and scalable solutions to major global issues like depletion of resources or rising pollution. These companies have potential to outperform peers and gain market share, particularly if they possess robust balance sheets and superior long-term profitability. Our process is based on extensive, proprietary research and enables us to demonstrate how our investment decisions align with our performance and impact objectives.
 

Risk diversification for global equity portfolios

Stocks are selected for Vontobel’s environmental impact strategies based on high conviction, not their inclusion or weighting in a global equity index, sector, or country. We believe that investing in businesses driving positive environmental change can yield attractive financial returns and long-term positive impact, and target companies poised to deliver this “double dividend”. The focused, high conviction portfolio only invests in desirable, consciously managed performance drivers. Unmanaged risks are avoided.

The result is a portfolio that looks very different to other global equity portfolios and can complement more traditional allocations by providing diversification. Graph three shows the low level of similarity in holdings our strategy has with other actively managed global equity strategies, comparing it with the five largest actively managed cross-border strategies (by AUM) among Global Large-Cap Growth and Global Large-Cap Blend Morningstar categories. This low level of similarity is persistent over time, as indicated by graph four. 

Further diversification is provided by global environmental strategies through portfolio market cap size. Most investors usually include market cap giants in their global equity allocation, while environmental impact strategies can often include large- and mid-cap companies providing scalable and proven profitable solutions, ensuring high liquidity and financial stability. As graph five shows, there is less exposure to the market cap giants versus an overweight in the mid- and small-cap area. Indeed, as of March 2024, the average market cap exposure for Vontobel’s environmental impact strategy was around EUR 55 billion (large cap).

Smoother performance through the cycle

As a result, environmental impact strategies may enhance a global equity portfolio by providing differentiated performance through the cycle. These strategies typically generate alpha at different times than traditional global equity approaches and display different style patterns – like size, quality, value, or growth. These factors could help to smooth a portfolio’s risk/return characteristics over time, due to the different portfolio selection approach compared to traditional equity allocation.

In conclusion, environmental strategies may not only offer outperformance opportunities with a risk/return profile akin to global equities over the long term, but also provide portfolio diversification benefits. They open up access to the structural growth opportunities stemming from the transition to net zero and sustainable development investments. Therefore, in our view, it’s crucial for global equity investors to reassess the significance and proportion of environmental impact in their investment selection.