Where investments are made – where capital flows – defines what the economy is. What we purchase and use, how we use it, and how we power it: the whole economy emerges from where investments have gone to provide those things. The economy can become far less or far riskier because of our investment decisions, and asset allocators therefore have an outsized role in determining the course of the future.
Tying a bow on 2021, a fast-onset suburban fire in Boulder County, Colorado, Green Alpha’s home, that in the span of hours destroyed upwards of 1,000 homes and businesses, was to most of the world one more scrap of data in another year full of climate change-related disasters. For us, it was more personal, causing an evacuation of our office and some employees’ homes as smoke blew in and ash fell; we are grateful that the entire Green Alpha team and our families are safe and well. As of this writing, our office is in a location that was under a strict evacuation order. Science has long predicted events like this would become more common and more intense, and that the stability of nature should no longer be taken for granted. Science is doing its part, but investment management has largely ignored scientists’ warnings, and; therefore, it remains a weak link in working toward de-risking our collective future. How the asset management industry mounts a response to climate change, via that industry’s function of deploying capital, is the proverbial hand on the dial that will in part determine the frequency and severity of more extreme events.
Our Portfolios in 2021 and Looking Forward
2021 was a year of market underperformance for Green Alpha’s strategies (see Portfolio Snapshots for detailed performance numbers and commentary). As we discuss below, we believe our thesis represents a reliable path forward in terms of preserving and growing our clients’ purchasing power, and that it will, over the longer term, prove effective over market cycles of inflation, deflation, stimulative policy, cooling policy, and as economic narratives real and imagined rise and fall. Whether or not you find yourself concerned about our 2021 relative underperformance, read on to learn how we’re looking forward.
It starts with the flexibility to source ideas wherever they occur, to be “go anywhere” in the service of finding attractive investments, and then doing the deep work of evaluating a company on its intrinsic merits. Plumbing the complexities of a company’s business and how it fits into the context of the world’s economic and environmental systems is harder and more complex than is looking uncritically at P/E ratios and ESG ratings. Yet it is work we like to do, because it has become so critical to analyze the actual position of a firm relative to the evolving complexities of the global environment and everything within it, including the economy. If we try to reduce ourselves to algorithmic rules, we eliminate the ability to be flexible in the face of change. In a time of accelerating risks, we can no longer assume simple ratios are telling us all that we need to know about our investments; we need to look deeper.
Companies delivering better business performance often outperform markets in generali, ii but investing based on business results requires patience, because news and zeitgeist narratives can drive market valuations more than fundamentals, sometimes for substantial periods of time.
For example, consider solar PV manufacturing. Solar exists in a fast-growing market for electricity, it is in demand because it is a zero-carbon source of electricity that is also cost competitive with any other source of electricity generation, and it can be profitably deployed almost anywhere, even at high latitude nations like Germany. As a result, solar is gaining market share from legacy sources at a rapid rate and it is doing so in a fast-growing TAM. The better-run solar manufacturers are growing revenues, expanding their production capacities, earning operating leverage to expand their margins, and using their newfound scale and credibility to lower their costs of capital. And yet, market multiples of these companies remain stubbornly low. Why? Partially due to genuine short-term concerns about supply chains and interest rates, but largely because of the common narrative. It is often said that solar is niche, it won’t work because it is intermittent, Solyndra was a disaster, solar isn’t core energy, it is an alternative. These and similar arguments are still surprisingly common in markets, and even embedded in our systems. For example, solar isn’t considered “energy” in MSCI’s Global Industry Classification Standard (“GICS”), but rather it is defined as “technology.”
But while narratives matter in the short and sometimes medium terms, it is business results and overall fundamentals that drive returns in the long run. Business results-based returns, which come from reinvestment of retained earnings into expansionary pursuits such as growing production capacity, improving production efficiencies, and aggressive spending to drive innovation, are more predictable and enduring than momentum or multiple-expansion-based returns. Companies capable of sustaining stronger-than-average business results over time are more likely to reward investors. Which is why we focus on the Next EconomyTM. It is our job to find what ideas are most likely to work, become much larger and more profitable, and still be effective and valuable in the face of the climate crisis, resource degradation, worsening inequality, and mounting human disease burdens. Among the companies delivering on these ideas, we research which own the most and best intellectual property (“IP”) for safely running the global economy, and which best manage their capital for intrinsic growth. Summed into one question, Green Alpha wants to know: Will this business enable us to thrive on the planet without disrupting the systems on which we rely? When we identify conviction firms, we can find value, tactically, in periods when the narrative turns against Next Economy companies.
This has been, is, and will be our focus. We won’t deviate from this thesis when the news narrative turns against one of our conviction sectors, industries, or companies. In 2021, the narrative was negative towards renewable energies, some advanced biotech companies, and disruptive innovation in general. Since we believe that science, research, and innovation are how we are solving – and will continue to solve our biggest challenges – we were often in disagreement with the 2021 zeitgeist. It is abundantly evident today that we live in what author Azeem Azhar has dubbed the Exponential Age, and neither economists nor asset managers can continue to assume that the economy will continue to slowly progress as an extension of the economy we already know. Rather, Green Alpha can devise new processes and implement systems to follow to make our methodologies as adaptive as possible. For this, we gain valuable insights from the disciplines of predictive modeling and scenario planning: assimilate as much macro and micro information as possible and develop an educated thesis that represents a probable set of outcomes for a given company, industry, sector, and/or the economy as a whole.
Within all of this, one thing is clear to us: future demand – and thus market returns – can expect to be correlated with the structural trend of climate change. As Nicholas Stern has reminded us, “climate change is the biggest market failure the world has ever seen.” In the context of Herbert Stein‘s Law, “trends that can’t continue, won’t,” we can use this to plot a path forward. By targeting the intersection of the most economically productive yet nondestructive (and ideally regenerative) innovations, excellent fundamentals, and careful capital custodianship, we’re adding waypoints to that path. Green Alpha is striving to set the standard for what asset management can and should do to realize a regenerative, zero-risk economy, and to earn competitive returns as that economy expands.
i Joseph D. Piotroski, Journal of Accounting Research Vol. 38, Supplement: Studies on Accounting Information and the Economics of the Firm (2000) https://www.jstor.org/stable/2672906
ii Clifford S. Asness, Andrea Frazzini, and Lasse H. Pedersen, Quality Minus Junk (2013) http://www.econ.yale.edu/~shiller/behfin/2013_04-10/asness-frazzini-pedersen.pdf
Nothing in this blog should be construed to be individualized investment, tax, or other personalized financial advice. Please see additional important disclosures here: https://greenalphaadvisors.com/about-us/legal-disclaimers/