Policy – Can’t Live With Them, Can’t Live Without Them
Recall our inaugural commentary last quarter, where we highlighted the numerous announcements from the U.S., Europe, and Asia on the back of the United Nations’ 26th Annual Conference of Parties (“COP26”) in Glasgow: it was resoundingly clear that the most impactful actors on the global stage were unified in their push toward net zero greenhouse gas emissions. Within the span of two months, the euphoria seemingly dissipated. A long-awaited Build Back Better bill in the U.S. was brought to a halt in Congress, a seemingly regressive draft proposal on net energy metering policies from California utilities (“NEM 3.0”) was unveiled, and it became apparent that Europe was suffering from an energy crisis that called attention to the region’s pace of its energy transition. Combined, these factors cast a cloud on the environmental sustainability landscape, to the detriment of related equities.
In the fourth quarter, equities whipped around amidst policy and broader macro uncertainty, including inflation and potential earlier-than-anticipated rate hikes in the U.S. Investors spent some time digesting the information and are taking a cautious stance heading into 2022, as uncertainty lingers around Build Back Better and other legislative and regulatory outcomes. High-level policies can heavily dictate shorter-term sentiment in a fast-growing industry – particularly in one angling to displace decades’ worth of existing policies and players and, ultimately, facilitate a smooth transition with no one left behind. An underdeveloped landscape such as this is ripe for disruption, and technologies and services that demonstrate bankability and the ability to generate profitable, sustainable growth should be the ultimate winners, in our view.
As such, volatility seems almost inevitable, and could perhaps be viewed merely as a “blip” in the path forward for energy transition investment opportunities. Pledges in Glasgow represent a unanimous step forward for major governments, companies, and institutions toward net zero targets. As long as those commitments are kept, we believe we are at an inflection point for the market to accelerate rapidly in the advancement and deployment of technologies and services that address that cause.
A Look Back On The Quarter
The VanEck Environmental Sustainability Fund (MUTF:ENVAX) returned 1.98% during the fourth quarter of 2021, underperforming the broad-based MSCI All Country World Index1 (NASDAQ:ACWI), which returned 6.77% in the same period. Inflationary and interest rate risks kept a lid on growth stocks broadly, while unfavorable regulatory policy pressured certain sectors.
EV Continues To Drive Performance In Advanced Materials
Tesla (NASDAQ:TSLA) (3.95% of fund assets), Infineon (OTCQX:IFNNY) (3.80% of fund assets), and Freyr (NYSE:FREY) (3.85% of fund assets) led in performance for the quarter driven by company-specific achievements, which speaks to the continued growth of the EV and battery supply chain and the importance of delivering on key performance indicators. Infineon remains a favorite holding, given its roughly 40% exposure to EV power semiconductors combined with a continued chip supply shortage in which, we believe, pricing could deliver incremental upside to margins. Freyr, who licenses the patented 24M lithium ion manufacturing process, enjoyed validation of its manufacturing strategy by means of Volkswagen Group (OTCPK:VWAGY), who announced a partnership with 24M. With this underlying demand environment for batteries growing day-by-day, we expect Freyr to find significant offtake quickly for its battery capacity.
Smart Resource Management – Healthy Capex, Strong Pricing: All Systems Go
Healthy global end markets in industrials and semiconductors benefitted most holdings in this sector as a reaffirmation of margin and growth targets assuaged concerns around supply chain and industry slowdowns. This was reflected in the performance of semiconductor test equipment manufacturer Teradyne (NASDAQ:TER) (1.38% of fund assets), which we also think is well-positioned in secular trends such as the increasing complexity of chips as well as industrial automation, in which it is a leader in collaborative robot (“cobot”) technologies. Infrastructure GPS solution provider Trimble (NASDAQ:TRMB) (3.09% of fund assets) continues to weather supply chain issues well, and remains focused on delivering on its software subscription momentum.
Mixed Bag In Agri-Tech
As part of the broader growth pullback in equities, food-based, consumer-facing holdings experienced significant weakness in the quarter. High valuations were not supported by the deceleration of strong growth expectations. This was partially offset by strength in biofuels, with Bunge (BG) (1.78% of fund assets) continuing to execute well, given a strong environment for oil seed crushing as well as management’s successful restructuring work as they continue to refine the business.
Renewable Energy – Everything But The Kitchen Sink
The California net metering proposal discussed earlier pressured solar names, with residential solar project developers hit hardest (Sunrun (NASDAQ:RUN) 1.82% of fund assets, Sunnova (NYSE:NOVA) 1.54% of fund assets) as growth prospects and project returns were called into question, given the structure of new proposed rates that would ultimately be punitive to solar homeowners. While evidence is mounting that the proposal in its current form will not pass, the subsector is in risk-off territory until more clarity arises. We believe the assets are oversold and that the project developers have already been pivoting away from a solar standalone sales model into a more integrated approach with EV and battery channels, but the macro environment remains a bigger driver of the stocks near-term.
Partially offsetting the negative residential solar performance was relative strength from inverter manufacturers (Enphase (NASDAQ:ENPH) 2.31% of fund assets, Solaredge (NASDAQ:SEDG) 1.99% of fund assets), which, despite broader solar volatility, ended the quarter higher driven by their global diversification and ability to weather supply chain shortages better than peers.
Themes We Are Excited About in 2022 and Beyond
Software And Artificial Intelligence (“A.I.”) At The Wheel
This year, we are optimistic that the pace of energy transition enabling technologies will continue to gain steam. The convergence of energy producers, consumers, storage providers, and data management systems creates the need for an interconnected and predictive technology to oversee seamless communication among them – a requisite as solar, electric vehicle (“EV”), battery, and overall electricity demand is increasing rapidly. (It pays to note that while California’s NEM 3.0 draft is viewed as blatantly punitive to solar standalone, it is highly supportive of battery storage, also echoed by Governor Newsom’s recent budget proposal2 toward climate change initiatives.)
We are particularly focused on the development of smart grid management solutions, which serve to link supply and demand more efficiently between consumers and producers. Battery storage plays a critical role in grid de-carbonization, based on its ability to store and deploy energy in a way that smooths out consumption curves and reduces costs for both consumer and utility alike. Software developers such as Stem (NYSE:STEM) (1.83% of fund assets) and Fluence (NASDAQ:FLNC) (0.16% of fund assets) are applying A.I. to consumption patterns with the goal of predicting forward usage, as widespread application from end consumers could effectively allow power providers to anticipate demand and greatly eliminate demand surges. With said technology, events such as the power crisis in Houston a year ago – where three consecutive severe winter storms and unprecedented energy demand contributed to the catastrophic failure of the city’s power grid – could have likely been avoided.
The 1.2 Trillion Hour Opportunity
While these next few years will be a tight race for automobile original equipment manufacturers (“OEMs”) to secure battery supply chains to meet their EV growth aspirations, there exists another opportunity set further out into the decade in which all auto OEMs are vying for pole position. Morgan Stanley (MS) estimates that humans spend roughly 600 billion hours in a vehicle a year, potentially doubling by 2040.3 The exact number in our view is less important than the opportunity, which is to reimagine entirely the hours humans spend in “passive focus”.
Autonomous vehicles (“AVs”) go hand in hand with EVs, and while the latter addresses a significant chunk of the carbon emissions from transportation (cars and trucks contribute to 80% of transportation’s overall share of carbon emissions), an AV is even more energy efficient. The concept of “platooning,” by which vehicles travel in a tight formation to reduce aerodynamic drag, could greatly improve energy efficiency by eliminating random start/stops and traffic avoidance. While deployment at scale is still several decades away (Morgan Stanley again estimates that it will not be until 2050 until fully autonomous vehicles account for some 47% of miles traveled), the technology is emerging today, in a variety of different applications.
Not all things autonomous are created equal – in that, there are not only different levels of “hands-off” driving (see below chart), but also different applications by vehicle. With passenger vehicles, current cars on the road are still broadly at level 2 (L2), with the leader in automation, Tesla aiming to achieve L4 autonomy in 2022 with the development of full self-driving (FSD) capabilities.
Levels Of Driving Automation
Trucking, which deals with a different set of challenges, including regulatory, weight, and safety hurdles, aims for L4 by 2024. Innovators in this space such as TuSimple (NASDAQ:TSP) (0.45% of fund assets) are successfully piloting “driver-out” test runs, where fully autonomous semi-trucks are able to navigate traffic signals, on and off ramps, emergency lane vehicles, and highway lane changes.
In agriculture machinery, Deere (NYSE:DE) (2.36% of fund assets) recently revealed the 8R, a fully autonomous row crop tractor ready for large scale production this year. It uses six pairs of stereo cameras, which allow for 360-degree obstacle detection, the ability to process captured images and decide whether the machine should stop or continue. It also utilizes GPS-enabled programming called “geofencing,” which can ensure accuracy of its position down to an inch.
We are still in early days of deployment and a while away from scale, but it is clear to us that autonomous technology addresses a significant opportunity in enhancing productivity and operating efficiency. There will be bumps in the road as different technologies emerge. We are watching this space closely.
All company, sector, and sub-industry weightings as of December 31, 2021, unless otherwise noted.
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1The MSCI All Country World Index (ACWI) captures large and mid cap representation across developed and emerging markets and countries and covers approximately 85% of the global investable equity opportunity set. The MSCI benchmark is a Gross Return index which reinvests as much as possible of a company’s gross dividend distributions. 2Source: https://www.ebudget.ca.gov/FullBudgetSummary.pdf. 3Source: The trillion-hour attention economy (and where the Apple Car fits in).
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