A world in transition

Written By: Martin Grosskopf Vice-President & Portfolio Manager AGF Investments Inc.

& Hyewon Kong Associate Portfolio Manager AGF Investments Inc.

& Jonathan Lo Vice-President & Portfolio Specialist, North American & International Equities AGF

Martin Grosskopf, Hyewon Kong and Jonathan Lo of AGF Investments discuss the implications for investors of a global transition to a cleaner and more sustainable economy

The world is amidst a sea of change. What has defined the global economic landscape for the past few decades is now shifting. These changes span political, sector, and socio-economic issues – and many of them are permanent, structural shifts. Perhaps the biggest transition, in our view, is the one towards a low-carbon economy – a long-term, structural shift that could take decades to play out, but is undeniably underway given the broad commitments made by governments around the world at last year’s climate change conference in Paris. But there are also smaller changes at work – both macro and micro – that are opening up investment opportunities. Given that some of these have been enabled by the move towards a lower carbon economy, we believe that the future investment climate will be different from the current one.

Investors who understand these winds of change are empowered to look for opportunities to benefit from them. In this piece, we attempt to describe some of the changes that we see taking place, as well as their impact as it pertains to investment opportunities broadly and to sustainable investing more specifically.

A Chinese economy in transition
China is in the midst of an enormous change, shifting from an export-oriented economy into a consumption- focused one. Already, services are now officially the largest part of the Chinese economy – and with this new configuration, there are implications for the commodity complex. With services now dominating GDP growth in China, incremental economic activity is far less energy-intensive than it has been for the past 20 years. Though overall commodity use is still increasing on an absolute basis, the intensity of commodity use is declining.

Why does this matter to us? Because, with this transition, the story of China-driven demand for commodities and its thirst for more fossil fuels to drive industrial expansion is an outdated thesis. In our view, China’s new configuration is one factor contributing to the structural decline for fossil-fuel usage, which has already begun. Moreover, China’s declining appetite for commodities has far-reaching knock-on effects on the investment landscape – we would argue that fossil-fuel exposure will be problematic for long-term investors.

A shift in Saudi posture
Saudi Arabia is another country where there has been a remarkable change in positioning. This began with the decision to cease acting as the global swing producer for crude oil, which sent oil prices significantly lower. Moreover, senior Saudi officials have begun to express concern about demand for oil longer-term.

Recently, Prince bin Salman announced a historic initiative to reduce Saudi dependence on oil revenues. His “Vision 2030” calls for a partial IPO of Saudi Aramco, using proceeds to set up the world’s largest sovereign wealth fund in order to invest in sectors of the economy not linked to oil. Perhaps this shift in posture is in part due to recognition that fossil fuels will face increased scrutiny and will be increasingly difficult to extract in future decades as the world grapples with greenhouse gas emission targets. Indeed, the Saudis are attempting to shift towards renewable energy, with the “Vision 2030” paper stating an initial target of 9.5 gigawatts of renewable energy, to be deployed by 2023.

A transition in power utilities
Saudi Arabia isn’t the only country paying attention to renewables. Renewable energy is now a material part of the global energy equation – a trend that is only going to grow in the coming years. Solar module prices have declined by 70% in the last five years – and by a factor of over 150x since 1970. In fact, Germany recently had so much renewable energy that the price of power plummeted and went negative – and commercial customers were being paid to consume electricity. Meanwhile, utilities in the United States are also boosting investments in renewable energy in anticipation of tougher new regulations on carbon emissions.

Change in the auto sector
Sometimes, transitions can be painful. In the case of Volkswagen, the company could not meet both price and emissions requirements at the same time, which resulted in scandal. More broadly, the auto sector is now in the midst of substantial change, driven by the desire for increased fuel efficiency and disrupted by companies such as Tesla. Indeed, themes such as fuel efficiency, active safety and the electrification of vehicles are now major growth drivers for the auto industry, with investment opportunities arising from exposure to these themes.

Transition in lighting
The lighting industry is another example where the desire for more energy-efficient solutions is driving growth. Indeed, the only segment seeing growth within the industry is LED lighting, while traditional, less energy-efficient forms of lighting are declining and losing market share.

Profiting from transition
We believe that these events have signalled an era of transition that is occurring within the global economy. In the case of China and Saudi Arabia, change is being brought on by governments that are changing with the times, attempting to evolve to produce a more sustainable and less volatile economy. In other cases, such as in the auto or lighting sectors, consumers have been the catalyst for change, voting with their wallets – not necessarily because they care about the environment – but because they want to save costs, they want to be more efficient or want the latest innovative technology.

We believe recognition of these transition trends provides a powerful lens through which investors can target profitable investments. Indeed, we would argue that the broad transition to a clean economy is already a reality and that investors should consider acting to capture opportunities that benefit from this transition.

The commentaries contained herein are provided as a general source of information based on information available as of April 30, 2016 and should not be considered as personal investment advice or an offer or solicitation to buy and/or sell securities. Every effort has been made to ensure accuracy in these commentaries at the time of publication, however accuracy cannot be guaranteed. Market conditions may change and the manager accepts no responsibility for individual investment decisions arising from the use of or reliance on the information contained herein. The information contained herein was provided by AGF Investment Operations. It is not intended to be investment advice applicable to any specific circumstance and should not be construed as investment advice. Market conditions may change, impacting the composition of a portfolio. AGF Investments assumes no responsibility for any investment decisions made based on the information provided herein.

References to specific securities are presented to illustrate the application of our investment philosophy only and are not to be considered recommendations by AGF. The specific securities identified and described herein do not represent all of the securities purcha sed, sold or recommended for the portfolio, and it should not be assumed that investments in securities identified were or will be profitable.

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Published Date: May 26, 2016