Swiss wealth and asset manager, Lombard Odier, discusses how investors should be positioning their sustainable investments globally amid the current fractured geopolitical world. 

Lombard Odier highlighted this week how the wealth management industry has taken a wide variety of approaches to sustainable investing. The firm is convinced that the transition to a sustainable economy is driving a transformation at least equal to the scale of the industrial revolution – and it is unfolding at the speed of the digital revolution.

Government policy, technological innovations, and the limits of the physical environment are driving system changes as the economy shifts to more efficient business models offering superior functionality and accessibility at lower costs. This is reconfiguring value chains and shifting profit sources across economic activities and geographies. As a result, dozens of ‘hotspots’ are emerging in areas as diverse as semiconductor materials, precision farming and digital healthcare, Lombard Odier said in a note. 

Sustainable investment approach 
In equities, Lombard Odier aims to identify companies leading this economic transformation. In fixed income, the firm focuses on assets such as labelled bonds (green, social or sustainability bonds, where the proceeds have a clear environment or social impact), or debt issued to fund specific systems transformations. Environmental, social, governance (ESG) or other traditional approaches to sustainable investing concentrate on a firm’s practices. Instead, Lombard Odier’s approach focuses on financial returns driven by companies set to provide the solutions to achieve this transition.  

Clearly, systemic changes to a sustainable economy are both long-term and structural, the firm continued. They are bound to unfold in a sometimes disorderly fashion through many business cycles. The gap between the energy transition’s growing momentum in the real economy and the dismal financial market performance of cleantech in 2023 is one illustration of this phenomenon, the firm said. Disruptions created by the fractured geopolitical world and the changing priorities of policymakers in the face of these changes offer another example. 

After the Covid pandemic and in the face of geopolitical rivalry and conflict, Lombard Odier highlighted that policymakers have accelerated the transition agenda. They have implemented near- and reshoring policies aimed at controlling value chains, promoting domestic policy support for the transition, which is now at an all-time high. This decade, between the European Union, the US and China, close to $1 trillion per annum of government  support will be directed at spurring innovation, accelerating the adoption of transition technologies, and defending national and supra-national interests, the firm said.  

Such government support is de-risking private sector investments. Private capital is now seeking solutions at speed, and scale. In 2023, $1.77 trillion was invested in the  energy transition, compared with $1 trillion in the coal, oil, and gas sectors. Energy transition investment was 17 per cent higher compared with the previous year, the firm added.  

China leading the way
Lombard Odier emphasised that China is taking a leading role in a range of transition technologies. China accounted for 38 per cent of this transition total, well ahead of investments in Europe and the US of 19 per cent and 17 per cent respectively. For the first time, electrified transport became the largest recipient of investment, ahead of renewable energy, which grew at a modest 8 per cent year-on-year. Sales of electric vehicles (EVs) now account for close to one fifth of the automotive market as the energy transition continues to accelerate. By the end of this decade, Lombard Odier expect EVs to make up almost two-thirds of the global vehicle market. Worldwide, 50 per cent more renewable capacity was added in 2023 compared with 2022 – the fastest growth rate in two decades. Here again, China led the way; the country commissioned as much photovoltaic panel capacity as the entire world a year earlier, the firm said.  

Performance
The performance of sustainable fixed income assets and sustainable equity investments was quite different in 2023, Lombard Odier continued. The corporate labelled bond market (green, social, sustainability and sustainability-linked bonds) delivered performance in line with the mainstream bond market in the first nine months of 2023. These bonds have comparable durations, credit quality and yields to the mainstream market.

In equities, 2023 and the start of 2024 were marked by much better-than-expected equity market performance. The MSCI World index rose 21 per cent over 2023, driven by a very narrow group of sectors and stocks. The information technology and communications sectors were key US market drivers, creating an historic level of concentration in equity performance. The share prices of the ‘Magnificent Seven’ firms (Tesla, Meta, Amazon, Alphabet, Microsoft, Nvidia and Apple) rose more than 100 per cent in 2023, compared with 26 per cent for the S&P 500 and 17 per cent for the equal-weighted MSCI USA.

Lombard Odier’s exposure to system changes, including electrification and low carbon energy, did not fully benefit from this equity rally. More generally, clean energy, water, timber and sustainable food indices all lagged behind the US IT sector and megacaps, partly due to their overexposure to small, European, interest rate-sensitive companies.

In addition, what has become clear in 2023 is that among idiosyncratic factors affecting the performance of clean technology, China has built a dominant position in the hardware part of the energy transition. The cost structure of Chinese leaders in the field is very difficult to compete with. They dominate most value chains and have built overcapacity. Today, Chinese companies account for more than 9 per cent of standard clean energy indices. As such, passive investment strategies focusing on clean energy companies from developed markets have not only been penalised by the effects of higher capital costs over the past two years but have also ended up being the wrong focus considering market shifts in favour of Chinese competitors. Hence the need for a selective investment approach that seeks to identify not only the tipping point in an innovation but also the technology leaders capable of maintaining strong margins and defending market shares as the transition unfolds.

Outlook
Lombard Odier is generally positive on fixed income in 2024, including corporate green bonds, amid declining yields. Regulatory support nevertheless remains an important driver for selected sustainability investment themes. Therefore, any policy changes or priority shifts by newly-elected governments in a busy electoral year will have to be carefully monitored and risks in actively managed portfolios will need to be mitigated using appropriate diversification.

Lombard Odier believes that sustainable investments will continue to gain in importance over the coming decade. However, geopolitics, economic growth and employment will continue to dominate the political agenda, with national and energy security sometimes taking priority over a cleaner long-term future. To manage these risks and catalysts, investors will need to be well diversified across the different sectors on which the transition depends, the firm concluded.