investment viewpoints
LOIM Circular Economy: three years of investing in the power of nature
Circular Economy, one of our high-conviction equity strategies, recently marked its three-year anniversary. The strategy seeks growth opportunities arising from the transition to a bio-based and circular economy, which harnesses and preserves nature and its valuable, regenerative resources.
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Investing in the circular economy
The strategy has demonstrated resilient performance since inception, in adverse market conditions. Its first two years delivered a 1.5% excess return against the benchmark index. In the three years since inception, the strategy has returned 8.6 versus 6.4 for the benchmark1.
In our view, the strength of Circular Economy lies in three attributes that are central to its investment strategy:
- We focus on small and mid caps, in order to capture companies that have greater potential for disruptive innovation and excess growth, high purity and profitable and proven business models
- A commitment to high thematic purity allows us to transform four long-term trends into portfolio opportunities. They are: the circular bioeconomy, resource efficiency, the outcome-oriented economy, and zero waste
- Finally, we target high-quality companies within our universe: those which demonstrate consistent profitability and cash flows, benefit from economic moats and whose business models are either accelerating, or aligned to, circularity
Our focus on companies generating an excess economic return (EER) provides flexibility in reducing unwanted biases during the portfolio construction process. With equal effectiveness, we seek growth and value stocks with strong financial cash flows, capital efficiency and a minimal dependence on external funding across market cycles, enabling us to navigate difficult and varied markets.
Achievers in the circular economy
The strategy invests in a vibrant, thematically pure universe of companies advancing circularity and leveraging nature’s regenerative power. The research underpinning the strategy continues to identify ground-breaking work by corporate innovators in this space. Here we outline three current holdings from our universe2:
Smurfit Kappa – circular bioeconomy
Trex – zero waste
Ansys – resource efficiency
Innovation watch
Our investment universe contains many exciting innovators who are creating new solutions to further disrupt our current, linear economic model. Some of these are in the early stages of development but have great potential to further embed circularity across industries.
For example, the exciting development of bacteria-based building materials has enormous capacity to change how we construct necessary infrastructure. Under the right conditions, cyanobacteria belonging to the genus Synechococcus can absorb carbon dioxide in order to grow and make calcium carbonate, the main ingredient in limestone. Bricks fashioned from this material can not only remove carbon dioxide from the air: these resilient creations could one day be induced to grow entirely new structures.
The outlook for CEF themes
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Circular bioeconomy
We are witnessing a noticeable shift towards bio-based materials across a range of sectors, including packaging, biofuels, and construction. These solutions are well-established and have reached mass-market status, but we continue to see developments around improvements to environmental and technical performance, including bio-based and biodegradable coatings for packaging, fuels derived from waste and residues, as well as new construction techniques and materials, such as cross-laminated timber.
There are several interesting technological developments aligned with this theme that we anticipate will reach maturity over the next three-to-10 years. They include biorefineries that convert biomass into a range of value-adding products, including biochemicals and biomaterials. These refineries integrate various conversion technologies including fermentation, enzymatic and thermochemical processes to maximise resource utilisation while minimising waste. Biorefineries have the potential to play a significant role in the circular bioeconomy by enabling the production of multiple products from diverse biomass sources. As the technology advances and economies of scale are realised, biorefineries can become economically viable and reach mass markets.
We are also positive on the outlook for technologies enabling food systems to minimise waste and create more sustainable and efficient processes. The practices associated with this transition include a focus on reducing food loss and waste, or adopting regenerative agricultural practices. Consumer preferences are shifting towards sustainable and ethical food choices. A recent study by Deloitte found that more than 25% of consumers are prepared to pay more for products and services that protect biodiversity, or for sustainable packaging and products. If this trend continues, circular food systems have the potential to grow into the mainstream. -
Resource efficiency
We have already seen a substantial uptake in digitalisation and analytics solutions by businesses. These are instrumental in promoting resource efficiency and enabling the transition to a circular economy. Through data-driven insights, businesses can identify areas of waste and inefficiency, leading to informed decision-making for process optimisation and reduced resource consumption.
Digital technologies can also enhance supply-chain transparency, facilitate circular design principles, product lifecycle management and recycling optimisation, promoting durability, repairability, and material recovery.
Across sectors exposed to this theme, we expect to see a significant shift in profit pools for materials and analytics firms. This is having the effect of contributing to the profitability of these solution providers, as well as the companies employing them.
The solutions we see reaching mass-market adoption over the coming years are digital twins helping organisations simulate real situations and outcomes, and digital product passports for collecting and sharing data about a product through its lifecycle. -
Outcome-oriented economy
Outcome-orientated models work particularly well for durable products and assets, and we see evidence that these models are being adopted in the construction machinery rental space, for example, as well as warehousing and robotics. Kilotou’s YOUSE app, for example, allows main contractors to register any heavy equipment which they would like to share with subcontractors working on the same construction site.
The idea is that products are kept in use for longer and business models shift from one-off sales to service provision. Consequently, if producers manufacture long-lasting products, this could potentially lead to an increase in profits, as more income is generated from fewer goods. We anticipate profit pool shifts and significant changes in the cost of ownership for the users.
This theme is characterised by a vibrant ecosystem of solutions under development, including companies specialising in electronics rental and repair, reusable packaging, and product-refill services for personal and home care staples. -
Zero waste
Europe is devoting significant effort to building up its recycling industry, especially around plastics. The European Union launched a strategy for plastics in January 2018, which is a key element of the region’s transition towards a carbon-neutral and circular economy. From 3 July 2021, single-use plastic plates, cutlery, straws, balloon sticks and cotton buds cannot be placed on the markets of the EU Member States.
This is a growing trend. Even the nations most successful at recycling plastic waste achieve rates of barely more 50%. Germany, named world recycling champions by the World Economic Forum, recycles 52.6% of its plastic waste, while the EU bloc as a whole, home to some of the most effective recycling schemes, achieves just 32.5%. However, the direction of travel is clear as sorting technology in material recovery facilities is taking off, improving the quality of bales and increasing recycling rates. Plastics recycling in Europe is now a rapidly growing industry, representing over EUR 8.7 billion in turnover, 11.3 million tonnes of installed recycling capacity, and more than 730 recycling facilities.
As a result, we see a growing opportunity in the recycling arena that opens doors to new business models, from vertical integration down by the waste managers, to vertical integration up by resource consumers. We are focused on the growth opportunities in those companies challenging conventional thinking in many areas such as waste collection and management, water treatment and food waste.
Strengthening circularity
In a range of market conditions, the Circular Economy strategy aims to continually strengthen its exposure to leading companies that benefit from growth avenues identified by our four themes. The outlook for these areas is positive, supported by policy action, the positive economics of circularity for businesses, and the growing consumer appetite for sustainability. The strategy further looks to identify companies with high-quality characteristics and can therefore potentially deliver robust financial performance across the cycle.
sources.
1 Source: LOIM as at 30 November 2023. Performance shown is for LO Funds – Circular Economy N A in USD, from 16 November 2020 to 16 November 2023. Benchmark: MSCI World SMID Cap USD ND.
2 Any reference to a specific company or security does not constitute a recommendation to buy, sell, hold or directly invest in the company or securities. It should not be assumed that the recommendations made in the future will be profitable or will equal the performance of the securities discussed in this document.
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