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Energy transition: Three key questions answered

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This is a sponsored article from Schroders.

Mark Lacey, head of Global Resource Equities
Alexander Monk, portfolio manager, Global Resource Equities

There is a lot going on in the financial markets right now. Meaningful inflation has returned for the first time in decades. Supply chains everywhere remain disrupted. Geopolitical and social tensions around the world are heightened, most notably with respect to Russia’s invasion of Ukraine. All this amounts to a challenging cocktail of risks for investors to navigate.

At a time of such heightened market volatility, it is of vital importance to take a balanced and disciplined approach. Detailed below are answers to the top three questions faced by investors in energy transition equities.

What is the most concerning risk?

Stepping back from the specific issues mentioned above, we see three headwinds associated with the shifting macroeconomic regime: (1) persistent supply chain pressures; (2) the threat of rising interest rates; and (3) the risks from a slowdown in economic growth.

From a risk perspective, we are more concerned about the earnings risk from prolonged inflation and supply chain constraints than a slowdown in economic growth, given the structural nature of the energy transition theme. While certain sections would be significantly exposed to weaker economic growth (for example, autos and electrical equipment), most companies are in structurally growing markets which offer an attractive growth profile compared to other listed equities. The positive long-term support provided by our decarbonisation, and now energy security goals, should ensure this is the case.

Any opportunities in the current environment?

Despite the clear risks associated with the current environment, we strongly believe that there are substantial opportunities too.

The renewed interest in energy security (in addition to our broad decarbonisation goals), supports the need for the build-out of local, abundant, cheap, clean energy supplies around the world. The driving forces behind the energy transition remain as strong as ever and the current market environment has only enhanced these long-term structural trends.

Over the next 30 years, we expect more than US$100 trillion to be spent on achieving the transition to a more sustainable energy system, with even more to be spent on making the economy more sustainable. This spending will create the potential for a significant and structural 30-year increase in earnings growth for companies across the energy transition sector.

This structural growth could be quite attractive during an economic slowdown. Moreover, if a more persistent inflationary regime were to emerge, the size and sustainability of potential earnings growth over time may outweigh any valuation de-rating when considering wealth preservation over the long run.

Finally, cheap, clean, abundant renewable energy could be a powerful solution to reducing energy dependence on Russia, creating an opportunity to remove one of Russia’s more powerful diplomatic threats. By accelerating the uptake of renewables, and particularly wind and solar which are produced using resources that are available in every country, there is a real tool to drive higher energy equality and perhaps help to reduce inflationary pressures too. Indeed, the wider realisation of this opportunity has fuelled the recent surge in valuations in renewables.

With climate change being the biggest challenge for the planet in the years to come, there are lots of positives about energy transition equities in the current market environment, which should not be overlooked by being overly focused on the threats.

Is now a sensible time to invest?

Energy transition shares aren’t cheap yet. In the short-term, there is certainly a material risk of de-rating across most parts of the energy transition space. With central banks tightening, the era of cheap money may also be coming to an end. However, for those investors willing to hold-on through the near-term pain and use weakness as an opportunity to build exposure in this structurally growing segment, the longer-term returns projection may look appealing indeed.

Find out more about Schroders’ insights and capabilities on sustainable investing here.

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This is a sponsored article from Schroders.

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