The long/short climate opportunity
By assessing what we refer to as “false negatives” and “false positives,” a market-neutral, long/short strategy may be able to capitalize on underappreciated opportunities within climate investing (Figure 1). False negatives represent long opportunities in companies that, in our view, are successfully transitioning their business models to be more insulated from the impacts of climate change, have compelling fundamentals, and are trading at attractive valuations, in part due to the fact that they do not meet the current bar for inclusion in ESG-mandated approaches. One area where we think false negatives are apparent is within sustainable transport. We believe the market continues to underappreciate both the speed of the transition to electric vehicles (EVs) and its impact on new entrants, incumbents, and the supporting infrastructure. An example of a false negative within this theme would be an automotive company that is successfully pivoting to the production and sale of EVs, but whose revenues from EVs do not meet the common 50% or greater threshold for inclusion in an impact approach, even if it will likely meet those thresholds within an investable time horizon. In such a case, the market may be underappreciating the climate transition in progress, leading to attractive valuations.
In contrast, false positives are short opportunities in companies that currently appear to be climate-advantaged but have weak fundamentals, do not have sustainable competitive advantages, and trade at elevated valuations, in part because they meet materiality thresholds for inclusion in ESG-mandated approaches. An example from this category would be an auto company that is climate-advantaged, but that has poor or deteriorating fundamentals and is trading at an elevated valuation. Despite being eligible for inclusion in many ESG strategies due to its historical dominance of the EV market, the company may not have a durable competitive advantage in a space that is ripe with competition from both legacy companies and new entrants.
In addition to the false negatives and false positives described above, our framework includes “true positives” and “true negatives” that we believe represent long and short opportunities, respectively.
Our true positives are climate-advantaged companies that are attractively valued. An example of a true positive company within sustainable transport might be a supplier of auto parts and technology that are integral to the production and advancement of EVs. The market may be underappreciating the durability of growth.
We believe true negatives are companies that are structurally disadvantaged from a climate perspective, such as a supplier of auto parts that, in contrast to the example above, focuses on internal combustion engine technology. As the world transitions to EVs, we believe companies in this category will continue to lose market share as their products and services become obsolete.
In summary, we think the long/short opportunity set is much broader than that of many other impact, thematic, or long-only climate strategies. Moreover, we believe today’s environment creates a growing dispersion between relative price and value, offering long and short opportunities within the climate change-based themes outlined in Figure 2.