27 NOV, 2023
By Johanna Zidani from RankiaPro Europe
Just last year, Dublin-based KBI Global Investors launched its Circular Economy Strategy, the latest addition to its suite of Natural Resources focused investment strategies. A year on, we took the opportunity to interview Senior Portfolio Manager, Martin Conroy about the way in which investing in the circular economy can deliver real impact on a global footing.
The transition from a linear economy to a circular economy is essential if we are to ensure the sustainability of the planet’s natural resources. Our investment approach for the Circular Economy Strategy employs a precise and proprietary definition of the theme – that is companies that are positively aligned with the United Nations Sustainable Development Goals and that are materially advancing the achievement of a circular economy. This proprietary universe of stocks ensures that the long-term trends we have identified will be the primary drivers of portfolio returns. These companies will enhance production processes and products to strengthen the circular economy, minimise the use or consumption of resources, reduce waste and increase sustainable recycling, and provide technology solutions enabling the achievement of a circular economy.
The low-hanging fruit of the circular economy are the areas where regulations or the required infrastructure are already in place. For example, certain geographies have had regulations for many years that impose additional fees on waste that goes to landfills instead of more sustainable alternatives. These regulations increase the demand for recycling and mean that collection and recycling infrastructure is already established and operational. The service providers in these areas already have efficient business models, benefiting from economies of scale and generating consistent organic growth because of steadily increasing recycling rates.
The biggest risk to an investor in the circular economy is gaining access to it through companies with low purity to the theme. By investing in companies that only apply the circular economy principles to their business model, an investor is not benefiting from the same earnings tailwinds as a company providing solutions. Here at KBIGI we focus on companies materially advancing the circular economy by concentrating our investments in ‘solution providers’. These companies are best placed to benefit from the megatrends driving the transition to a circular economy, thus enjoying stronger earnings tailwinds, which ultimately will result in a higher stock price. Low purity exposures such as Fast Moving Consumer Goods stocks likely mean higher exposure to sectors such as consumer discretionary, and often, stocks are widely held in broader global equity portfolios.
The transition to a circular economy as an investment theme remains in its infancy, and very few strategies focus purely on the opportunities this transition offers. This provides an advantage to early movers in the space that can access the long-term drivers using a suitable risk-reward framework. Our 23 years of experience investing in thematic equities has shown that as a theme develops and new investors enter the space, valuation disconnects can occur, which is why we apply a strong valuation bias to our investment approach.
We use an investment horizon of 3-5 years and believe investors should be considering investments in the circular economy theme in this timeframe to unlock its potential value. However, the investment opportunity associated with the circular economy is multi-decade in nature, and we envisage a long runway of positive earnings growth for the space.
KBIGI believe the best opportunities to generate alpha from investing in thematic equities is to focus on companies that truly benefit from the megatrends behind a theme, such as the circular economy. This is done by investing in solutions providers, where the secular tailwinds at play are a driver of earnings.
The other lesson we have learnt during our years of thematic investing is that the markets can get overly excited about thematic investing, and we have seen several cases of valuation disconnect. This is why we believe an active, diversified and valuation-aware approach to investing is essential in this area. KBIGI apply these principles to the circular economy portfolio.
While we invest in stocks across the market-cap spectrum, we tend to have overweight positions in small and mid-cap exposures relative to a broad market index. These companies tend to be under-researched by the investment community and under-owned by larger generalist fund managers. This gives us the potential to generate positive returns when combined with our experience investing in this space and offers investors access to under-researched smaller companies.