Shares winning from this ‘unstoppable’ mega-trend

Sam Benstead sits down with Polar Capital Smart Energy manager Thiemo Lang to discuss the opportunities arising from the transition to a clean energy economy. 

He speaks about the driving forces behind the transition to clean energy, including politics, and the compelling economic case for renewable energy, and also shares his view on clean power adoption in India and China.

Polar Capital Smart Energy is a member of ii’s ACE 40 list of recommended sustainable funds.

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Sam Benstead, deputy collectives editor, interactive investor: Hello and welcome to the latest Insider Interview. Our guest today is Thiemo Lang, manager of Polar Capital Smart Energy fund. Thiemo, thank you very much for coming in.

Thiemo Lang, manager of Polar Capital Smart Energy: Thank you for having invited me.

Sam Benstead: The active share of the portfolio is 98%, so there's just a 2% overlap with the MSCI All Country World Index. That means you look nothing like the index at all. Why is that? Why is there such a small overlap with the benchmark?

Thiemo Lang: The clean energy sector is a highly thematic, limited area of investing. We have 250 companies in our eligible universe. Therefore, this is not a broadly investing global equities fund. This is a fund focusing on companies we are confident will drive our energy transition. Therefore, for sure we have a pretty high tracking error to the MSCI World index, at 12% right now. This shows that if you invest in a fund such as ours, you have to accept a certain volatility compared to the broader indices.

Sam Benstead: And what types of markets will this fund generally perform best and worst in? Is there a theme there or are you very much tied to the stocks and how they do on a fundamental basis?

Thiemo Lang: Yes, we have sectors that are very interest-rate sensitive, that's for sure.

Sam Benstead: Can you explain that? Why are the companies interest-rate sensitive?

Thiemo Lang: For example, with the buildout of new renewable power capacity, is the idea that your cost of capital goes up if interest rates go up. From a sentiment perspective, whenever we see interest rates going up, this sector, for example, is hit. Also, you mentioned electric vehicles before, and for sure consumer behaviour will change if interest rates go up. Even though electric vehicles gain market share to combustion-engine cars, you will still see that the consumer might become more cautious. And, therefore, we have an interest-rate sensitivity in this product, which we have to accept.

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Sam Benstead: The fund's been going for about two and a half years now. It's underperformed the benchmark. Is that all linked to macroeconomic factors or have there been stock-specific issues as well?

Thiemo Lang: The clean energy sector has underperformed the MSCI, but to be fair we have done fairly OK. We compare ourselves more to our internal benchmark, which consists of these 250 companies, and here we have done very well. This is the benchmark that we are measured against internally.

We have also done very well [compared] to the peer group, so that’s very interesting. We compare ourselves to eight peer group funds, which are only £1 billion assets under management, and here we have outperformed the average of the peer group since inception by 10-12%, which is pretty good. Historically, we tended to outperform the average of the peer group by 3%. And it is our ambition to repeat this.

Sam Benstead: Clean energy is a sector that is quite vulnerable to hype, to overexcitement and then over-pessimism. We saw a lot of excitement in 2020, 2021, then a lot of pessimism last year. Where are we, do you think, in this cycle of optimism and pessimism towards the sector? Is now a good time to be investing in it?

Thiemo Lang: I think so, because in 2022, there was a bit of hype due to the Inflation Reduction Act in the US, which was signed by President Joe Biden in August 2022. There was also some sort of hype with what happened in Ukraine, and the invasion of Russia. We have also seen lots of panic from governments [over] accelerating the energy transition. This has supported the valuation of the companies. Since then, yes, we have seen more like a sort-of correction, and it's very important if you invest in clean energy to not put all your eggs in one basket. You really have to look at the whole value chain.

We see more value in the infrastructure buildout and on the energy efficiency side than on the power generation side. Therefore all the funds that over-emphasised, and continue to over emphasise, solar and wind, got hit pretty hard last year, while we did pretty well. Our dollar share class was up 18% and the MSCI World index was up 22%, so it's fine now. But we have seen some funds that were strongly negative last year.

Sam Benstead: The Inflation Reduction Act in the US. Can you explain what that is and why it is good for the clean energy sector?

Thiemo Lang: The Inflation Reduction Act has objectives to accelerate the deployment of clean power solutions, battery production of electric vehicles, and it has an element to source more manufacturing from the US. They say the whole programme will cost $370 billion (£292 billion) over 10 years, but the cost will probably be much higher.

There are very supportive elements for the acceleration of the deployment of clean energy solutions in the related infrastructure, which is good. But at the same time, it has elements that we are maybe a bit more sceptical about, such as whether it makes sense to build up module manufacturing in the US, or another final assembly in the US. It’s good [in some ways], but you also have to be very aware of risks that are linked to a subsidy scheme that might not last forever.

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Sam Benstead: You brought me on to the issue of politics, and politics is a big theme when it comes to renewable energy. Every party has a different view on it. Lots of voters vote depending on what the parties will do regarding climate change. So, is this something you have to adjust your portfolio for, and what are the big risks around having a politically sensitive investment area?

Thiemo Lang: The political landscape and what might be decided from any new political leaders has an impact on us and our sectors, at least in the short run, and we have to be aware of it. Also in the US, we don't know whether, if a Republican government follows, they might amend, or even cancel, parts of the Inflation Reduction Act.

We don't think we are too exposed there right now, and we prefer not to invest in companies that are 100% dependent on politics, subsidies and protection.

We really want the sub-sectors in clean energy to become self-sustained without any strong governmental frameworks necessary for them to thrive. We want to drive down costs, and we really focus our investments on those companies where we see that they will make their way with or without any initial term interference from politicians.

Sam Benstead: And which are those companies and sectors that can win, regardless of who's in office?

Thiemo Lang: We are 100% convinced that the trend towards electrification is unstoppable, right? And the trend towards renewable deployment is unstoppable. We drive down unit costs of a solar module by 8% each year, and it's just becoming the cheapest form of energy generation over the long run in most countries. And then we have to develop it further.

We have to develop storage units and batteries, which are also coming down in price. We have to develop intelligent grids, smart grids. We have to develop an IT overlay for the grid where we can always then match demand and supply. So, all the companies that add intelligence to the way we produce, transmit and consume energy, these are the companies you should invest in.

Sam Benstead: And what about electricity grids, particularly in the UK? I've heard that although the technology can be there to produce the electricity, distributing it to households will lag a long way behind. Is that some it you think about?

Thiemo Lang:It's a huge issue now that we have to accelerate the buildout of the grid. So, adding more and more renewable capacity is one part of the story. But the big theme over the next five to 10 years that we have to catch up [on] is also building out the grid, not only on a national scale, but also on a global scale.

The larger your grid, a pan-European grid, the better it is, so that in the end you can transmit tidal-power generating electricity from Norway to Spain if you want to, right? And the broader, more international, and stronger a grid is, the better it is and the more efficient it is.

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Sam Benstead: Europe is very forward-thinking when it comes to renewable energy, but what about India and China? Nearly 3 billion people there. Are we seeing the introduction of renewable energy in those markets as well, and does that help your portfolio?

Thiemo Lang: In India, not so much yet, but China is the biggest deployer of renewable energies. The solar market last year was 420GW or something, and more than half of it was in China.

In China, they have a renewable energy target of deployments of solar and wind. I think it’s 1,200GW in 2030. And they have put out this target in 2020, and they will achieve it this year, so six years ahead. So, China is doing the most of all the countries worldwide in really deploying solar and wind.

Sam Benstead: Finally, the question we ask all our guests, do you personally invest in your fund?

Thiemo Lang: Yes, I'm strongly invested in my products.

Sam Benstead: Thiemo, thank you very much for coming in.

Thiemo Lang: Thank you for your interest.

Sam Benstead: And that's all we have time for today. You can check out more Insider Interviews on our YouTube channel where you can like, comment and subscribe. See you next time.