Maria Lozovik, Portfolio Manager and Co-Founder, Marsham Investment Management.

Andrew Putwain: What climate transition technologies are you seeing companies adopting? How are they contributing to environmental sustainability and financial growth in the fixed income market?

Maria Lozovik: To address the second part of the question – applicability to fixed income – we need to analyse companies holistically. To do so, we use an equity-like analysis of the company, its strategy, and its climate and sustainability profile. Then we look at the instruments. I don't think the analysis will be dissimilar between fixed income and equity, from that perspective.

In terms of climate transition technologies, we feel climate change has had two types of effects on businesses. One is from the risk perspective. There are floods, droughts, and a lot of necessary changes required to adapt to the impacts of climate change. These risks need to be quantified, and there are extra capital expenditures (CapEx), operating expenses (OpEx), and other considerations involved.

For us, the main investment driver – and our main strategy focus – is that climate change has made businesses think they need to transform their industrial and operational processes to become more sustainable. It’s a need that comes from practical business and financial considerations, rather than trying to do global good.

Companies realise that in order to keep, or even potentially increase, their market share, they need to be forward-looking – thinking about the technologies they're using and taking extra steps in terms of research and development (R&D). For these companies, there are a lot of investment opportunities and potential upside to be captured both in equity and fixed income markets.

"[Transport, industrials, and power generation] account for the largest portion of greenhouse

gas emissions; this is where we're seeing focus on innovation and transition."

There are also big companies that are happy in their existing business state and aren’t rushing into extra CapEx for the transition.

When it comes to the new technologies we’re seeing, there are three industries that account for the largest portion of greenhouse gas (GHG) emissions: transport, industrials, and power generation. This is where we’re seeing the biggest focus on innovation and transition.

These industries affect all the other industries nearby. For example, transport includes electric vehicles, and there are lots of industries in its supply chain with auto part components, battery waste facilities, battery storage facilities, and other infrastructure elements.

With power generation, the world is moving toward electrification. This means that different sources of power generation will be necessary – for example, replacing coal with hydrogen and nuclear – and many other infrastructure changes will need to be made to facilitate that.

The other thing it implicates is the global electrification idea, which encapsulates circulatory capabilities. It’s a different pattern of the industry, where generation is currently centralised.

Andrew: How do investment managers identify and evaluate strategies in ‘old economy’ industries – such as utilities and automotive, for example – for climate adaptation, whilst maintaining competitive yields for investors?

Maria: This is the area where extra yield lies and where we see upsides.

In my view, innovation due to climate change is shifting from what we once perceived as ‘innovative’ industries – such as fintech and biotech – to ‘old economy’ sectors, such as infrastructure, utilities, power, oil and gas, and telecommunications. We’re at the start of an innovation boom in those industries, both from the equity and debt perspective.

"Because these sectors are big polluters, they aren’t seen as attractive investments –

however, unless we work to transform them, we won’t get to net zero."

From the debt perspective, there is a lot of upside to be captured because these industries are undervalued.

From the ESG perspective, because these sectors are big polluters, they aren’t seen as attractive investments – however, unless we work to transform them, we won’t get to net zero. That means routing capital in that direction is necessary.

There is no quick filter or tool to identify these transitional industries and companies – unlike, say, in the green bond market. Instead, it's a detailed fundamental analysis. We have our in-house models on how we screen for companies – which includes building financial models, forecasts, stress tests, looking at the strategy, at M&A, R&D, and cross-industry partnerships.

We also use a scorecard we developed with an AI company partner. The analysis has to be done thoroughly to identify the right companies.

Andrew: How can the industry balance achieving attractive total returns and aligning investments with environmental sustainability and social responsibility – especially in the context of climate change adaptation?

Maria: Climate change is an investment opportunity. It’s where we can earn higher returns and generate alpha. The term ‘ESG’ bundles three different areas together and can lose nuance and specificity.

Governance, for example, is a risk that investment managers irrespective of strategy have been considering for many years. All listed companies have to go through a diligent governance framework to be admitted to the listing.

On top of that, social and climate metrics are different – which means that grouping them together might not be effective.

However, from our perspective, the environment side is where we think we can achieve more attractive returns than in a broad bond portfolio.

Andrew: How can investment management firms leverage substantial government and industry funding for the energy transition to better drive innovation and investment in the fixed income market?

Maria: The global government push – especially since COP26 – alongside corporate commitments to the climate transition are huge and tangible.

"We're seeing competition between governments on how much they're going to

give to businesses – which has a tangible effect on financials."

This is especially the case for the biggest economies, such as the US, Europe, the UK, and China, which all have specific investment amounts. There are subsidies, rebates, favourable taxation, and direct investment specifically to power and electric vehicles.

In Europe and the UK, we’re seeing direct incentives from the government to buy electric vehicles. These incentives are tangible and motivating to companies. Firms are being courted by governments around the country in which they will build their electrical plants depending on the subsidies.

So, we’re seeing competition between governments on how much they're going to give to businesses – which has a tangible effect on financials. This is something new that investment managers can factor into their models and use as an investment opportunity going forward.

Andrew: Are there misconceptions about investing in this area?

Maria: With climate, in particular, there are two investment misconceptions that I’ve seen over the past year.

One is that impact comes at the expense of returns – which isn’t true. If anything, we see additional returns. You need to look in the right places, but there is a huge investment opportunity.

Second, we’re seeing misconceptions around negative screening – and the idea that we don’t want to invest in fossil fuels. This idea is missing the transitional aspect, from a financing point of view. It’s important we don’t overlook this element, because oil and gas companies, for example, were making headlines with the idea that they still had billions of CapEx invested in oil extraction.

"This idea is missing the transitional aspect, from a financing point of view.

It’s important we don’t overlook this element."

In reality, alternative fuels are not yet scalable. This means you can’t invest billions of dollars into hydrogen because the R&D hasn't been completed and the technologies aren’t yet scalable – but they will in five or seven years.

The process takes a while. It doesn’t just involve building production facilities; it also means changing critical infrastructure. Renewables – hydrogen, nuclear, solar, and wind – have different project-build lifespans, and the infrastructure to be built has its own lifespan as well.

This all means that, yes, there will still be substantial CapEx in old production methods, and new technologies will remain small for the initial period.

However, this isn’t the right metric to consider. You need to look at whether the company is doing everything possible in R&D for new technologies and materials – to buy disruptors, to give scale to new technologies. If they are, this is the trend and strategy, and you can forecast where they will be in five to seven years.

Andrew: Why have you focused on bonds as your main investment area?

Maria: I don't look at it from the perspective of, “That’s a great company. What should I buy: bonds or equity?”. I look at it from the perspective of, “I’m a bond investor, so how can we make more money for our clients?”

In the fixed income space, finding the upside from climate change is how we consistently deliver better returns for our clients.

 

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