Economic development since the Industrial Revolution has moved in 40- to 60-year eras, with each era being succeeded by another. For instance, the so-called age of steel, electricity and heavy engineering between 1870 and 1910 was followed by the age of oil, automation and mass production between 1908 and 1970.
And each era was characterized by difficult transitions which challenged the established order, yet also created investment opportunities, according to Hyewon Kong, associate portfolio manager at Toronto-based AGF Investments Inc., and co-manager of the $46-million AGF Global Sustainable Growth Equity. "What is driving the transition is that the cost curve has to come down a lot," she says. "At the beginning of the auto era, for instance, it was very expensive. But mass production can only be achievable by the cost curve coming down a lot."
Since about 2000, Kong argues, the world has been transitioning to a low-carbon, "green" economy, which has encouraged a host of companies that have developed innovative solutions for the world's social and environmental challenges.
"The thesis of this new era, which has just started, is that we had enjoyed unrestricted access to resources," observes Kong. "Pollution and carbon emissions were not factored into regulations or investment decision-making. But post-Paris Climate Summit (held last December) it's a very different world," says Kong, who shares duties with Martin Grosskopf, vice-president. Kong joined AGF in 2014 after more than a decade of experience focusing on environmental and social impact themes.
The realization of the need to rein in rampant exploitation of resources, Kong adds, has been accepted by regulators, corporate players as well as consumers. "Three things are driving this transition," says Kong, who earned an M.Sc. from Oxford University in 2005. She then worked in the United Kingdom as a senior analyst for WHEB Asset Management as well as Henderson Global Investors. At Henderson, Kong's roles included managing the clean technology and health-care portions of a global innovation fund.
"It's not just governments and regulators forcing companies to comply with new rules," Kong says. "But private-sector players understand that they must meet the challenges. Disruptive innovation is happening. It is the way of survival. In the current low-growth environment, where is growth coming from?"
In Kong's view, growth will come from technology disruptors. Take, for instance, the transition taking place in the lighting industry, where growth in conventional lighting manufacture has dried up, she says. "The only lighting company that is growing quickly is one that provides LED (light-emitting diode) solutions. The rest of the industry is not growing. Growth is only coming from new technology. The same thing happened with cell phones. Smartphones took over (conventional) phones. Consumer bought more smartphones. Why? Because the prices came down."
One of the companies that Kong favours is Acuity Brands Inc. (AYI), a leading provider of "smart" lighting solutions. "With more than half of sales coming from LED lighting, Acuity is best positioned in the market with the increasing adoption of LEDs. The company stands out with the 12th consecutive quarter of double-digit growth and high margins and returns."
In a similar vein, Kong points out that the plummeting cost of solar energy has driven the adoption of the technology. In 2009, it cost more than US$200 to generate a million BTUs (British thermal units). In 2012, the cost fell to about US$20 per million BTUs. "The cost curve has to come down for mass adoption," says Kong. "Solar energy is more competitive than in the past. In some countries that have a lot of sunshine, solar energy is already comparable in price with conventional energy sources."
A firm that Kong owns in the portfolio and is benefitting from the transition to solar is Hannon Armstrong Sustainable Infrastructure Capital Inc. (HASI), which provides debt and equity financing to the energy efficiency and renewable energy markets. Technically a real estate investment trust, Hannon Armstrong is a "major financier for energy efficiency projects for the U.S. government," says Kong, adding that the REIT pays out 100% of earnings. "It has increased its dividend by double digits every year since its initial public offering in 2013."
The AGF fund's holdings tend to reflect transition occurring in four areas: energy and power, water and waste-water solutions, waste management and environmental health and safety (which encompass healthy living and sustainable food practices). Kong and Grosskopf rely on AGF's global network of 17 research analysts to provide investment ideas. The fund, which is in the Global Small/Mid Cap Equity category, has a 2-star Morningstar Rating for risk-adjusted returns. However, it also has a 5-globe Morningstar Sustainability Rating.
"Our message is that the transition is happening everywhere. Not just in the energy sector. It's happening also in the auto and industrial sectors," says Kong, adding that the latter is exemplified by Japan's Toray Industries Inc. (TRYIF), the world's largest maker of carbon fibre that is increasingly used in autos and airplanes.
"There is the principle of the Three R's: reduce, recycle and re-use. It's a very old concept," says Kong. "But everybody is focusing on 'How can we be more effective in the use of resources?' That's where the innovation is happening. Disruptive technologies are changing the whole industrial dynamic."
