Not many managers can look out of their window and watch potential interest in their fund literally ebb and flow.
Lucas White at GMO can. He is based in the firm’s Boston headquarters, a wharf building that juts out into the harbor. He is also the manager of the firm’s recently launched GMO Climate Change fund, alongside Citywire AA-rated Thomas Hancock.
White is aware of the irony of his situation. ‘If you could short coastal commercial real estate that would seem like something to do,’ he says, laughing. ‘We can measure the water every month.’
As it is, the fund does not short its own office or indeed any other coastal real estate, or even traditional fossil fuel energy. It is a long-only global equity vehicle that invests in companies focused on climate change mitigation and adaptation.
‘It is a lot easier on the long side to figure out what are good plays than who is going to suffer on the short side,’ White says.
Despite the small pool of companies to select from – around 2% of the broad equity market – and the firm’s out-of-favor value focus, White has not been short of opportunities.
Some are the sorts of plays investors might expect from a fund of this kind, including solar, wind and other clean energy providers, while others are less predictable, such as Chilean salmon farming.
The latter is a climate change adaption play, as fish farms are set to benefit as fish numbers decline due to climate change. Despite this secular trend, Chilean salmon farms, which dominate the market alongside their Norwegian counterparts, have been available at decent valuations due to local issues.
‘Salmon prices have been very high the past couple of years, largely due to Chilean supply,’ White says. ‘There have been a lot of problems with fish sickness, super algae blooms, sea lice and various issues with the Chilean operations.’
This has led many investors to turn away from the farms, presenting a value play for White.
‘There is some bearishness about the companies, but we are excited because the
companies look really cheap right now,’ he says. ‘Supply is expected to bounce back in Chile in the near future.’
Launched in April this year, the fund has a minimal track record and just $19 million in assets. However, the same cannot be said of its managers. Hancock is head of the focused equity team and has a PhD in computer science from Harvard, while White joined the firm in 2006 and is a member of the focused equity team. They are also managers of the $229.1 million GMO Resources fund.
The Resources fund, launched in 2011, comes in at the top of Citywire’s Global Natural Resources category for three-year risk-adjusted returns, and inspired the Climate Change fund. White explains that one of the biggest risks facing the Resources fund was the threat of traditional energy companies losing value through stranded assets. As a result, the fund limited energy exposure to 40% versus the benchmark’s 70%, and excluded tar sands and coal companies. It also began exploring clean energy, and the managers found an increasing number of opportunities here.
While a part of White wishes he had launched the Climate Change fund in 2012 when he first had the idea, he acknowledges that the opportunities for many of his investments today have improved significantly in the intervening years.
‘As the years went on we were doing more and more research, but also the economics were changing for these companies,’ he says. ‘Six, seven years ago electric vehicles were a joke. We had Teslas at $80,000 to $120,000, but nothing that could make a dent in the auto industry.
‘Then you slash their battery prices by 75% or 85% and all of a sudden you can see light at the end of the tunnel and electric vehicles could actually be cheaper than gas vehicles on an upfront cost. Once you get that kind of parity it’s a no-brainer.’
White is playing the rise of electric cars in a number of ways in the Climate Change fund, not least his 9.4% position in copper. These vehicles use three times as much of the metal as their gas counterparts.
However, White is skeptical that Elon Musk’s company represents good value. ‘I would feel much more comfortable betting on electric vehicles generally than on any individual manufacturer,’ he says. ‘The kind of valuations Tesla trades at imply that it is going to dominate the auto industry in a way that the auto industry has never been dominated before.
‘It has always been a fragmented industry with lots of players and… Tesla is going to have a lot of competition coming down the pipe. It hasn’t proved it can be cash flow positive or make money for investors. It continues to dilute its shareholders. It’s just hard to get comfortable with it as a value investor.
‘It’s doing great for humanity. I’m super excited that Tesla exists and it’s pushing the envelope and has disrupted the auto industry. Those are all great things for the world – it just doesn’t mean that’s a good investment.’
White’s position in copper is more straightforward.
‘Everything with clean energy relies on copper,’ he says. ‘Wind and solar use four or five times more copper than a gas or coal power plant. The chargers for all the electric vehicles we are going to be producing are incredibly copper intensive. The electric grid needs to be overhauled in order to incorporate distributed intermittent renewables… and that’s going to be incredibly copper intensive.’
Add to this a global supply shortage and the continued industrialization of the emerging markets, and the price trend for the metal becomes clear. However, these short-term factors and an ensuing copper rally have complicated things for White.
‘It’s one of those interesting things as an investor, when you have this a long-term thesis and all of a sudden your thesis doesn’t play out but prices move in your direction. What do you do in the long term?’ he asks.
Long term, he still likes the metal, although he has reduced his position slightly in the short term due to increased valuations, which he thinks may drop again soon.
‘I wouldn’t be surprised at all if we are here a year from now and copper prices have gone down 20%,’ he says.
The fund’s biggest allocation, using its own subsectors, is clean energy at 32.8%. Within that, solar comes out on top at 10.5%, as at June 30.
White bought in earlier in the year when there was negative sentiment surrounding the sector, something he says has shifted since.
‘Sentiment was terrible. The solar industry has burned a lot of people in the past and that makes it easy for it to become a sector that is beaten down,’ he says. ‘And generally when the solar industry is beaten down then all the solar companies get beaten down.’
Despite this he believes he has selected companies with sufficient fundamentals to survive such mood swings. The fund has benefited from the sector’s recent rally following two quarters of strong earnings.
While he expects the outlook to be less clear in 2017/18 – demand for solar had been pulled forward to 2015/16 because of the expected, although eventually postponed, end of US government subsidies that year – White says that the industry is worth the risk in the long term.
‘We are long-term value investors, so that reads like an opportunity to us,’ he says. ‘We are willing to take on short-term risk.’
The same could be said of having launched the fund. Like many sustainable-themed strategies, it is unlikely to see assets flood in in the near term, but could win big over a longer period.
‘10 years from now there will be much much more money deployed in those strategies. The question is how much more,’ White says. ‘It could be twice as much, which would not be much, or it could be much much more.’
Head of investment research, Citywire
It is certainly too early to tell how well this strategy will fare. However, in a tough climate, the group’s traditional resources fund has climbed to the top of the Global Resources peer group. The big question is whether those skills have transferred to the Climate Change fund.
One thing in its favor is that green energy and climate change investment have rarely been a smooth ride, with more downs than ups as the new global energy order starts to take shape. This is a truly global portfolio with only a modest allocation to the US, reflecting the lack of investment both from allocators and domestic energy providers. This international focus provides a nice alternative to traditional ex-US exposure.