Stewart: Welcome to another edition of the InsuranceAUM.com Podcast. My name’s Stewart Foley; I’ll be your host. And today we’re talking about climate and energy transition in emerging markets with Matt Christ, Managing Principle and Head of the Transition Debt Strategy for Ninety One. Matt, thanks for being on.
Matt: Stewart. Great to be here. Good to see you.
Stewart: Nice to see you, too. And we’ve had a little bit of a prep call and we’ve talked about some of these topics and I’m really excited to get into it because it’s a hot topic today, for sure. But before we go too far, we want to start this one like we start them all. Where’d you grow up? What was your first job? And what’s a fun fact?
Matt: All right. So the first one’s easy, I’m a proud Clevelander. Long-suffering sports fan and general Cleveland enthusiast. First job, I was a maintenance and grounds person at a school in my town. I think I learned a lot of lessons from that job, frankly. And fun fact, when I was in college, I thought I was going to be an academic. My dad is an academic. I majored in English and French at a very small liberal arts college. So obviously my career has gone in a different trajectory, but I would say that investing has been very intellectually gratifying nonetheless.
Stewart: Very cool. What small liberal arts school?
Matt: Middlebury College in the middle of Vermont.
Stewart: Oh no, that’s a great school. Very well done. That’s great. As I mentioned at the top of the show, we have something in common, actually, by the way, I was a groundskeeper and maintenance man for my grandfather. And that paid zero and I learned a lot of lessons, too, believe me.
Matt: I bet you did.
Stewart: Yeah, it was not pretty. It’s hot in Missouri in the summer. So as we talked about earlier in the show, climate and energy transition are a hot topic these days, no pun intended. Can you talk a little bit about what makes your approach unique and really wrap that into maybe a little background on Ninety One, just in case some folks who are listening to you might not be as familiar?
Matt: Sure. At the end of the day, the thing that we’re most focused on is having real-world impact in decarbonizing the world. And too often, the tools that investors use to approach this asset class are divestment and exclusion. And I think at the end of the day, you’re not really getting the impact that you think you are by just excluding or divesting part of the investment universe.
And there’s an amazing stat about Ninety One, where as a house, we invest in about 1200 unique companies, whether in debt or in equity. Of those 1200 companies, about 20 of them represent 50% of the emissions that we finance. So it would be really easy for us tomorrow to sell those 20 companies and have some splashy announcement that we’d reduced our finance emissions by 50%. But what would that have actually achieved in terms of decarbonizing the planet?
So what that means for us, is that we really lean in to working with heavy-emitting economies, to working with heavy-emitting industries that are particularly hard to abate, and to help drive change in those places. So while we are working with heavy emitters, we also know that the critical sectors to reaching net zero which are power, industry, transportation, agriculture, and buildings that represent 85%+ total emissions, we don’t have the technologies to decarbonize those industries, those sectors. So we also need to be investing in the solutions and the technologies and the innovations of tomorrow. So really, we’re moving in two directions in terms of our investment profile to facilitate the transition. And emerging markets are something that are very near and dear to Ninety One, in that we were founded in South Africa, we continue to call South Africa home. And I think that emerging market origin has a real impact on the way we think about what a just transition looks like today.
And emerging markets are really important for the transition because they represent over 60% of today’s emissions. And that’s because, over the last few economic cycles, developed markets have outsourced their emissions to emerging markets. And when you look at the history of emissions in the planet from the beginning of the industrial age to today, it’s not the emerging markets that have put us into this place. It’s the developed markets that have, since the industrial revolution, have been contributing to the emissions in the atmosphere.
So to now, from New York or London to shake your finger at an emerging market and say, “Hey, you got to decarbonize today,” when they also need to think about socioeconomic development, we don’t think that’s the right approach. So different countries, different sectors need to be on different pathways, and it’s not a one-size-fits-all solution. And I think that really comes from the fact that at Ninety One, we see the world a little bit differently. We’re really built to develop with changing investment landscapes. And that’s how we’ve approached the transition.
Stewart: I really like that when you and I first talked and first started talking about doing a podcast, you had mentioned this before, the idea that a lot of times folks just say, “Well, I’m going to divest from that,” or, “I’m going to run from that,” as opposed to, “I’m going to provide the capital and finance the technology to change the situation.” That’s something that we’re going to talk a little bit more about. One of the things, that’s my understanding, is that a characteristic of your strategy is that you combine public and private credits in the strategy both. Can you talk about why you do that and how you do it?
Matt: If you look at where carbon sits today and you peel the onion back and you do a real carbon underwriting of the world, it’s a story of a relatively few number of companies. So the top 10 emitting companies in the top 10 emitting economies in emerging markets represent 70% of the emissions from those markets. When you look at those top 10 companies in each of those markets, they all have public bonds. And so they’re big balance sheet companies that finance themselves in the public market. So if you didn’t engage in the public bond market, you are neglecting to work and to help improve the companies where carbon sits today, which gets back to that question of that 60%+ of the world’s emissions.
What’s more concerning for emerging markets is that they are on a trajectory to represent 90% of the world’s emissions growth to 2030. And a lot of that’s coming from the fact that emerging market countries are not making really aggressive nationally-determined contributions to bring down their carbon profiles. In the private sector and in the corporate sector, we’re seeing a much higher willingness and an ability to make those investments and to implement those transitions. So when we work with public bond issued entities and emerging markets, we’re really bringing down emissions today. So identifying the companies that have really credible plans to reduce their emissions in the short term.
On the private side, we’re focusing on different pools of impact. The first is project finance, still a big part of the private investment landscape. Power is the most important sector to decarbonize. So we’re talking about renewable projects in wind, hydro, solar, and in the near future, green hydrogen. So big opportunities there in the private space. The second is small companies that have a growth tailwind from everything that we’re seeing in the decarbonization process, whether those be minerals for the transition, like lithium for electric vehicle batteries or metallic silicone for solar panels. Those companies have a really nice growth tailwind behind them. Our private capital can help them grow to being a bond issuer in the future. And the last is really these new innovative companies that might not have a financial history that likens themself to a bond issuance, but are working on really important ways to transform those five critical sectors that I highlighted. So that’s the impact side.
On the portfolio construction side, the private names we’re targeting are all senior secured with high levels of collateralization. Through the cycle, we think those assets can represent 200 to 300 basis points of incremental spread over similarly rated public comps. So we’re getting a yield enhancement from the private piece. We’re getting an improved downside protection element from the fact that these are structurally secured with stated collateral. 90%+ of these assets are floating rate. So in an environment of higher rates, there’s some protection embedded in there. And obviously, the private sleeves are less correlated towards global markets because these are private instruments.
The public side, lets us be fully invested at all times, in that the public market gives us ample opportunities, it’s a $2.7 trillion marketplace of emerging market corporates, bigger than the US high yield market. So there’s really better opportunity to deploy capital in a diversified way in the public side in quick order, and also to offer this product with liquidity that we think is interesting. So it’s portfolio construction, it’s return enhancement, and it’s also impacted to the dual purpose of the blend.
Stewart: That’s a great explanation. And this brings me to these terms ‘greenwashing’ and ‘transition washing’. How do you think about those terms? Because we’ve got lots of folks throw out a lot of climate-oriented strategies. How do I separate the weed from the chaff there?
Matt: I think that’s a good way to put it. Separating the weed from the chaff. I think at the end of the day, the short answer to your question is it takes a lot of work to prevent greenwashing and transition washing. Which is to say that in the same way that the analysts on our team don’t take a credit rating from a credit agency and say, “This is my view of a company’s credit fundamentals.” They do their own underwriting and they come up with their own assessment of the credit fundamentals and the direction of the credit fundamentals. We take the same approach on the carbon side and on the impact side.
So we’ve developed an impact assessment framework with my colleagues in the sustainability team, which members of the team have climate backgrounds. And they’ve brought a lot of more scientific evidence to bear in this process given their backgrounds. And we process every investment through this impact assessment framework, that at the outset, the analyst is going to answer a series of questions to make sure we’re prioritizing one of those big five sectors, power, industry, transportation, buildings, agriculture. Because I could build you a zero carbon portfolio right now of tech companies, but that’s not really doing what we’re trying to do. We want to lean into these core sectors.
And then we need to make sure that they fit into our definition of transition, which is a company that is moving its emissions on a science-based pathway towards net zero by 2050. So they’re either doing that, they’re committed to doing that, and they need financing to implement that plan, or they are enabling another sector to transition. So an easy case in point there is a mining company for lithium and what that means for electric vehicles.
Once we’ve established that it fits into one of those transition buckets, the real carbon underwriting is we need every investment in the portfolio to have a credible plan to reduce or avoid carbon by 2030. And we need to be able to articulate that reduction in terms of tons of carbon dioxide reduced on a gross cumulative basis to 2030. So what that does, and it’s something that I think is really important, is something that we spent nine months doing. Because it took a lot of time to get to a point where we felt like we had a universe of assets that we felt really good about from a transition standpoint. It translates the qualitative into the quantitative and it allows us to have a benchmark for our impact performance.
In any given year, out to 2030, we have an expectation of how much carbon the individual assets will reduce or avoid, and the portfolio will reduce or avoid. And if we don’t see a company meeting or surpassing our expectations, that becomes a tool for engagement, to sit down with them and say, “Hey, based on your plans, based on your reduction targets, based on your investment program, you should have been reducing X in this year. And we only saw Y. What’s going on?” That doesn’t mean that we sell the name, but it does mean that we need to see continued willingness for them to improve their metrics and to continue the transition. So I think it’s hard work. I think it’s making things measurable. There’s that old IBM saying, “You can’t change what you can’t measure.” So finding a way to measure what our impact is trying to deliver, and then being really transparent with investors with what our expectations of impact are and how we’re performing versus those expectations.
Stewart: It leads me, and I want to talk about the availability of data in just a minute, but geopolitical tensions, it seems like every podcast I do involve some discussion of geopolitical tensions. How has that changed over the last year? How has it impacted the opportunity set? How are you dealing with it?
Matt: Good question. Look, I think the first order effect of what has happened in Ukraine is that it has put more emphasis on energy and food security. And if you are a country that is not energy self-sufficient and you are an energy importer, it has led you to make a series of decisions. In some instances, that has been an expansion of misaligned climate activities, so restarting certain fossil fuel energy-generating activities. That’s the bad side.
I think the good side is it has kick-started a process that was already happening, which is, if you’re going to be energy self-sufficient and you are not blessed with fossil fuel resources, which is probably why you weren’t self-sufficient to begin with, you need to develop alternative means of providing energy for your people. And we can see that, probably most pronounced in terms of the opportunity set in India, in terms of what we’re seeing with traditional renewable projects, whether they be wind, hydro or solar, but also the large four or five biggest Indian conglomerates who are putting billions and billions of dollars into the development of green hydrogen. And one of those players thinks that, based on their plans in terms of the megawatts that they can produce through green hydrogen, they can single-handedly transform India from a net energy importer to an exporter, which is something of an unfathomable thing to think about, but that’s some of the potential that’s embedded in the green hydrogen opportunity.
So we’re seeing that energy self-sufficiency, we’re also seeing more onshoring or nearshoring, and that’s a really big part of the emerging market story. From the beginning of this asset class, EMs have played really important role in global value chains, and we’re seeing great examples of the opportunity set. And one of them is in the solar panel space, which the solar sector has always been challenged by the fact that 90%+ of the most critical raw material, which is metallic silicone, comes from Xining, China. And the reason it all comes from Xining, China is because coal is cheap, abundant and dirty.
So when anybody installs a solar panel from the beginning of the solar panel industry, there’s been an issue in that a scope three analysis of all of the parts that went into the manufacturer of that solar panel has this really dirty raw material built into it. We’re seeing American companies that are developing solar panels wanting to source their metallic silicone from cleaner places and they want it to be closer to home. So we’re working with companies in Latin America that produce metallic silicone purely with renewable energy. These are smaller companies today that have not been part of the global value chain because it’s been so dominated by China, but by the way that geopolitical landscape has been shifting and people want to be closer to the source of their raw material and their value chain. They’re seeing a massive growth opportunity.
So this is an example of the private lending market opportunities, where we see a company that does $30 million in EBITDA today, too small to do a bond, but through some growth capital that we’re doing in the form of lending, over the next four or five years, they could grow their EBITDA 300, 400 million and they could be a bond issuer. And by the way, then we’re putting cleaner metallic silicone into the development of solar panels, and the whole solar value chain gets a lot cleaner in the process. So look, the geopolitical tension has had serious effects, and like I said, I think some good, some bad, but I don’t think it’s changed our opportunity set just from a depth perspective. We’re still seeing new opportunities because the decarbonization trend is happening.
Stewart: It seems, you had mentioned earlier in the podcast that we simply don’t have the technology to make some of these processes green. That just doesn’t exist. I heard somewhere the percentage of the world’s emissions that are tied to cement was unbelievably high. Can you get into the weeds a little bit about where the big emission sources are, and am I right about cement? What’s going on with that industry?
Matt: Yeah, you’re dead on, and this is really where working with big public bond issuers adds a lot of value to our impact story. These are companies that have been in the public bond market for decades, and they are very institutionalized. They are very, very credible companies, and they just operate in very challenging sectors to abate from a carbon perspective.
There’s a name that we really like and we think is a real industry leader in Mexico, which is CEMEX. It’s the third-largest cement company in the world. It’s the second-largest emitter in Mexico. And CEMEX is a great example of someone who is doing what they need to do in the short term to reduce emissions, but they’re also trying to do the moonshot at the same time.
So what’s CEMEX doing in the short term? Well, they’ve developed very aggressive, by cement industry standards, plans to reduce emissions by 2025 and 2030. How are they doing that? They’re changing the way they source electricity and energy in their operations, moving more towards renewables. They’re replacing internal combustion mixing trucks with electric mixing trucks. So doing things that rely on technology that’s available today.
So if CEMEX is successful in implementing these programs and hitting their targets to 2025 into 2030, they will take 46 million tons of carbon out of the atmosphere, by our calculations, out of the atmosphere versus them doing nothing and just producing cement on their current trajectory. So that’s a huge amount of carbon from the second-highest emitter in Mexico.
But what’s CEMEX also doing? They’ve developed a joint venture with a Swiss company called Synhelion, who’s trying to develop green clinker. Now, Stewart, you were dead on, cement is about 7% of the world’s emissions. 90% of that 7% comes from one process in the cement process, which is making clinker. And clinker is calcifying limestone, which becomes the binding agent for cement. It uses a lot of chemicals that release emissions, it requires heating a kiln to 1600 degrees Fahrenheit, very energy-intensive.
So CEMEX and Synhelion, this project, has produced clinker using only renewable energy. So it’s green clinker. They’ve done it on a small scale, and over time they think they can do that at a commercial scale. Now, that’s not embedded in our calculations of how much carbon they can reduce to 2030. As I said, this is more of the moonshot transformational type of activity. But if you can think about how big they’re aiming, they’re trying to take out 90% of 7% of the world’s emissions through this program. So we’re not talking about little efforts here. These are big projects.
And we’re seeing the same thing on the other side of the world with POSCO, a Korean steel company, which is similarly doing things today to reduce carbon to 2030. What are they doing? They’re increasing the amount of recycled steel that they use, they’re changing the way they source their energy, but at the same time, they have a product called HyREX, which is a green steel production process, which is using hydrogen technology to actually produce the steel and eliminate fossil fuels.
So again, that’s not part of our 2030 expectation with someone like POSCO, but if they’re successful with what they think they can do in the short term, that’s 26 million tons of reduction by our calculations. If they can do what they think they can do in the big picture, steel is 11% of the world’s emissions. So you start to piece these things together and start to talk about moving the needle in a real way.
And something that I think is very interesting, and just staying with this topic of cement and steel. Where I think this comes home for people in America and in developed markets is we might not produce as much steel and as much cement as we used to as a society, and we often source it from emerging markets. But if you think about the buildings that we build, or the bridges or the infrastructure or everything that we’re building, to the extent that CEMEX or POSCO cleans up their cement and their steel, and that then goes into our buildings and our construction, it helps decarbonize the whole process. So we talk about the world being less globalized, but in many ways, we’re seeing it just as globalized as it always has been.
Stewart: I always get a great education on these podcasts. As we wrap here, if you were going to drop a nugget in the ear of our audience about EM, climate and energy transition, what would it be?
Matt: I think just climate and impact investment in general. The thing I would just put on people’s radar is don’t let perfect be the enemy of good. And it comes back to something you brought up earlier, which is the data issue. Data’s not perfect, it’s developing. This is a nascent investment landscape. In 5, 10, 15 years, it’s going to be very standardized, without a doubt. But if we wait 5, 10, 15 years to start making investments, the horse is going to be long out of the barn, and we’re going to have a much bigger problem on our hand.
So we could sit here and say that CEMEX doesn’t have perfect scope three reported, because it doesn’t, but what do I know? I know that they’re bringing down their emissions in the short term, and I know that as stewards of capital within the cement industry, they’re best in class, and they’re directing it towards near-term benefits and also big-picture benefits. So I think it’s to work with investment managers to talk about how they’re quantifying their impact, but don’t let there be a lack of effort just because you don’t see things perfectly laid out for you. I think that there’s a lot of progress we can make today to help avert a disaster in the future.
Stewart: I’ve learned that. What a great education, I really appreciate it. I got one fun one for you on the way out the door. If you could have lunch with anyone in history, alive or dead, who would it be? This is why I get paid the big bucks, Matt. This is why, it’s questions like this.
Matt: It’s a good question. You know who it’ll be? It would be Alexander Hamilton, and it’s because my six-year-old twins can’t stop listening to the musical. So I spent so much time thinking about Alexander Hamilton, and it’s an amazing story, and I know it’s overplayed, but it’s very popular in my house at the moment.
Stewart: I love it.
Matt: So it might be Alexander Hamilton.
Stewart: That’s perfect. Thank you. We’ve been joined today by Matt Christ, Managing Principal Emerging Markets Transition Debt Strategy Head at Ninety One. Matt, thanks for being on.
Matt: Thanks, Stewart. Great to be with you.
Stewart: Thanks for listening. If you have ideas for a podcast, please shoot me a note at firstname.lastname@example.org. Rate us like us, and review us on Apple Podcast. We certainly appreciate it. Thanks for listening. My name is Stewart Foley, and this is the InsuranceAUM.com Podcast.
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