As part of NordSIP’s new series of insightful interviews with sustainable investment experts, we meet Ulrik Fugmann, Co-Head and CIO of the Environmental Strategies Group at BNP Paribas Asset Management. Fugmann is currently based in London where he has spent the past 23 years. Before he embarked on his exciting international career, however, he started off as a macro analyst in Denmark, at Alfred Berg, a Nordic firm that was since acquired by BNP Paribas Asset Management.
“While studying macroeconomics, econometrics and political science in Copenhagen, I developed a strong interest in how markets were working in general and development economics in particular,” shares Fugmann. “That took me to Goldman Sachs in 2001, where, realising that global macro would be a good fit for me, they put me on the investment side. That is how I got involved in looking at how the world energises, feeds, and builds itself. The companies and sectors I worked with weren’t considered that sexy back then but have since developed incredibly.”
“To start with, there weren’t many electric vehicle, hydrogen or solar companies, although we did have one or two wind companies in Denmark very early on,” he recalls. “Such investments were just a fraction of a broader investment universe involving traditional energy, industrials, and agriculture. It all really changed in 2016 -2017. Not only because of the growing awareness of climate change. Also, the macro environment shifted after the financial crisis, allowing for sustainability to emerge as a theme not just in venture capital or early-stage project finance and infrastructure investing, but in public markets, too. It became clear that energising and feeding the world in a more sustainable manner is going to be the growth engine of society going forward.”
Defining a theme
Thematic strategies, like the ones managed by Fugmann and his colleagues, should be well positioned to capitalise on such dramatic investment shifts. “There is a lot of confusion around the concept, though,” he says. “In my opinion, a thematic investment strategy means working with a universe of companies unified by a specific theme, providing solutions, and having significant exposure to it, either through their revenues or capital allocation. The theme could be AI, or robotics, or, as in our case, the energy transition,” he explains. “For us, energy transition is not about buying companies that are using the solutions, but the ones that provide them. We invest in solar, wind, batteries, EVs, smart grid, hydrogen, etc., rather than in big tech, financials or other industrial companies that use the power.”
“One of the characteristics of thematic investing is that they provide an opportunity to outperform over a cycle. If constructed correctly, however, thematic strategies are also more volatile due to the high correlation between the companies in the smaller investment subset. And why should you invest in that? Well, society is changing, whether through the energy transition, the advent of technology, or other shifts. It is logical to assume that companies addressing these issues will make above-normal profits and provide good investment returns. Investors do get higher intercorrelation between these companies, but also a more focused exposure that could benefit them in the medium to long term.”
Rewarding risks
While there is a variety of themes that can serve as a base for designing an investment strategy, Fugmann and his colleagues have picked the environment as their starting point. Solutions apart, such a strategy inevitably comes with a number of risks specific to the theme.
“There are always risks when you invest in innovation and new technologies,” admits Fugmann. “Certain technologies turn out to be less economical or get replaced by better ones. It is our job to be vigilant and pick the solutions with the highest probability to stand the test of time.”
“There is a lot of debate around environmental solutions. I read an article recently making the point that it is risk capital funding the net-zero transition, not asset managers and I agree with that. Unfortunately, most asset managers just talk about aligning their portfolios with net-zero solutions, without actually investing in the solutions,” says Fugmann. “We are very proud to be one of the world’s biggest investors in solutions such as hydrogen, residential solar or energy storage. What makes me sad is that a lot of investors seem to be in favour of the net-zero transition only as long as the returns are better than under a ‘business-as-usual’ scenario. Of course, given that decarbonisation projects are at a fairly early stage, this is entirely unrealistic.”
The drivers of energy transition
Climate change is an obvious driver, of course. “Yet, a lot of people tune out when they hear about the catastrophes around the world triggered by climate change,” reflects Fugmann. “They can’t connect with a flooding that is not happening in their basement, or the rising temperatures elsewhere. Frankly, people have enough problems as it is, so, when you start talking about polar bears on the melting ice in Greenland, they don’t want to hear it.”
“Yet, energy transition is about much more than just climate change,” he says. “It is also about geopolitics. We are more aware today of the tensions and human catastrophe created by the unequal distribution of energy resources. Meanwhile, no one owns the sun, the wind, or the water used for hydrogen. Renewables offer ways to get rid of some of the geopolitical tensions.”
Affordability is another important aspect. “As we are moving into a recession, renewable energy is a deflationary force. The sun or the wind do not charge you per additional unit of energy, whereas digging out a molecule of gas or oil is costly. So, the more renewables we have, the lower our power prices.”
“These are some of the drivers that make the theme interesting,” summarises Fugmann. “The main one is climate change. Even if you don’t believe in it, though, you can’t ignore the statistics saying that households are going to double their demand for power in the next 27 years. This is easy to believe when I look at my kids using iPads and my kitchen having more and more connected machines. At the same time, we can’t squeeze more energy out of fossil fuels. That is where solar, wind, and hydrogen come in.”
Electrons vs. molecules
Speaking of hydrogen, BNP Paribas is one of few asset managers focusing on this kind of opportunities. The technology is somewhat controversial. “What we need to understand is that there is only so much decarbonisation we can achieve with renewable electricity, or electrons,” says Fugmann. “In many industries you need molecules similar to those of gas or oil. Transportation, for instance, especially trucking, airlines, and shipping, as well as steel manufacturing still rely heavily of fossil fuels. Hydrogen offers a replacement for those fossil fuels.”
“The technology is incredibly simple and powerful: you take water and you split it into its components, hydrogen and oxygen, through electrolysis. If you use renewable energy to do it, you have a zero-carbon technology to create a molecule that can be used in all the industries where renewables just can’t solve the transition. That is why we have seen massive investments in hydrogen both in the US and in Europe.”
“Hydrogen also provides an opportunity for oil and gas companies to shift their portfolios. Fossil fuel producers don’t really understand electrons, but they know about molecules. Once the technology starts scaling up, we might see mega cap hydrogen companies emerging.”
When is the right time to invest in hydrogen, though? “Timing is always hard. We already saw a hydrogen boom in 2020, aided by zero rates. Now we have rates at almost 6%, a much trickier financing environment for a capital-intensive innovative industry. Still, massive projects have been announced in Europe, many in the Nordics, so we are optimistic. Especially if rates turn downwards, that should provide a boost for an industry which is already one of the fastest growing ones in clean energy.
Many paths to net zero
In the wake of the Paris Agreement, countries but also businesses and investment firms have made commitments to ‘net-zero’. Concretely, that means targeting a drastic reduction of greenhouse gas emissions, but also compensating for the existing emissions by taking away some of the carbon from the air. Everyone knows planting trees is a good idea, but there are also other natural and technological means of capturing carbon.
“We are following the emerging carbon-capture technologies. Today, however, they are still very expensive. Meanwhile, the only sector where you can really go negative carbon emissions is agriculture, mainly by changing the way we grow produce. The soil is probably the most complex and effective carbon capture mechanism in the world. Yet, current industrial farming practices like tilling, for instance, destroy the soil’s ability to absorb carbon.”
“This is a different theme from energy transition, so we have left it in the hands of our sister fund to explore ecosystem restoration and carbon absorption. In combination with all the efforts that we are doing on energy transition, the ecosystem restoration fund tries to pull the other way and make sure we get to that net-zero equation,” Fugmann continues.
Engagement vs. exclusion
Could it be that some asset managers are using the energy transition theme as an excuse to continue doing business as usual, i.e., investing in fossil fuel companies that claim to be transitioning. They say they are engaging with companies to help them transition, buying themselves another few years of decent returns while everyone is playing the same game. A game of musical chairs where you are waiting for the music to stop, but you must continue dancing.
“Another analogy I like is that of shifting deck chairs on the Titanic,” says Fugmann.
“We believe the way to invest in the energy transition with integrity is by making sure that a significant amount of the revenues associated with each investment goes straight into environmental solutions. That means we are not investing in oil and gas. In a way, what we are saying is, let’s not spend all our time shifting those deck shares again. Let’s just focus on a very underserved part of the market.”
Fugmann laments that despite the growth in ESG assets, investments are still not flowing into solution providers. “It is partly because the returns that you get from investing in that space deviate significantly from broader benchmarks which most institutional investors track. I have a lot of sympathy for this dilemma. At BNP, we aspire to give our clients a choice, not stuffing things down their throats. If they want to mimic the market and just tilt their portfolio towards companies signed up to net-zero, we can help them engage with those struggling with the transition. I am very proud of how BNP engages on environmental issues. We have one of the best records among asset managers and it is an important part of the ethos behind what we do here. That is not what we offer at the Environmental Strategies group, however. We are on the other side of the equation, focused on the solutions. What is extraordinary is that it feels like being on a lonely island. I wish there were more of us!”
Fugmann speculates that what we today call energy transition and innovation theme will become mainstream investing. “No doubt we will see the Microsoft of hydrogen in ten years’ time, or the Microsoft of energy storage, residential solar lines, etc. These fast-growing industries will eventually make their ways into portfolios. Just like AI which wasn’t a big thing several years ago now weighs massively in stock indices. I think there is a mutually reenforcing effect between solutions, adopters, and combining the two. Investors can mix and match depending on their risk and reward preferences.”
