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Funds Juggle Emerging Universe as Circularity Shrinks

Investment in the circular economy remains a moving target, as rising demand for critical raw materials widens the ‘circularity gap’.

Circular economy funds are too narrow in focus and investors must look “holistically” at key sustainability challenges, such as resource efficiency, to “decouple the linear relationship” between material production and growth, according to David Osfield, Fund Manager at investment management firm EdenTree.  

His comments come as rising material extraction has shrunk global circularity: from 9.1% in 2018, to 8.6% 2020, and now 7.2% in 2023. A new report by think tank Circle Economy said the resulting ‘circularity gap’ has left the world almost exclusively relying on new (virgin) materials. 

More than 90% of materials are either wasted, lost or remain unavailable for reuse for years as they are locked into long-lasting stock such as buildings and machinery, the report added. 

In a typical circular economy fund, it is not uncommon to see companies like Microsoft, Nike and Coca Cola, said Martin Conroy, Portfolio Manager at KBI Global Investors, a boutique asset management firm. 

All three companies are making efforts around issues like renewable energy and water consumption, he said, but suggested the impact is greater from a marketing perspective, in many cases, than achieving meaningful business model change.  

The “true drivers” of the circular economy, he said, are paper-based packaging companies accelerating the shift away from single-use plastics and waste management companies reducing levels of landfill waste. 

The investment universe is still emerging, said EdenTree’s Osfield. “As innovative solutions develop, dedicated circular economy funds may struggle with too narrow a focus.” 

Capital is flowing into circular economy initiatives with the area attracting US$1.3 trillion in annual investments aimed at reducing waste and promoting reuse and recycling, according to a report from Chatham House.  

But the circular economy it still a relatively small asset class and there are challenges, says Man GLG Portfolio Managers Yohann Terry and Jann Breitenmoser, in written responses to ESG Investor. 

“If funds aren’t directly invested in companies providing solutions and focus instead on selecting companies which are either selling solutions in relation to the circular economy or which have implemented processes which comply with that concept, their effectiveness can be limited.” 

Both believe that greater impact can be made by investing only in the providers of solutions and equipment in relation to the circular economy.  

“It allows investors to get more direct exposure to the growing circular economy trend,” they said.  

“Going a step further, we think it would be possible to see a bigger impact by integrating circular economy KPIs in non-specialised funds, which could then have more impact on companies through engagement practices.” 

“Can-kicking” initiatives 

While technology innovation is helping to accelerate the transition to a circular economy, portfolio and fund managers are calling for bigger carrots and larger sticks.  

“In a similar way to global carbon emissions, policymakers continue to favour what might be described as “can-kicking” initiatives, deferring the challenging and immediate action to address longer term challenges,” said Osfield.  

Conroy of KBI Global Investors called for disincentives to be put in place for waste and incentives for recycling, reuse and circulatory business models, particularly in industries like household goods and consumer electronics. 

“There needs to be regulation in terms of penalties associated with the production of goods that can be produced in a manner that is more environmentally friendly,” he said. “There’s many companies that are making no efforts in terms of designing out waste.”  

However, he conceded that despite the benefits of tighter rules, resistant lobby groups and stakeholders were slowing the path of regulatory change.  

While the pace of supporting regulation is varied globally, a number of governments are introducing the concept of extended producer responsibility into domestic legislation, while the EU included a Circular Economy Action Plan into its European Green Deal in 2020.

The majority of critical materials like cobalt, coltan and lithium come from developing economies where issues of corruption are a challenge and make regulation difficult, he said, noting also the slow progress in developed markets, describing the level of household recycling in the US as “absolutely terrible”. 

The US is recycling just 5% of its plastic waste, with around 85% of it ending up in landfills and the remaining 10% incinerated, according to a report by the Last Beach Cleanup and Beyond Plastics. 

“Although the concept of a circular economy has attracted more interest recently, its potential in fighting climate change has yet to be promoted,” said Mirtha Kastrapeli, Head of Consumer Sector Research at ISS ESG, the responsible investment arm of Institutional Shareholder Services. 

The practical information hub for asset owners looking to invest successfully and sustainably for the long term. As best practice evolves, we will share the news, insights and data to guide asset owners on their individual journey to ESG integration.

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