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Steering Automotive Holdings Through the Net Zero Race

Asset managers outline investment strategies to tackle the transition challenge.

While it is clear that internal combustion engines (ICEs) are a thing of the past, it is less certain how the automotive sector’s net-zero transition will unfold.

Investors in automotive holdings need to consider that the pace of transitioning is becoming critical.

The opportunities and risks of allocations will be more transparent, as firms increasingly adapt to the immense shift from ICEs to electric vehicles (EVs) in line with the goal of net-zero greenhouse gas emissions by 2050.

Aanand Venkatramanan, Head of ETF Investment Strategies at Legal & General Investment Management (LGIM), believes that larger automobile firms without EV plants today will inevitably face their doomsday.

Antonio Celeste, ESG ETF Product Specialist at Lyxor Asset Management, explains that firms are under pressure to align their business models or otherwise face declining market shares.

“Car makers and auto component [manufacturers] must shift their production from ICE vehicles to EVs now in order to achieve economy of scale during this decade and be competitive in the next one,” he explains.

According to a preliminary estimate by the International Energy Agency, global sales of EVs increased sharply during Covid-19, climbing over three million in 2020, a record-breaking year, from 2.1 million in 2019.

In Europe, EV sales more than doubled 2019 levels, reaching about 1.3 million in 2020, backed by existing policy schemes.

With price parity between EVs and ICEs expected from 2022 to 2029, EVs could enter “a phase of exponential growth to reach 100% zero emission vehicles sales by 2035”, a report by NGO ShareAction says.

Time to Transition

“Given that the average lifespan of an ICE is around 15 years, and all transport needs to be zero emission by 2050, all new cars sold need to be fully electric by 2035 the latest, requiring an ICE phase out by that date,” the ShareAction report estimates.

Euractiv has reported that the European Commission’s proposed Euro 7 rule would amount to “a ban through the back door” of ICEs as of 2025.

Current EU emissions target regulation was created based on net-zero objectives and a mobility strategy, published in 2020 by the Commission, and will likely be tightened in June 2021.

Car manufacturers which sell vehicles that do not meet EU carbon dioxide targets face significant fines. Volkswagen, for example, is expected a fine of about €240 million for having exceeded carbon dioxide emissions in 2020 by a small margin, the report says.

To assess the preparedness of their auto holdings to transition, investors can examine whether the 2050 net zero commitments are aligned and plausible for new vehicles in use, including short- to medium-term targets, ShareAction suggests.

Jana Hock, Senior Research Officer at ShareAction and the author of the report, explains that investors should also pay close attention to “companies’ electric vehicle sales targets and ICE phase outs when considering climate risk in the auto sector”.

The NGO assessed the five largest European car manufacturers under assumed upcoming and tougher emissions regulation in line with the EU’s climate objectives and ICE phase outs.

It found for this scenario that “German and French car manufacturers’ current climate commitments severely lag behind what is needed”.

“Renault is the only company with net-zero aligned commitments, with the acclaimed German electrification leader Volkswagen still playing catch-up. Daimler, BMW and Groupe PSA, who all significantly rank below their rivals, appear to be asleep at the wheel on climate change,” it concluded.

ShareAction added that it pressed Daimler for an ICE phase-out by 2035 at its AGM in March, and that following this, the company announced plans to phase out diesel and petrol vehicles before 2039.

Growing value chain risks

ESG Investor has talked to a number of asset managers about transition risks and opportunities for the automobile sector and how their investment strategies seek to address these.

Raphaël Lance, Head of Energy Transition Funds at Mirova, explains that the value chain of ICE vehicle manufacturers needs to adapt to new technologies and that the production of raw materials and batteries will likely shift to other geographic areas.

Training of employees in areas such as energy storage and connectivity technologies will be necessary too, he adds.

Jörg Schneider, Portfolio Manager at Union Investment, highlights general ESG-related reputation risks that may emerge with the transition to EVs.

“Currently, there is no visibility of supply chain carbon dioxide emissions and whether battery materials will continue to be produced with coal energy mixes,” he explains, which could make EVs a bigger climate killer than ICEs.

Among other risk factors, he says, are that new competitors lack control of raw material supply chains and human rights protection, as well as the absence of recycling solutions or strategies to increase the availability of metals.

Tactics to circumvent risks

Asset managers seek to invest in firms able to control the supply chain, transform with the fastest pace or which are already part of the future market.

Union Investment’s Schneider suggests to invest in components providers, or original equipment manufacturers (OEMs), which he says have the ability to transform the quickest.

In terms of automotive suppliers, Schneider explains that they favour companies “with full supply chain controls in place and a clear Scope 1, 2 and 3 emission reduction strategy – including major milestones to be achieved well before 2050”.

“Sufficient metal supply and recycling technologies are also crucial for the transition into EV production,” he adds.

LGIM’s Venkatramanan says the firm invests in more pure-plays with their own battery storage technologies because of their independence and ability to leverage a differentiating and higher performance of cars.

The firm provides a net zero solution with three ETF themes on clean power value chain, battery value chain and the hydrogen economy value chain.

Mirova’s Lance sees the most mature technologies in the upstream and unlisted value chain as offering investment opportunities.

“Mirova is investing in low-carbon mobility unlisted companies and benefits from knowledge synergies with the listed fund managers about the whole value (batteries, electrolysers, fuel cells, hydrogen storage),” he notes.

Lyxor’s Celeste suggests embracing the entire future mobility eco-system to diversify risks and multiply opportunities.

Lyxor reviews its future mobility sub-themes of its ETF annually, including autonomous vehicles and related technologies, mining companies and shared mobility, to monitor evolutions and stay invested in the companies with high revenues, Celeste explains, adding that they select best ESG performers.

Dominik Schmaus, Product Manager at US investment management company VanEck, pursues a pure play approach, excluding major automotive manufacturers as long as they receive the majority of their revenues from other areas than hydrogen.

He says that “the index underlying our ETF ensures that companies are included in the universe that generate at least 50% of their revenues in the hydrogen segment and, to a certain extent, also include companies related to fuel cells and industrial gases”.

Taking in the broader picture, achieving net zero will need a fundamental transformation of the energy mix in the grid to ensure that EVs are powered by renewable energy and not from fossil fuels.

“Investing in additional capacity of wind, solar, offshore wind is very important. Without that we wouldn’t be able to achieve net zero; and that is happening,” Venkatramanan says.

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