Energy transition and AI – investing in the enablers of secular change
While these themes are often interpreted as style waves of “growth” or “value”, we strongly believe this is the wrong way to think about them. In each case, a small group of industries benefitted from changes in the underlying macro environment. These changes drove outsized increases in revenues, earnings and cashflows for well-placed companies creating big winners in the stock market.
It seems reasonable to wonder if we will once again see a similar wave as we head into a new decade. Based on the winners in past decades, we are looking for a secular change that is extremely large and where affected industries and companies will see a step change in performance. In past cycles we have often seen businesses accelerate from pedestrian growth rates to market leading growth rates, with the change coming entirely from structural shifts in their industries.
In our view, the areas that hold the most promise in the 2020s are the global energy transition and a new wave of digitization driven by artificial intelligence (AI).
We outline the opportunities we see in both areas below, before turning to how we have applied Bluewater’s investment philosophy to find related investments for our portfolios.
Energy is arguably the single most important industry on Earth. Every time supply is disrupted it causes significant turmoil, as almost all other industries require energy. A global consensus has grown that the energy industry must be transformed to limit the impact of human-caused climate change, resulting in the global energy transition.
In our view, this shift fits the pattern of a massive global change that creates an inflection point for many industries. To decarbonize, the world has begun to switch from fossil fuels towards renewable sources, including wind and solar. The electricity grid, possibly the world’s most complex human-designed system, will need to be rebuilt to accommodate this change. The current grid is simply unable to meet future demands, both in terms of supply as well as demand.
The global transportation industry is undergoing its own transition from fossil fuels to electrification, which will place further strain on the grid. Finally, numerous industrial processes, from steel and cement manufacturing to heating and cooling of buildings, are also transitioning toward cleaner energy sources, including electricity and hydrogen.
This is a multi-decade investment cycle that could run into the hundreds of trillions of dollars. Will the benefits be worth the time and effort? We think so! The current energy system traces its roots back to the late 1800s and is increasingly ill-suited to a modern economy. The new system will be very different. Instead of large power plants feeding big transmission lines, we are moving to a much more flexible structure with thousands of points of renewable power generation, integrated power storage, and smaller and shorter transmission lines. Instead of high and rising fuel costs with the ever-present risk of shortages, we will end up with near-zero fuel costs as sunshine and wind are free.
Artificial intelligence and digitization
This has been the breakthrough year for artificial intelligence, with the rapid adoption of generative AI models, including ChatGPT. Although it may seem like AI came out of nowhere, the underlying technologies have been evolving for over a decade. The AI wave is the fifth major spillover from digitization and semiconductors.
The earliest integrated circuits were developed in the 1960s. Since then, they have been improving at a rate consistent with Moore’s law, which posited that the number of transistors (the microscopic switches at the heart of all digital technology) on a computer chip would double every two years. While this may not sound all that impressive, steady compounding can achieve remarkable growth over time. After roughly 60 years of Moore’s law, each cutting-edge chip now contains nearly 100 billion transistors!
The constant improvement in semiconductors has created repeated technology waves. From computers to the internet, smartphones, cloud computing, and now AI, each wave has had major impacts on how the economy functions.
There are two major types of AI moving into general use
In both cases, as computing power continues to advance with Moore’s law, the AI model will get faster and better.
Durable growth investing
We view both the energy transition and AI as clear areas of investment opportunity. However, they also have the potential for significant risk. Fast-moving areas with uncertain technologies and high levels of competition are not always kind to investors. A component of the Bluewater investment philosophy is focused on finding the key enablers of change. We often draw the analogy to the companies supplying the “picks and shovels” during a gold rush. While a small handful of miners will hit it big, the vast majority will find little to nothing, but the tool suppliers will win no matter what.
The energy transition is extremely complex and touches numerous industries globally. In our view, the fossil fuel related industries are no longer a growth area of the economy. As a result of our outlook for slower growth in the sector we no longer own companies in this area. In addition, many of the companies associated with the energy transition that we have analyzed do not meet our investment criteria. There are, however, a select group of companies that we believe will be key enablers of the energy transition.
They include global leaders in their industries, like Schneider Electric (software and products for the electrical grid), ON Semiconductor (semiconductors for electric vehicles), Trane Technologies (commercial-grade heat pumps), and Linde (hydrogen production).
The AI wave relies on a pair of foundational building blocks: semiconductors and cloud computing. If AI is going to be broadly adopted, like all other major technology rollouts it will need to be implemented by experts. Our key portfolio holdings enabling AI include global leaders like Synopsys (software for semiconductor design), Accenture (IT consulting and implementation) and Microsoft (large-enterprise cloud computing).
Transition and technological change create winners and losers, often upending entire industries. The Bluewater team looks to add return while limiting risk by owning the key enablers, while avoiding industries and companies at risk of being displaced.
Our businesses are highly profitable, generate substantial free cash flow and have strong balance sheets. Some will have an added growth tailwind over the coming decades as they benefit from the energy transition and the AI wave, and we look forward to seeing this play out for our clients.
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