When Xavier Chollet considers making a new investment, one of the questions he asks is about the company’s ‘purity’. Given Chollet’s portfolio is built around businesses that are leading the energy transition, you’d think this focus would mean the nature of the companies he chooses would be obvious – but in many cases, it is anything but.
‘As active managers, our value-add to our clients is not just to assemble all the pure plays of the energy transition,’ said Chollett. ‘If I just come to you with a Vestas [a wind turbine manufacturer] or a solar panel producer or [electric vehicle] pure plays, you’re going to say: “Sure but I could go to any ETF out there and have the same thing with lower fees.”’
While Chollett’s fund does have a sprinkling of investments in renewables – wind, solar and other new-energy ventures that are clearly in tune with the world’s move away from fossil fuels – it also has plenty of technology businesses, semiconductor manufacturers, engineers and the like.
‘There are very different approaches out there. We try to have companies whose products or services have an important role or are enablers in the energy transition,’ said Chollet.
‘The easy part [of the decision] is the production of energy, solar or wind. Otherwise, it’s products or services that have an important role in energy efficiency. It can be building with insulation materials or energy-efficient air-conditioning systems. It can be ways to produce more efficiently in our factories, or electric cars, or the theme of how efficient they are.’
For any company to be even considered ‘pure’ enough for the portfolio, at least a third of its enterprise value (market cap plus net debt) must be linked to the theme of the energy transition. And no more than one-fifth can be tied to areas the fund managers dislike, including oil, coal and nuclear power.
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Elite energy
Chollet’s approach has served him well. He is classified as an Elite Investor by Citywire, ranking in the top 3% of the more than 10,000 equity managers monitored.
His Pictet-Clean Energy Transition fund has outperformed the MSCI World index over five years but has lagged over more recent periods amid a backlash against investments driven by ESG issues. Sentiment has turned on some of his favoured stocks while renewable energy markets struggled with higher interest rates and inflation. The company has stayed well ahead of global renewables indices over the last three years, though.
Chollet, who has worked at Pictet since the start of his career in 1998, is part of the thematic equities team and runs the fund alongside three other portfolio managers – Manuel Losa, also an Elite Investor, Pam Liu and Guillaume Martin-Achard.
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Silicon sizzlers
While still an analyst in 2007, Chollet added clean technology to his existing coverage of global semiconductors at the time of the fund’s launch. He found himself travelling and sharing meetings with the then-portfolio managers. Having made clear his interest in the fund’s mandate, when the opportunity arose to join the team, he grabbed it.
‘I have a background in semiconductors so I added quite a few semiconductor opportunities, not only in our investment universe but also to the portfolio,’ Chollet said.
‘That adds amazing investment opportunities with absolutely no correlation with renewables and also adds something else, which is profitability, high barriers to entry and intellectual property. And with all that comes high margins, high free cashflow generation. You don’t need subsidies and you don’t need external financing to grow. You just use your billions of free cashflow to grow.’
If it sounds like this stretches the energy mandate, think again. Among the fund’s top holdings are Marvell Technology (US:MRVL) and Broadcom Inc (US:AVGO), both of which make customised AI processors. These are by far the most energy-efficient way of operating data centres, which according to some forecasts will be responsible for 25% of all US electricity consumption by 2030 due to rampant growth in demand from AI.
Woke ain’t broke
The US accounts for just under three-quarters of the fund’s portfolio, while renewables make up 13%. However, Chollet has few fears for the Donald Trump presidency, despite heavily pro-fossil fuel rhetoric and the president’s quick move to pause the expansion of new wind projects.
Chollet believes the momentum behind renewable energy is unstoppable and that Trump will find it extremely difficult to unwind Joe Biden’s Inflation Reduction Act, which created hundreds of billions of pro-green energy subsidies and millions of American jobs, predominantly in Republican states.
‘Today, where the transition to renewables is driven by economic sense, is very different from 10 or 15 years ago,’ he said. ‘In 90% of the world, it makes economic sense to produce electricity with wind and solar as the cheapest sources. It’s tough to go against that.
‘Even if you look at the first Trump mandate, when renewables were more expensive than they are today, and despite the “drill baby, drill” and “we want coal miners to come back” [rhetoric]… coal as a percentage of the electricity mix in the US went from 30% at the beginning of the mandate to 20%, while renewables increased from 15% to 20%.’
The fund invests on the principle that companies leading the energy transition will generate a persistent return premium over the long term, one that is often missed by a wider market obsessed with short-term gains.
‘You know the direction of travel for the next few decades,’ Chollet said. ‘For our companies, it means they have exposure to amazing secular growth. And really, the sustainability of this secular growth is very often underappreciated.’
Pulling it together
How, then, do the managers go about finding the right companies?
‘We start from the global equity market and apply different techniques. We know the industry quite well, we tend to know which companies would make sense, which IPO is coming to market, this type of thing. But then we also use natural language processing, AI and keywords to grab new opportunities we didn’t know about. That forms a smaller universe.’
Chollet equates the tech-driven side of the business – the team also uses an internally developed ‘portfolio optimiser’ that suggests changes to the fund’s composition based on factors such as volatility – to having a fifth portfolio manager, capable of making decisions stripped of emotion.
‘That brings a lot of added value because, at the end of the day, you want to feel strong conviction in a volatile stock but you want to be able to compensate, so the portfolio is not too volatile.’
After a company’s ‘purity’, the team looks at several other factors, including business franchise, management and valuation. The business franchise component is crucial, according to Chollet. The team looks at, among other things, a company’s position in its market – as well as the characteristics of the market itself – profitability, return on equity, free cashflow generation and capital allocation.
‘We’d prefer to have a great business model at a fair valuation than a company that has a very attractive valuation and is very cheap but for a reason,’ Chollet said.
