3 stocks for climate transition

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Lex Hall: Hi, I'm Lex Hall for Morningstar. And today, I'm joined by Jaime Ramos Martin. He is one of the co-portfolio managers for Aviva Investors' new Climate Transition Global Equity Fund and I thought today we would have a look in a bit more detail about three stocks that Jaime has included in the fund.

Jaime, welcome again to Morningstar.

Jaime Ramos Martin: Thank you, Lex.

Hall: Now, you look for companies that contribute to what we now know is the decarbonization of the economy. And the first name on our list today is Union Pacific. Can you tell us a little bit about Union Pacific? What it does?

Martin: So, Union Pacific is one of the biggest US freight rail operators. And basically, sometimes it's odd kind of holding in a climate transition fund. And I think it's a good reflection of maybe when people don't look at the full picture. So, freight rail is obviously somewhat carbon intensive and mostly in the US there are diesel trains. So, if you analyse Union Pacific on a standalone basis, it could look not totally suitable for a climate fund.

Now, what is the catch? The catch is that freight rail used to be not very well organized. Usually, the trains we just wait until they get full and then just get to whatever was the destination. For companies, that was manageable. If you needed in the just supply chain at time of day that your goods will get to the factories, you couldn't work with freight rail. Now, there were big changes in the industry, particularly brought by the Canadian Railways called precision railroading and now is a perfect substitute for tracking. Now, the catch on emissions is that freight rail basically is 75 per cent less emissions per ton than trucks and that's an opportunity that if when companies, they want to—and we talked before about science-based studies—when they want to align themselves with the Paris Agreement, they're going to look at the supply chain and say, like, how we can optimize the carbon footprint of our logistics. And we believe that freight rail is in pole position to benefit from that. And not only that, these companies are looking at setting science-based targets and there is a plan to transform those diesel locomotives that you want to electrify them. So, I think it's something that the market is not focusing the attention and we believe it's a great way to reduce emissions.

Hall: Okay. All right. The second name today is Trane Technologies. Tell us a little bit about Trane Technologies.

Martin: Yeah. So, Trane Technologies falls into a category that we like to call adaptation to climate change. And what I mean by that Lex is there's a certain—as we know, already we are 1 degree above preindustrial levels. Paris Agreement wants to limit that warming to 2 degrees. So, there is an element of climate change that is going to happen anyway, Lex. So, we need to adapt for that to happen, for temperatures to be higher, for sea levels to rise, and Trane falls into that category of stocks. So, Trane is one of the best HVAC manufacturers and basically adapting and making sure workplaces and factories, buildings, residential, they're at the right temperature is very important and in a very efficient way. So, that's where Trane, kind of, if you want benefits from companies and buildings and societies adapting to a warmer climate.

Hall: All right. The third name on the list, I must admit I was a bit surprised by this one, but you have very good reason to include it. It's Volkswagen. It was of course caught up in that emissions scandal in 2015. But today, it's back in favour. Tells us why.

Martin: Yeah, well, clearly back in our favour. There's clearly controversy, which I think clearly—not dwelling in the past, I think that Dieselgate was something that in a way transformed the vision of Volkswagen apart from substantial management change and changes of policies. We believe it might be one of the causes that made them to invest so heavily in electric vehicles. So, at this point, we believe Volkswagen is in pole position of the legacy auto manufacturers to catch up on the electric vehicle race. It was the first one and to our view, very successful one in basically building a totally new platform for the electric vehicles which the competitors thought it was too much investment and it wasn't the right thing to do. And now, all the competitors are coming to that same conclusion. So, they are in in the lead. They recently have a planning session with the market where they reiterated they will invest 35 billion in electric vehicles in the next five years and they expect that 20 per cent of its sales or 3 million cars—to sell 3 million electric vehicle cars by 2025. So, we believe that its value as an auto legacy stock while it's in the pole position to electrify and to do that transition to sustainable transport. So, yeah, that's the reason that it's in the fund.

Hall: I suppose a question without notice in your fund speaking of electric vehicles, do you include Tesla or…?

Martin: No. So, in the holdings—we respect Tesla's efforts and technologically we think, clearly, they've been ahead, and they are just very innovative company. We basically find difficulty to overcome the valuation of the stock. So, we think we can well recognise, as I said, their success or their technology. We think that—we agree with Tesla in the sense that electric vehicles are going to be much bigger proportion of the auto fleet, if you want, than maybe the market is thinking right now. But there are other stocks that you can look at in terms of battery manufacturers or other parts of the supply chain that will benefit from that trend. So, we basically want to focus in stocks that we understand, and we believe we have (indiscernible) consensus, and in Tesla we don't.

Hall: Sure. Okay, fair enough. That's well explained. All right. So, that's Union Pacific, Trane Technologies and Volkswagen. Jaime from Aviva Investors, thank you very much for your insights today. That was fascinating.

Martin: You're welcome, Lex.

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