Closing the loop: how to build a circular economy
The circular economy promises a radical rethink of how we interact with our planet. What does this mean for investors?
In 2005 Ellen MacArthur became the fastest solo sailor to circumnavigate the globe, having spent 71 days alone at sea. To survive the journey she carried everything she needed with her, and this left her with the realisation that the foundation of the global economy is essentially the same: finite resources are extracted, consumed and discarded.
Five years later – with her first-hand experience of the planet’s delicate, interconnected cycles still fresh in her mind – she founded the Ellen MacArthur Foundation, which is committed to turning the idea of a circular economy into reality.
What is a circular economy?
In principle, a circular economy is a building block for a more sustainable future. It reimagines the way value is created, moving away from the ‘take, make, waste’ linear model and closing the loop. The three guiding principles of the circular economy are:
- Eliminate waste and pollution
- Circulate products and materials (at their highest value)
- Regenerate nature
From collection and manufacturing to packaging and distribution, each stage of a product’s lifecycle can play a role in reducing harm. But although the merits of this idea are widely acknowledged, the circular economy is misunderstood by many, remaining the ugly duckling in climate-transition-focused strategies.
However, we see an intrinsic link between resource consumption, waste generation and greenhouse gas emissions, making circular solutions critical for the transition towards a low-carbon economy.
Where are we now?
Progress on circular solutions has been slow, particularly on global recycling rates.
This is despite economic benefits to higher recycling rates, such as material savings. One reason for the slow progress is continued worries over quality degradation of assets if recycled material rates increase.
In order to overcome this inertia, we believe significant investment is required, both at the opex and capex level. Consumer behaviour is another challenge, though this could potentially change rapidly and without the need for large investment.
Encouragingly, we see significant potential for the developing regulatory landscape to help accelerate a circular transition. One example is the extension of the EU Taxonomy to include a ‘Transition to a Circular Economy’ category, which could increase capital deployment in this area.
Turning from government initiatives to the role of industry, it’s worth noting that today up to 80%1 of products’ environmental impacts are determined at the design phase.
Increasingly, we find evidence that corporates are finding new solutions and design methods following ‘cradle to grave’ lifecycle assessment of their products.
Meanwhile, there is a growing concerted effort across the value chain, with collaboration and strategic partnerships driving advanced recycling capabilities and a broadening of technology applications.
As the graph below shows, all of this could have a substantial impact on European carbon emissions if it increases the circularity of key materials.
Potential winners of the circular economy
As the principles of the circular economy gain acceptance, we believe alpha-generation opportunities could potentially be created across numerous industries. We see potential upside for innovative operators in chemicals, industrials, consumer, utilities and real estate, among others. This transition also entails risks, as companies that do not keep pace with changing thinking may lose investor support.
As part of our Active Ownership programme, we are engaging with companies to better understand how they can increase the circularity of materials within end markets. We look to encourage companies to increase their circular commitments, including R&D and capex to unlock new commercial opportunities.
Looking ahead, we expect more companies to make greater use of recycled materials and supply chain optimisation. Our analysis suggests improving the design characteristics of products can benefit the cost base over time, while creating new growth avenues in existing and new verticals.
We believe the ‘picks and shovels’ enablers and industry backers of the circular economy have potential to create value for shareholders, as well as supporting environmental progress.
1. Source: UBS Research, April 2022.