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Policy and innovation are driving the next chapter in the circular revolution, pushing the boundaries beyond the simple 3R –"reduce, reuse, recycle" – model, writes David Osfield, Fund Manager at EdenTree Investment Management

The seeds of a Circular Revolution

David Osfield David Osfield Fund Manager

The seeds of a Circular Revolution

David Osfield

David Osfield
Fund Manager

Policy and innovation are driving the next chapter in the circular revolution, pushing the boundaries beyond the simple 3R –"reduce, reuse, recycle" – model, writes David Osfield, Fund Manager at EdenTree Investment Management.

It is difficult not to be underwhelmed by the slow pace of the transition to a circular economy. Less than 10% of the world’s resources are properly circular with nearly every industry deficient when it comes to circular practices.

According to analysis from Berenberg’s ESG Team, some 71% of plastics are mismanaged and landfilled globally, while 30% of food is wasted, representing 8% of global emissions.

Creating a circular economy is therefore more than just about “responsible consumption and production” – goal 12 of the SDGs – it is of critical importance for tackling climate change.

However, beyond the dismal headlines we are seeing the seeds of a circular revolution. Policy is finally starting to step up and innovation is offering solutions beyond the simple reduce, reuse and recycle model. This is creating a deeper growth opportunity for investors, with some estimates expecting the theme to see investment of $4.5trn by 2030.

Why are we still hooked on a “take, make, dispose” economy?

In a similar way to tackling climate change, policymakers have long embarked on “can-kicking” initiatives, deferring the challenging and immediate action required to bring about long-term change.

The fact that waste largely remains a poorly costed economic externality hasn’t helped. In many countries it remains too simple and cheap to send waste to landfill (or to incinerators) than change the status quo. This is particularly evident in countries such as the US where landfill capacity remains abundant, creating little incentive to recycle. Disappointingly, when the EPA last analysed US rubbish trends in 2018, it reported a decline in the US recycling rate from 34.7% in 2015 to 32.1% in 2018.

And for too long Western governments were able to export the problem overseas. When China banned the import of waste in 2018 under its “National Sword” policy, it effectively forced the hand of the West. Landfill and incineration rates ballooned as local governments lacked the infrastructure to deal with the sea of waste that remained onshore. But it also proved to be a wake-up call, heralding change with businesses seeking to produce easily recyclable packaging and policymakers taking a sharper focus on reducing single-use plastics.

While a number of export bans have been introduced, many countries in the Global North still export unsorted recycling to the Global South, including textiles that are typically cheapest to produce, are a key source of microplastics, and are among the most challenging forms of waste to recycle. The Changing Markets Foundation highlighted the scale of this ongoing problem in Kenya in its documentary Trashion: The stealth export of waste plastic clothes to Kenya.

The drivers of circular change

Increasingly, businesses are recognising that circularity starts with the design stage of a product. However, such is the inertia and “lock-in” in the current linear economic model, the circular transition still requires massive policy support and long-term investment to update or replace legacy systems.

With an estimated 1,100 regulations now in play globally, we are encouraged to see a strong incentive framework coming into place. Of these polies, some 339 regulations are spread across 44 countries in Europe, with the UK and US catching up.

The UK Government, for example, introduced the plastic packaging tax on 1 April 2022, which imposes a £200 per tonne levy on plastic packaging with less than 30% recycled content, whether manufactured locally or imported into the UK. The policy aims to disincentivise the use of virgin plastics in packaging, and reduce the amount of plastic polluting the ocean, sent to landfill or incinerated. This policy should help support a significant increase in the domestic recycling and reprocessing industry.

In the US, meanwhile, America’s Plastic Makers, a division of the American Chemistry Council, have committed to helping achieve a circular economy for plastics with two ambitious goals: “100% of plastic packaging to be recyclable or recoverable by 2030”, and “100% of plastic packaging to be reused, recycled or recovered by 2040”.

Australia is also catching up and has embarked on an ambitious seven-point plan, which includes a ban on waste exports (already enacted), the phase out of “problematic and unnecessary plastics” (i.e. single use plastics) by 2025 and a recovery rate of 80% from all waste streams by 2030. Textiles, which currently have a recovery rate of 5%, are included as one of these streams.

Innovative thinking

To create scalable, cost-competitive circular solutions requires innovative thinking and R&D. We have started to see this amongst solutions providers like packaging business DS Smith, which we hold in the EdenTree global equity funds. This company has partnered with the Ellen MacArthur Foundation to develop a tool called Circulytics to enable companies to measure how circular they are and offer circular solutions within the packaging industry.

More broadly, innovation is driving more circular approaches to manufacturing, food production, management of supply chains and waste. Berenberg has highlight four key areas of innovation when it comes to the circular economy: “digitalisation – smarter design and manufacturing of goods”, “efficient food production and processing”, “remanufacturing within industrial sectors” and “advanced recycling for plastics and textiles”.

Indeed, when mapping out the investment opportunity, they have expanded the 3R framework to a 10R model, adapting a framework developed by academics at Utrecht University. In one form or another, this wider set of categories is increasingly featuring in our conversations and engagement at management level of companies across many industries now subject to tighter circular economy regulations.

As investors at EdenTree, we are keen to identify secular growth opportunities, particularly those that contribute to a “just transition” through the creation of good green jobs. With that in mind the International Labour Organisation (ILO) forecasts an additional six million jobs globally as a result of a transition to a circular economy. These will be in areas such as “recycling, repair, rent and re-manufacture” which will replace the current model of “extracting, making, using and disposing.”1

Opportunities for investors

Within the global equities team at EdenTree, we have a long history of investing in circular solutions and are excited about the opportunities that a combination of regulation and innovation are producing. DS Smith, mentioned earlier, is one example of where the global equity funds have exposure to this theme. The Fund has also had long-standing exposure to waste and recycling businesses which have been among the early innovators and enablers in this space. The portfolio has benefited from takeover bids for holdings in Bingo Industries (Australia) and Biffa (UK) in the last 18 months. Both companies have set leading examples by embracing the opportunities provided by the circular economy: in Bingo’s case in the area of recycling and reusing construction and demolition waste in Australia, while Biffa’s polymer recycling centre in the UK has enabled plastic bottles to be fully recycled. Given the attractions we have outlined, it should be no surprise that we continue to evaluate new circular economy enablers particularly in landscapes where the national legislation is supportive rather than restrictive.

We take a holistic approach to this theme and are excited about the prospects offered by increased digitisation, including in areas such as food production, the development of more advance recycling systems for plastics and textiles, as well as remanufacturing. Getting this right will require significant investment, hence forecasts of a multi-trillion-dollar opportunity between now and 2030.

Nevertheless, we are also mindful that decoupling the linear relationship between material production and growth remains hugely challenging. Solving this problem isn’t just about technology. It’s also about a shift in mindset and setting a higher threshold in terms of a product’s viability, longevity and ability to be repurposed and recycled. We are encouraged by the shift in thinking we are seeing first hand with our conversations with companies, as well as the broader move to look beyond the “3R” model that is helping to push the global economy in a more circular direction.

First appeared in ESG Clarity 20th March 2023. View here

The views contained herein are not to be taken as advice or recommendation to buy or sell any investment or interest. The value of an investment and the income from it can fall as well as rise, you may not get back the amount originally invested. Past performance should not be seen as a guide to future performance. EdenTree is authorised and regulated by the Financial Conduct Authority and is a member of the Investment Association.