Future Returns: Investing In The Circular Economy

The shift to a global economy based on reusing, repairing, and recycling—instead of making things, using them, and then throwing them away—is gaining traction as a sustainable investing theme.

Today, only 8.6% of the global economy is circular as the world consumes 100 billion tons of materials a year, according to Circle Economy, an Amsterdam-based global impact group.

Closing the loop on how goods are produced and consumed can address the problems created by depleting the Earth’s resources, in addition to the problems of pollution and climate change. According to the U.K.’s Ellen MacArthur Foundation, 45% of global greenhouse-gas emissions are generated by the creation and use of products and food, while the rest is generated by the use of energy.

Rising environmental challenges such as drought, fires, and flooding, in addition to changing consumer preferences and government regulation, are driving companies big and small to break away from a reliance on finite resources and to seek other solutions, says Jessica Matthews, head of sustainable investing at J.P. Morgan Private Bank.

That means, “by 2030, the circular economy could yield up to US$4.5 trillion in economic benefits globally,” she says. The benefits? “Saving 92 million tons of textiles in landfills, 1.3 billion tons of food waste, and 45 trillion gallons of water wasted through food production every year,” she says.

This multi-trillion dollar opportunity is leading growth-oriented, as well as sustainability-minded, investors to pay attention to this growing theme, as the push to create a circular economy drives innovation and new business models.

“Companies are innovating to tackle the challenge,” Matthews says. “That’s why it’s a growth story.”

The private bank currently has about US$12.5 billion in client assets invested in sustainable strategies across 100 funds on its platform, Matthews says. The assets are in all kinds of vehicles, from exchange-traded funds to private equity—and represent a range of investing approaches.

Matthews recently spoke with Penta about the potential for investing in the circular economy today.

The Business Case

What makes the circular economy an investing opportunity is that companies stand to profit more by reusing, refurbishing, and repairing products rather than sourcing virgin materials to make them, Matthews says.

Circular practices already are being used by clothing companies as well as technology and manufacturing companies, the Ellen MacArthur Foundation said in a September report titled “Financing the Circular Economy.”

In 2019, the resale market for fashion, including companies such as the RealReal, grew 25 times faster than the broader retail sector, while Philips, a Dutch conglomerate, reported 13% of revenues resulting from its circular practices.

In addition to major companies that are reforming how they make things—such as Unilever’s pledge to cut its use of virgin plastics in half by 2025—small companies are sprouting up to facilitate the shift, the report said.

Examples include RePack, based in Helsinki, which makes reusable, returnable packaging for products bought online, and Algramo, a Chilean startup, which allows consumers to refill cleaning products made by companies such as Procter & Gamble and Nestlé.

The move away from plastics for packaging is expected to create a US$700 million demand for corrugated cardboard in Europe and the U.S., the foundation said.

Investing Opportunities

According to the Ellen MacArthur Foundation there are 10 public stock funds globally focused on the circular economy, either in full or in part, including BlackRock’s BGF Circular Economy Fund, the Geneva-based Decalia Asset Management’s Decalia Circular Economy fund, and BNP Paribas’s Easy ECPI Circular Economy Leaders UCITS ETF.

There were also at least 10 corporate bonds issued globally with the assistance of major investment banks such as Goldman Sachs, HSBC, and Morgan Stanley, with proceeds either in full or in part dedicated to circular practices, the foundation said. Issuers include Alphabet’s US$5.75 billion sustainability bond (with a circular economy component), Daiken Corp.’s JPY5 billion (US$46 million) bond, and Owens Corning’s US$450 million bond.

Private market equity, debt, and venture capital funds are also on the rise—there were 30 funds as of the first half of last year, up from three in 2016, the foundation said.

At J.P. Morgan, Matthews is evaluating the available public mutual funds and is looking to bring one on its platform. Since many of the companies involved in the circular economy today are in niche businesses, “you have to be careful about how limiting you are in your universe,” she says.

Public funds focused broadly on companies with the best environmental, social, and governance practices also buy stocks of corporations on the leading edge of the circular economy, even if these companies—such as Unilever, Adidas, and Nike —don’t represent a distinct circular economy story.

J.P. Morgan is also looking at private markets. Similarly, the bank has found more opportunities to invest in the circular economy through funds that look at sustainability broadly, Matthews says. For instance, the bank has invested with a private venture firm focused on sustainability and climate solutions that has invested in a company working to create cold-pack packaging with less Styrofoam.

“Where [the circular economy] becomes more widely adopted and seen is in being favoured in broader sustainability portfolios,” Matthews says, adding that ESG managers doing fundamental research today will find themselves looking at some of the trends around circular, because “they are still underappreciated by the market.”

U.S. investors’ enthusiasm over Japanese stocks at this time last year turned out to be misplaced, but the market is again on the list of potential ways to diversify. Corporate shake-ups, hints of inflation after years of declining prices, and a trade battle could work in its favor.

Japanese stocks started 2024 off strong, but an unexpected interest-rate increase in August by the Bank of Japan triggered a sharp decline that the market has spent the rest of the year clawing back. Weakness in the yen has cut into returns in dollar terms. The iShares MSCI Japan ETF , which isn’t hedged, barely returned 7% last year, compared with 30% for the WisdomTree Japan Hedged Equity Fund .

The market is relatively cheap, trading at 15 times forward earnings, about where it was a decade ago, and events on the horizon could give it a boost. Masakazu Takeda, who runs the Hennessy Japan fund, expects earnings growth of mid-single digits—2% after inflation and an additional 2% to 3% as companies return more to shareholders through dividends and buybacks.

“We can easily get 10% plus returns if there’s no exogenous risks,” Takeda told Barron’s in December.

The first couple months of the year could be volatile as investors assess potential spoilers, such as whether the new Trump administration limits its tariff battle to China or goes wider, which would hurt Japan’s export-dependent market. The size of the wage increases labor unions secure in spring negotiations is another risk.

But beyond the headlines, fund managers and strategists see potential positive factors. First, 2024 will likely turn out to have been a record year for corporate earnings because some companies have benefited from rising prices and increasing demand, as well as better capital allocation.

In a note to clients, BofA strategist Masashi Akutsu said the market may again focus on a shift in corporate behavior that has begun to take place in recent years. For years, corporate culture has been resistant to change but recent developments—a battle over Seven & i Holdings that pits the founding family and investors against a bid from Canada’s Alimentation Couche-Tard , and Honda and Nissan ’s merger are examples—have been a wake-up call for Japanese companies to pursue overhauls. He expects a pickup in share buybacks as companies begin to think about shareholder returns more.

A record number of companies have also delisted, often through management buyouts, in another indication that corporate behavior is changing in favor of shareholders.

“Japan is attracting a lot of activist interest in a lot of different guises, says Donald Farquharson, head of the Japanese equities team for Baillie Gifford. “While shareholder proposals are usually unsuccessful, they do start in motion a process behind the scenes about the capital structure.”

For years, money-losing businesses were left alone in large corporations, but the recent spate of activism and focus on shareholder returns has pushed companies to jettison such divisions or take measures to improve them.

That isn‘t to say it is going to be an easy year. A more protectionist world could be problematic for sentiment.

But Japan’s approach could become a model for others in this new world. “Japan has spent the last 30 to 40 years investing in business overseas, with the automotive industry, for example, manufacturing a lot of the cars in the geographies it sells in,” Farquharson said. “That’s true of a lot of what Japan is selling overseas.”

Trade volatility that hits Japanese stocks broadly could offer opportunities. Concerns about tariffs could drag down companies such as Tokio Marine Holdings, which gets half its earnings by selling insurance in the U.S., but wouldn’t be affected by duties. Similarly, Shin-Etsu Chemicals , a silicon wafer behemoth that sells critical materials, including to the chip industry, is another potential winner, Takeda says.

If other companies follow the lead of Japanese exporters and set up shop in the markets they sell in, Japanese automation makers like Nidec and Keyence might benefit as a way to control costs in countries where wages are higher, Farquharson says.

And as Japanese workers get real wage growth and settle into living in an economy no longer in a deflationary rut, companies focused on domestic consumers such as Rakuten Group should benefit. The internet company offers retail and travel, both of which should benefit, but also is home to an online banking and investment platform.

Rakuten’s enterprise value—its market capitalization plus debt—is still less than its annual sales, in part because the company had been investing heavily in its mobile network. But that division is about to hit break even, Farquharson says.

A stock that stands to benefit from consumer spending and the waves or tourists the weak yen is attracting is Orix , a conglomerate whose businesses include an international airport serving Osaka. The company’s aircraft-leasing business also benefits from the production snags and supply-chain disruptions at Airbus and Boeing , Takeda says.

An added benefit: Its financial businesses stand to get a boost as the Bank of Japan slowly normalizes interest rates. The stock trades at about nine times earnings and about par for book value, while paying a 4% dividend yield.

Corrections & Amplifications: The past year is expected to turn out to have been a record one for corporate earnings in Japan. An earlier version of this article incorrectly gave the time frame as the 12 months through March. Separately, Masashi Akutsu is a strategist at BofA. An earlier version incorrectly identified his employer as UBS.