The Need for a Circular Economy

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We live in a linear economy, where all world materials produced are ultimately wasted. Our current linear economy largely operates on a 'take-make-dispose' model, where materials are extracted, used, and then discarded as waste.

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As of today only 7.2% all the world materials are cycled back into the economy to be re-used, as highlighted by the annual Circularity Gap Report. And unfortunately the world is less circular every year, as consumer demand is increasing faster than our capacity to recycle and reuse resources. The fact that the world economy as of today is only 7% circular, means that more than 90% of materials we produce and consume are either wasted, lost or remain unavailable for reuse. Which in other words, it means that the globe almost exclusively rely on new (virgin) materials.

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The reliance on virgin materials puts immense pressure on Earth's finite resources and emphasizes the urgent need to transition to a circular economy. This transition involves rethinking product design, production processes, and consumption patterns to focus on eliminating waste, reusing materials, and regenerating natural systems.

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Circularity is not just essential for environmental sustainability but is also key for achieving net-zero emissions. While improving energy efficiency and adopting renewable energy sources are important, they address only 55% of global emissions. The remaining 45%, related to how we produce and consume products, requires a shift towards circular economic principles. And this is called the Circular Economy, based on the principles of:

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1. Eliminating Waste and Pollution: Reducing greenhouse gas emissions across the value chain.
2. Circulating Products and Materials: Retaining their embodied energy and value.
3. Regenerating Nature: Enhancing carbon sequestration in soil and products.

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The case for Circular investing

The circular economy represents a significant investment opportunity as a new market for resources recycling will be created. By 2040, the market size of the circular economy is expected to reach EUR 820 billion in annual revenues. This growth is driven by increasing demand for sustainable products and services, as well as the economic advantages of improved resource efficiency and waste reduction.

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The shift toward a circular economy involves four main strategies, each representing a substantial investment opportunity:

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1. Circular Business Models: Maximising the value derived from each product produced.
2. Material Efficiency: Reducing the amount of material required for production.
3. Circular Materials: Substituting new primary materials with recycled equivalents.
4. Residual Waste Management: Extracting maximum value from remaining waste.

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Investing in circular economy strategies not only supports environmental sustainability but also offers financial benefits. Companies embracing circularity are better positioned to adapt to changing market conditions, regulatory pressures, and consumer preferences, presenting attractive investment opportunities. Some of the benefits of circular investing include:

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1. ‍Reduced Default Risk: Circular companies typically have lower default risk on debt. Research from Bocconi University shows that for every 0.1 increase in a company’s circularity score, there is an 8.6% decrease in the one-year probability of default. This reduction is due to their enhanced resource efficiency and better preparedness for regulatory changes.‍
2. Higher Risk-Adjusted Returns: Circular companies often achieve higher risk-adjusted returns on their stocks. A 0.2 increase in a company’s circularity score is linked to an improved Sharpe Ratio, which indicates better returns for each unit of risk. This improvement is driven by greater resource efficiency, lower regulatory costs, and new market opportunities.‍
3. Capitalizing on Sustainability Trends: Circular companies are well-positioned to benefit from growing consumer and business demand for sustainable practices. This trend can lead to increased revenue and market share, providing investors with both financial gains and a positive impact on the environment.

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We are at the point of inflection

Several forces are propelling the economy toward a circular tipping point, creating a perfect timing for investors:

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1. ‍Policy and Regulation: Strong regulatory frameworks in the EU are pushing circularity forward. Major regulations include content quotas, product design regulations, disclosure mandates, and waste treatment and handling rules.‍
2. Cost and CO2: Volatility in material prices and rising CO2 costs are incentivizing businesses to focus on recycling and material efficiency to manage costs and reduce their carbon footprint.‍
3. Consumer and Value Chain Pressure: Consumers and large organizations are exerting pressure on suppliers to meet CO2 targets and incorporate recycled content into their products.‍
4. Energy and Supply Security: Recycled materials require less energy and are locally available, mitigating geopolitical risks. Circularity supports reduced reliance on imported resources, builds resilient supply chains, and accesses new resources.‍
5. Technology Advancements: Rapid advancements in recycling technology, such as improved sorting technology, reprocessing methods, and digital tracing, are enhancing the efficiency of circular processes.‍
6. Digital Circular Business Models: The rise of digital platforms for reusing or sharing durable consumer products is facilitating the shift towards circular business models.

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How to Invest in Circularity

Investors interested in the circular economy can adopt the following approaches:

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1. ‍Exclude: Do not invest in companies with a negative circular impact—those that contribute significantly to waste and pollution or are misaligned with circular economy principles. This involves excluding companies, sectors, or practices based on circular economy criteria. Example: "Plastic-packaging startups" that produce single-use plastics which are difficult or impossible to recycle. Investing in these companies contradicts circular economy principles and perpetuates environmental waste.
2. ‍Promote: Invest in companies with a positive circular impact—those that do not directly operate a circular economy business model but implement circular economy principles within their business operations. Example: "Patagonia" is an example of a company that promotes circular economy principles through its Worn Wear program. While Patagonia’s core business model is not entirely circular, the company supports circularity by encouraging customers to repair their clothes and offering a trade-in service for used gear.
3. ‍Invest: Invest in companies based on circular economy business models, where revenue is generated through one or more of the 10R activities: recover, recycle, repurpose, remanufacture, refurbish, repair, reuse, reduce, rethink, and refuse. Example:"Too Good To Go" operates on a circular economy model by generating revenue from reselling surplus food from restaurants and stores at discounted prices. This model prevents food waste and engages in recovery and repurposing, aligning with circular economy principles.

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Conclusion

The transition to a circular economy is both an environmental necessity and a significant economic opportunity. Investors who integrate circular principles into their strategies can mitigate risks, maximize returns, and contribute to a more sustainable and resilient global economy. As Pete Seeger wisely noted, "If it can’t be reduced, reused, repaired, rebuilt, refurbished, resold, recycled, or composted, then it should be restricted, redesigned, or removed from production." Embracing circular investing aligns financial goals with environmental stewardship, paving the way for a sustainable use of resources and the potential of exponential returns.