Luc Simoncini, Senior Investment Specialist, Kames Equity Investment assesses the impact to investors of the recent turmoil at Volkswagen.
“Last week, the Environmental Protection Agency (EPA) announced that Volkswagen had violated the Clean Air Act by installing ‘defeat devices’ to meet pollution tests in various VW diesel models. These included Turbocharged Direct Injection (TDI) versions of the Golf, Jetta, Beetle, Passat and A3 from 2009 to 2015 – affecting several million vehicles.
“Vokswagen’s CEO later admitted that some 11 million “clean” diesel cars sold worldwide contain the software – the vast majority of these cars likely to be in Europe – and the company announced it was putting aside €6.5 billion (Q3 15) for remedial costs of the vehicles involved (not accounting for fines or legal actions at this stage).
“A raft of regulator statements ensued from The European Commission, the German, French, Korean governments and more, all announcing an in-depth investigation into the industry practice and validity of current emission tests. The US Department of Justice also opened a criminal investigation and various class action law suits are currently mounted in the US.”
What does this mean for investors?
“The full magnitude of the emission scandal at Volkswagen is likely to remain uncertain for a long time. The dramatic events do however raise questions about how widespread this kind of practice has been across the industry and which manufacturers and which sectors might be involved or impacted in the medium to long term.
“As with any bout of volatility, the developments at VW (and the prospect that this may be the start of a bigger industry issue) presents both investment opportunities and risks.
“A number of sectors have already reacted to developments at VW, with the European car manufacturers sector falling by 16% and the European auto parts sector down by over 11% since last week. Investment decisions from here depend to some extent on the initial investment universe. For instance our global equity team has reduced our exposure to auto original equipment manufacturers (OEM) as a cautious stance since there are still too many uncertainties for the sector while there are still plenty of investment opportunities elsewhere.
“Car manufacturers could be tarnished for some time, irrespective of the individual merit of each company. The scandal currently hurting VW echoes eerily of the scandals which tarnished big banks at the peak of the financial boom. Years of strong growth led to poor corporate governance practices and excesses. Not all banks engaged in unhealthy practices but equally all companies got tarred with the same brush until more clarity emerged, especially around regulators response.
“For the auto industry, it is still unclear what the response of regulators across the world will be, especially around the implementation of new tests. In addition, the long term case for diesel engines for compact cars could be in jeopardy and could impact the fundamental valuation of most players in the sector. From a global investing perspective, there are simply too many other investment opportunities to remain exposed to the auto sector at this point in time (which is also a relatively small component of the global equity universe).
“We will continue however to review auto-related sectors (from chemicals to auto equipment manufacturers and to car retailing) to gauge whether individual investment cases have been impaired and if in balance the risk adjusted return expectations become attractive again over time.
“This episode could see a transition of part of the diesel market to greener, cheaper, more fuel efficient cars.”