We live in a world that needs to transition. We need new energy systems, new mobility solutions and new consumption habits, amongst others. The history of the tech company Aptiv is a testimony of the fast changing world we live in.
Aptiv: A new frontier for mobility
In 2009, the iconic American automotive giant General Motors went bankrupt. Bondholders proposed a reorganisation of the business through a legal process in the US known as Chapter 11. This was in order to keep the business alive and pay creditors over time.
During that process General Motors was forced to sell its powertrain unit. In 2011, this then listed on the stock market under the name of Delphi. Delphi subsequently became one of the leading manufacturers for the automotive industry.
Then in 2017, Aptiv was created. The spin-off of the powertrain unit kept the Delphi name, and Aptiv retained two divisions. These captured megatrends such as electric vehicles, hybrids and most excitingly, autonomous vehicles. Aptiv sends a powerful message to its customers and investors. It aims to be at the forefront of the “convergence of safe, green, connected solutions in new mobility and autonomous driving”. Let’s take a deeper look.
As cars electrify, so is the electric content in the car. Especially on the high voltage side. Aptiv estimate that the HV equipment for an electric car is 1.5-2.0x higher relative to a traditional ICE car. (Internal Combustion Engine, your typical car running on petrol/gasoline or diesel). Between 2019 and 2023, car makers are intensifying their electrification efforts. According to carmakers announcements, there could be up to 40 new platforms for EV and/or hybrid cars. This is expected to result in a significant increase of this market segment. High Voltage is a small market today roughly $1bn  but can grow at a staggering pace of 40% p.a. to 2022 . Aptiv has a dominant market share in this niche segment, but fast-growing segment, of around 30-35%. 
Autonomous vehicles: the new normal?
Let’s dig into an acronym – ADAS (Advanced Driver Assistance System). A few years ago, cool stuff such as rear cameras, parking assistance, or trajectory sensors were only found on high-end cars (mostly German). It has become mainstream and for the greater good (who has not thanked this system when trying a desperate and bold attempt to park your car when there is barely enough space?). It is still a fast-growing market (today in excess of $5bn) and Aptiv’s market share is above 20% . These systems are absolutely necessary to one of the most promising evolution of mobility: autonomous vehicles.
Aptiv has formed with Hyundai Motor a joint venture (or JV – they have both dedicated $2bn this JV) whose objective is to develop a robot taxi platform. The first model should be ready before the end of the year, and a new version for 2022. Hailing a ride from your smartphone is no longer new (Uber anyone?). However, riding in an electric/hybrid vehicle driven by a computer system is being tested commercially in Las Vegas. For once, what happens in Vegas doesn’t need to stay in Vegas.
These examples of leadership positions can translate into above average operating margins, a solid balance sheet, and a positive generation of cash through the cycle – enabling the company to be at the forefront of innovation. Yes, COVID-19 will likely have adverse effects on financial metrics in 2020, but barring a prolonged economic depression, the profound transformation of the car industry (potentially to “mobility as a service”) should provide secular tailwinds for the years to come.
In a nutshell, Aptiv’s strategic positioning fully aligns with future mobility trends and plays a critical role in offering solutions to tackle climate change. In addition, agencies (CDP, Dow Jones Sustainability Index) widely recognise its corporate governance practices (ESG) as being well above average. Aptiv was notably named for the 8th year in a row as one of the most ethical companies by Etisphere . Lastly, its ability to operationally and financially execute, and its leadership status, make Aptiv a supplier of choice for car makers that are embarked on this fascinating journey. It comes with a dual objective: make the roads cleaner and safer.
With investing your capital is at risk. This information is for illustrative purposes only and is not investment advice. Past performance is not a reliable indicator of future results. Clim8 Invest portfolios hold positions in Aptiv and therefore Clim8 Invest has an interest in providing a favourable analysis of this investment.
At Clim8 Invest, our goal is to offer our clients portfolios that make a positive impact on the environment. Our selection of actively managed funds and ETFs that have been designed with an investment philosophy we share and an above-average thematic exposure to our six core investment themes: Clean Energy, Clean Tech, Clean Water, Circular Economy, Sustainable Food and Clean Mobility.
These financial products are not invested in big techs (as of end-of September 2020). We select our investments with extreme care and a shared ethos on crucial points, such as avoiding Big Tech.
Solutions to climate change vs. Do less harm?
We struggle to see how Big Tech companies offer solutions to the demands of the circular economy; or how they participate in the development of clean energy. Their absence across our portfolio is, in our view, testimony to our high standards of due diligence and fund selection process.
Clim8 Invest’s mission as a sustainable investor is striking the right balance between:
– The ‘What’ (what are the products and services and how can they be solutions to address our six investment themes);
– The ‘How’ (how companies are behaving as corporate citizens, and notably take good care of the environment).
Climate commitments: a starting point
Does it mean Big Tech cannot become environmental stewards over time? Of course not. By decarbonising through specific pathways, and leveraging their extensive financial resources to implement bold measures we believe Big Tech can become leaders of the transition economy (the substance of this article).
At least when it comes to tackling the ‘How’, they have the power to perform extremely well. The ‘What’ however, remains the missing piece. For now.
The Clim8 Investment Team
Investments of this nature carry risks to your capital. Investing in equities involves a high degree of risk. This information is for illustrative purposes only and it must not be construed as investment advice.
The Clim8 Investment team doesn’t believe Big Tech (Google, Apple, Facebook and Microsoft) provides solutions to the climate crisis. Hence why we do not hold them in our Clim8 portfolios. More our team’s view on Big Tech here.
Still, we paid close attention to their recent climate commitments, taking the measure of Big Tech’s leadership to a net zero transition economy. And have ranked all four companies accordingly to provide clarity on the actual impact of such measures.
Net Zero by 2030
Announcement: September 2020
Science Based Target Initiative: Committed
Climate Investment Pledge: n/a
Facebook comes in 4th place as although their pledge is ambitious it falls short in a number of areas.
Facebook is unique as its social networking sites have immense influence on people’s thoughts and behaviours. Its largest footprint is arguably on how it impacts climate change education and the release of their Climate Science Information Centre was very exciting.
It was also however plagued by the sheer amount of climate misinformation spread via its algorithms and paid adverts. Unfortunately, no acknowledgement or strategy is outlined in tackling this as part of this announcement.
Facebook’s Net Zero commitment is holistic. It includes a commitment to set a Science Based Target (yet to be approved) and to invest in carbon removals as part of its offsetting strategy.
“Our approach to carbon removal builds on carbon credit purchases of more than 100,000 metric tons in 2019 from projects such as forest conservation.”
This impressive offset number however amounts to less than half of their 2019 emissions — meaning they fall shy of achieving Carbon Neutral status. Unsurprisingly, they also failed to provide any transparency on the offset projects they support.
The criteria for their intended carbon removal strategy is welcomed, even if it lacks in detail: “When selecting carbon removal projects, we will prioritize those that demonstrate additionality, are designed for permanent impact, align with social and environmental co-benefits, and enable climate justice and equity. In addition, project benefits need to be quantified using recognized standards and assured by an accredited third-party verifier.” – Facebook Sustainability
Their climate action strategy is focused on energy efficiency and they have achieved 3rd party certification (LEED platinum). They unfortunately fail to break down what they mean by 100% renewable energy. Are they planning on developing their own projects, purchasing of Renewable Energy Credits (RECs) or simply source from a renewable energy provider? These details matter.
They are the only ones to talk about material sourcing for their data centres — also explained by the fact they procure very few other raw materials. Their purchasing of a natural fiber-filled polypropylene (NFFPP) — derived from renewable jute fibers — has apparently reduced their footprint substantially but it’s not disclosed by how much.
Carbon-free by 2030
Announcement: September 2020
Science Based Target Initiative: n/a
Climate Investment Pledge:£10 million
Despite the somewhat comical wording, the Carbon-free commitment is ambitious: Google wants to bring their direct (Scope 1) and indirect (Scope 2) emissions to zero, 24/7.
Much like all of the large tech players, the big challenge here is the usage of fossil fuels to power data centres during those hours where the sun or wind don’t generate enough energy or as emergency backup.
Google is using its expertise to improve predictability of renewable energy. For example, through a collaboration with DeepMind they have developed a machine learning system that predicts power output from wind farms 36 hours in advance, which in turn makes it more valuable to the electricity grid.
In land-constrained countries Google is also showing creative ingenuity. For instance, by collaborating with local authorities for the placement of solar panels.
Unfortunately they only name one of the projects they have supported (a landfill gas project in upstate New York) and provide very little transparency on what they mean by ‘high quality’ offsets — a failed opportunity for shared learning. The only detail provided is a document from 2011 that describes in generic terms what offset projects are and what their due-diligence looks like.
To achieve their 2030 ambitions they will be exploring new tools “such as advanced nuclear, enhanced geothermal, green hydrogen, long-duration storage, or carbon capture.” – Google 24/7 by 2030
Where Google’s commitment lacks in ambition slightly is with regards to Scope 3, i.e. all other indirect emissions arising in the value chain. They manufacture far less physical products (e.g. Pixel Phones) than Microsoft or Apple, however, the lack of clear commitment on their Scope 3 (especially supply chain) emissions is a little disappointing. No mention of Science Based Targets either.
Carbon Neutral for its supply chain and products by 2030
Announcement: July 2020
Science Based Target Initiative: n/a
Climate Investment Pledge: undefined part of a $100 million Racial Equity and Justice Initiative Fund
This announcement is all about its products which is very exciting as this is by far their most material impact category (76% of emissions are in product manufacturing and a further 19% are the result of transport and use related to products).
They have already been Carbon Neutral for their Scope 1 (direct greenhouse gas emissions) and Scope 2 emissions (indirect emissions resulting from the use of electricity), and have recently extended this to parts of Scope 3 including business travel and employee commuting.
They provide lots of transparency on their renewable energy strategy for electricity (Scope 2) outlying the breakdown of the energy generation they own (12%), where they have an equity stake (4%) and where they have long-term contracts (86%). Unlike Google, they have not made a specific commitment to running on clean energy 24/7.
To make their products more sustainable they plan on:
Using 100% recycled materials: Which substantially reduces the footprint. For example, usage of 100% recycled aluminium in the enclosure of the 2019 MacBook Air helped cut the product’s carbon footprint by nearly half
Driving energy efficiency: Both in the manufacturing of their products, their offices and for their data centres. They also make a fantastic statement: “Simply put, the cleanest energy is the energy we don’t use.” This also extends to developing more efficient and durable products, and ensuring all of their suppliers use green energy
Enabling greener transport: Perhaps the vaguer of their pledges, they plan “to partner with our shipping suppliers to leverage fleet improvements, sustainable fuels, and supply chain efficiencies”
What is also particularly exciting is their communications around their products’ environmental impact through their environmental report cards — see an example for iPhone 12 here.
Their Carbon Neutral commitment is in fact aligned with a science-based Net Zero pledge, which involves an ambitious 75% reduction in emissions with a 2015 baseline. They plan to offset the remaining and unavoidable 25% through carbon removals. Carbon removal projects take carbon out of the atmosphere as opposed to avoiding them. Apple has decided here to focus on nature-based solutions that protect and restore forests, wetlands, and grasslands. Excitingly, they also disclose that they are supporting a mangrove restoration project in Colombia and a savannah conservation project in Kenya. Another win for transparency.
Carbon Negative by 2030
Announcement: January 2020
Science Based Targets Initiative: Targets Set
Climate Investment Pledge: $1 billion
Microsoft was the first to announce an ambitious climate commitment this year and what an announcement it was. Carbon Negative means they want to remove more carbon from the atmosphere than they emit, thus going beyond Net Zero. They are also the only tech giant to have an approved target from the Science Based Target Initiative.
Microsoft has been Carbon Neutral since 2012 (Scopes 1 & 2) and has pledged to remove all of its historical emissions since they were founded in 1975 by 2050— a display of true responsibility. Some of the carbon offset projects selected for this will hopefully be announced before the end of the year.
They are currently pursuing LEED Platinum certification for their campuses (no mention of data centres like Facebook) and on the renewable energy front, although they don’t disclose the exact breakdown of their own projects they have developed and invested in a number of projects. They also aim to further “green the grids around the world.” For example, they offer backup generation to the grid in Wyoming and are piloting integrated energy storage batteries with GE in Ireland.
Their $1 billion Climate Innovation Fund is particularly noteworthy. It’s a meaningful amount of money and the fund has clear application criteria. They have already started deploying the money with their first investment ($50 million) in Energy Impact Partners in July 2020.
Microsoft is truly putting a price on carbon across the organisation and their supply chain. They are the only ones to have mandated that their suppliers report on their own Scope 1, 2 and 3 greenhouse gas emissions data by beginning of 2021. They have also set an internal carbon tax that is (actually!) being implemented.
‘Unlike some other companies, our internal carbon tax isn’t a “shadow fee” that is calculated but not charged. Our fee is paid by each division in our business based on its carbon emissions, and the funds are used to pay for sustainability improvements.’
The Microsoft Sustainability Calculator provides cloud customers with transparency into their total carbon emissions — Scopes 1, 2 and 3 — resulting from their cloud usage. Microsoft is the only cloud provider to to provide this level of transparency.
Finally, they are also piloting Carbon Neutral Xboxes, meaning they have specifically calculated the lifecycle carbon emissions associated with an Xbox, actively reduced its impact where possible and offset the unavoidable emissions, e.g. relating to the product’s raw materials, logistics and/or transport. This is exciting as it’s bringing the conversation about climate change in consumers’ hands. After all, people care most about products, not companies.
Today, Microsoft’s level of ambition and progress puts them comfortably in first place when it comes to climate action. Close monitoring of announcements relating to Apple’s supplier engagement initiatives, Google’s updates to their Scope 3 strategy and the specifics behind Facebook’s Science Based Target will be key to see if they can retain it.
As the climate crisis becomes more pronounced, we can and should expect bolder climate action from all companies. The ‘tech giants’ have an even greater responsibility as they have the knowledge, means and resources to lead the way. Let’s hope they live up to their commitments and inspire others to follow suit. Humanity desperately needs the good news.
Clim8’s CIO Vincent Gilles shares another example of a company included in the portfolio that we have curated at Clim8 Invest.
Orsted is one of the few names in the clean energy space which is generally well known.
There is a good reason for this: this Danish company has turned itself from a traditional Government-owned and run Oil & Gas company into a recognised world leader in wind energy  changing its name on the way from DONG to Orsted.
By virtue of doing so, the company has not only become more profitable , which was not obvious at the start of their process, but also more valuable for its shareholders. The share price has nearly quadrupled in less than 4 years . And it has also won awards, for example the prize of the world’s most sustainable company.
Orsted is one of the top positions in our portfolios, held through several of the leading sustainability funds that we have curated through our in depth “due diligence” process.
As a reminder, we invest into a wide range of carefully selected shares and funds, all focused on sustainability. Orsted is regularly one of the top 20 positions in such funds.
A couple of figures to start with:
Orsted currently owns and runs about 7GW of off-shore wind assets with 3 GW in construction to be online by 2023 .
The company’s goal is to reach 15 GW by 2025, which should produce enough power to supply up to 30 million people (or equivalent to 45% of the UK population, an amazing figure) and finally 30GW by 2030.
Like the UK, Denmark is well supplied in natural wind resources  and, on average, Orsted’s assets produce more per MW of capacity than most other offshore assets .
We touched upon offshore in our article on Greencoat UK Wind plc, another one of our top holdings, but it is worth having a couple of figures in mind about the rise of offshore wind:
The UK has ambitions to go from 10GW in 2019 to 40GW in 2040
Germany from 8 to 20GW
Japan from 0 to 5GW
The US from 0 to 20GW
That tells you how ambitious Orsted’s targets are (or how slow the rest of the world is reacting).
The big kick behind this drive is politics and the ambition of so many countries to be as close to carbon neutral as possible by 2040 or 2050. But technological progress can also help enormously. The cost of manufacturing a MW of off-shore wind capacity collapsed in the last few years as wind turbines became bigger (sorry not bigger, gigantic!). Today, the cost of producing power with off-shore wind compares with that of generating with coal and gas .
In other words: we can produce both cheap and zero carbon already now.
Through the transition from an Oil & Gas national champion to its current state, c90% of power generated is zero carbon , Orsted has reduced its emissions by 86% since 2010, avoiding 11 million tonnes of carbon .
That’s about the same as telling 6 million people to stop using their car for a year.
The company‘s ambition is to remove the last piece of coal-based generation by the end of 2023 . It even has the ambition to have its scope 2 and 3 emissions (i.e. the indirect emissions resulting from their clients using Orsted’s energy) down by 50% by 2032 vs. 2018 .
Of course, these are very aggressive and lofty goals but. so far, Orsted has achieved its targets. And there is no better way to keep a company on its toes than by having very aggressive targets!
So is everything perfect in the Kingdom of Denmark? (sorry, could not help!) Yes, in principle, but there are some issues investors should keep in mind:
First. The stock has been a tremendous success. As said, the stock price has nearly quadrupled in less than 4 years and it is up nearly a third in 2020 . So, we cannot argue that no one has heard about Orste. But it is one of the very few ‘pure plays’ investors can turn to when trying to invest low / zero carbon.
Second. As a result, in our opinion, the stock could be described as well priced with a ratio of stock price on future earnings above 48x, as we write, which is significantly higher than many of its competitors (admittedly there are few of them) and peers (a slightly bigger group) . Typically, companies involved in clean power generation would trade close to 30x (for example, NextEra in the USA, also one of the companies that is likely to be in our top 20 holdings at any given time) 
So, using a slightly technical term, Orsted is currently trading at a premium to its peers which we believe is explained by the market perceiving it has better prospects to grow faster and more profitably than the rest of the crowd.
A last word on Corporate Governance: the current CEO, Henrik Poulsen announced earlier this year in June 2020 that he was stepping down . When the company announced the appointment of Mads Niper (the current CEO of Grundfos), we found remarkable the fantastic transparency of the company regarding the remuneration of the incoming CEO, a real example of great governance put into practice to the benefit of investors.
Investments of this nature carry risks to your capital. Investing in private equity involves a high degree of risk. Please invest aware. Please note this information is for illustrative purposes only and it must not be construed as investment advice. Past performance is not a reliable indicator of future results.
 Credit Suisse Utility Workbook 2019  Orsted Annual Report 2019, FactSet [3; 14; 15] FactSet  Orsted H1 Financial Report 2020  Global Wind Energy Council [6; 12; 13] Orsted  UK Government, German Government, EU Commission DG Energy, Global Wind Energy Council  BNEF, Credit Suisse  EU Commission, Danish Government, Orsted  Analyst Presentation, Orsted, 2019  EPA for the calculation of how much a car emits  FE Analytics, FactSet, Clim8 Invest  Orsted, Company Announcement, July 2020
In the course of the next few weeks, we will share more details about the components of the portfolios that we have curated at Clim8 Invest.
We will try to minimise technical investment jargon and make clear what our users are investing in. We are starting with 3 portfolios, investing in our 6 key sustainable themes. These include clean energy, clean technology, smart mobility, sustainable food, clean water and recycling. Our aim is to create value for our investors and make sure we are investing in “impact” stocks.
Greencoat UK Wind
I will start with one of our main investments in the fascinating space of wind power: Greencoat UK Wind Plc is a share listed on the London Stock Exchange that holds investments in wind energy assets in the UK. Greencoat is one of our top holdings at close to 2% in our balanced portfolio. We run a well diversified portfolio and such a 2% position is actually very significant.
Given the complexity of their business, Greencoat typically targets fund managers and other professional investors, rather than retail investors. Part of Clim8’s job is to give our retail investors access to such quality assets thanks to our selection and due diligence process.
Greencoat UK Wind is one of the largest listed wind energy asset holders with a total value (or “market capitalisation”) in excess of £2bn.
It owns more than 1 GW of onshore and offshore wind farms (split: 83% onshore and 17% off-shore). A total capacity of 1 GW can provide, in typical weather conditions, the power for around 800,000 homes. Their assets are very new (more than 80% are less than 10 years old) and they are all operating.
Translation: investors do not get directly exposed to the risk of development and construction…anybody who has built a house will get this point straight away!
Their goal is to deliver between 8 and 9% return , each year, to investors through a combination of a generous dividend committed to rise with RPI (inflation) every year. And Greencoat has delivered this return since day 1 in 2013 , along with a rise in value of the share. The trust that investors have for the team at Greencoat is reflected through the stock trading at a premium to NAV.
*NAV = “net asset value”, a bunch of words to say the underlying value of the assets, that valuation specialists have calculated.
Currently, Greencoat Wind UK is trading at close to 10% premium to NAV i.e. it is currently well regarded .
This share (legally classed as an “Investment Trust”) is focused on an area of high growth in the renewable energy space: wind energy. Anyone who lives in or visits the UK will realise that the island is blessed with abundant natural wind resources. This is “free fuel” and doesn’t emit greenhouse gases like coal and oil. The trick is how best to harness those resources, to turn them into power and therefore into money.
The UK is currently one of the leaders in terms of ambitions in the world to decarbonise the economy, along with the likes of Denmark and Germany. It has a goal to stop emitting carbon by 2050.
True, the goal is a ‘net zero carbon’ which means that residual emissions will have to be offset. My cynical self will probably say that 30 years is a long time away. And that no politician making the decision today will be around to face the consequences of their decisions. Yet it would probably be a bit unfair. It’s not possible to turn the economy on a dime with regards to how it creates power. But we have made tremendous progress already – a third of the power produced in the UK is based on renewables and this places the country very high in the world hierarchy.
Currently, nearly 24 GW of wind is installed in the UK, 10GW offshore (i.e. on the sea) and 14 GW on the land.
The role of subsidies
In order to kick-start the development of clean power, the UK created a number of complex incentive schemes that aimed to financially support the achievement of returns for the operators and, therefore, to the investors into those operators .
Gradually though, over the last few years, the cost of producing power with wind (and solar) has plummeted. As a result, Governments across the world -including the UK- have been moving towards removing expensive subsidies (better for you as a tax-payer) and encouraging companies to share a growing exposure to market-based power prices. This means that the operators have to find a balance between the remaining Government subsidies and long-term contracts (“power purchase agreements”, or PPAs) that give full visibility to their investors.
At the end of June 2020, more than 50% of Greencoat’s revenues were Government-backed (i.e. sovereign backed, so low risk). While the rest was largely free of market risk. True, the higher the power price, the better off Greencoat will be but they can achieve the needed profitability with the prices that are currently envisaged in the UK.
Anyway, in my view, the risk is limited because the cost of producing wind energy with a wind turbine has plummetedin the last 20 years to a level where it is now nearly as cheap to produce with zero carbon emission as to generate with a modern gas burning plant.
When we interviewed the team at Greencoat as part of our selection process, we came to the view that they have a very good grip on the risks and know how to mitigate them, plus they have a good vision of the future of wind energy in the UK. Note that as I am writing these lines, Greencoat UK Wind Plc has announced a £400m capital increase that will help the company finance one very large asset acquisition and also reduce its current debt level (they can carry debt like any other company).
And if you are a big kid like me, here is a fantastic image: the diameter of modern wind turbines are so gigantic that you could fly an Airbus 380 between the tips of the blades! These are awesome machines. And they have become incredibly reliable over the years, as well as more energy efficient, as engineers and operators have learnt how to “tune” them. A great combination in my view.
Investments of this nature carry risks to your capital. Investing in private equity involves a high degree of risk. Please invest aware. Please note this information is for illustrative purposes only and it must not be construed as investment advice. Past performance is not a reliable indicator of future results and the value of investments may rise as well as fall.
You would have needed to be on another planet not to have heard that sustainable investments have outperformed markets since the Covid-19 crisis.
Over Q1 2020, out of 206 sustainable equity funds and ETF in the US tracked by Morningstar, 44% were in the top quartile in terms of performance, 70% in the top two and only 11% in the bottom quartile. The performance was good with assets in European sustainable funds down 10.6% in Q1 20 vs. a 16.2% decline in the overall European fund universe. Evidently, ESG and sustainable fund providers (yes even those who ask to be forgiven for investing in fossil fuels until very recently) have aggressively promoted this success. As for stocks, the S&P Sustainable index outperformed overall S&P by 0.9% over the last 3 months in $ terms, clearly benefiting the defensive qualities of such assets in a period of market turmoil.
Yet, the really striking data is to be found elsewhere.
Since inception in September 2007 until end of February 2020, the MSCI ACWI ESG leaders index (largely used in the market as a benchmark) returned 5.24% vs. 4.48% in the broad market. The interesting point here is that this data does not encapsulate March 2020 when sustainable and ESG funds did even better.
We have seen the interest in sustainable investment clearly within our own activity too, during our recent crowdfunding campaign, we secured 300% beyond our target – that being pre-launch and during a global pandemic.
Let’s take a deep dive and see whether outperformance is a happy coincidence or evidence of a long-term trend, to try to anticipate what the future may hold. Our conclusion is not only that sustainable investment is turning mainstream but that it has the basis for a sustained out-performance in the medium-term, irrespective of views on the environmental crisis.
Why the strength of sustainable investment in the recent storm was rationale, not emotional
There are 5 objective reasons why sustainable investment was a recent winner:
Sustainable and ESG investment funds nearly always have low exposure to commodities, in particular, Oil & Gas stocks, which were the worst hit during the market crash. So, as a result, sustainable investments were likely to outperform only by virtue of not being commodity-exposed.
Most sustainable and ESG funds entered the crisis with long healthcare and tech positions. Those were the two sectors that out-performed, which in turn compounded in performance terms the benefit of low exposure to commodities. I would argue that these two points are pretty uncontroversial.
There is a correlation between the quality of management and the sustainability of the business model of companies. Typically, we see that companies whose management has for a long time prepared to pivot towards a more sustainable model ended up with a more resilient business model. This, in turn, protected them to an extent against a collapse of their markets. There is a growing body of academic studies showing a positive correlation between ESG factors and a Company’s Financial Performance (CFP). More than 9 out of 10 companies show this positive correlation according to a recent Harvard research piece. By virtue of linking ESG and CFP, it is possible to establish materiality which is a key factor in our view.
It could also be argued that investors anticipated future political developments, with many countries putting the environment at the centre of their recovery programmes. Investors take a risk there but a limited one: calls to base future economic growth on cheap oil and gas have been muted. Investors were very rational in particular in light of the evidence provided by the CBI that clean investment accounted for 1/3 of the economic recovery in the UK post the 2008-10 financial crash. In the next few years, investment opportunities in electric mobility and energy efficiency, to take two examples, could provide a drive towards economic recovery in two key sectors.
The collapse of commodity prices, in particular oil, could have been a very negative development making pollution cheaper than in the recent past. Yet again, investors took a very rational view: with oil demand likely never to fully recover from the current crisis (“peak oil”), returns in the Oil and Gas industry are likely to collapse. A few years ago, E&P would yield 25%+ returns, with Brent price below $30/bbl, returns of renewables will at least match those of fossil fuel. Investors have anticipated the move.
What about the medium to long term?
The future is very positive sustainable investment. Let’s take our five point format and see the rational arguments for sustainable vs. “traditional” investment in the next decade:
Those long term reasons driving investors mentioned above, in particular, the link between ESG targets and financial performance will not disappear.
It is anticipated that billions if not trillions of investment money will leave fossil fuel/ polluting industries and be redeployed towards sustainable investment. This will simply happen because investors want it. It is worth having in mind that, if $2.6trn of investment were moved towards clean energy by 2035 to meet the COP 21 climate change targets, this would imply that c10% of the money invested in pension funds in the western world would leave polluting investments and be redeployed towards cleaner options. A simple demand and supply equation that can only help the relative valuations of sustainable assets. Already $30bn of investment moved towards sustainable investment in 2018, a 30% rise vs. 2016. In the first four months of 2020, in the thick of the C-19 crisis, according to Morningstar $35bn found their way into the European sustainable fund universe, a 50% rise vs. the same period last year. At the same time, the outflow for the overall European fund universe was $170bn.
Economics. We argue above that more money will be thrown in by Governments, but to an extent, this money is not necessary: wind and solar + storage are now competitive with coal and gas. After years of investments, hydrogen and storage are becoming competitive too. These technologies will amplify the trend towards clean/sustainable solutions not being a moral choice any longer but being the obvious choice based on an objective risk/reward analysis. Which fund manager would want to be invested in a heavily polluting asset when a clean asset delivering the same level of returns is accessible? The risk analysis frameworks are changing quickly for fund managers: clean energy is a way to reduce risks now, not just to diversify.
As more and more evidence of the growing environmental crisis emerges, regulations will continue to get tougher with polluters and encouraging sustainable solutions. I see the current US administration as an aberration, not a show-stopper. Those who look at the US in detail know that clean energy is progressing quickly.
We are making progress so that the definitions around sustainable investment and ESG are becoming clear and investors have frameworks. The EU taxonomy together with the UN SDGs is a solid base fund that fund managers can refer to. In turn, investors can more easily compare fund structures and performance. The situation is far from ideal but it is so much better than a couple of years ago. Thanks to this growing culture amongst investors, to dig deeper, the most egregious greenwashing will gradually disappear.
Where we could turn to be too optimistic
However rosy this scenario may appear, I can identify three risks that may at least partly derail it. Firstly, traditional polluting industries have benefited over the years from heavy levels of subsidies from Governments because they are large job providers. Oil gets $380bn of subsidies a year worldwide, nearly 3 times as much as clean energy (yes, shocking). It will be politically difficult for Governments to cut those industries adrift too quickly.
Additionally, while the number of funds claiming to be sustainable is growing exponentially, the number of assets to invest in remains limited. Anyone wishing to invest in zero-carbon power generation in Europe will likely end up investing in Orsted. It is a fantastic company but it trades on very high multiples.
To diversify their portfolio, investors have to consider investing in companies like Enel or Iberdrola who have reduced their emissions drastically but are not zero emitters. This simple example shows the type of dilemma investors will face until they have more assets to invest in that fit tight criteria.
Finally, if big Oil decides to re-direct their investment towards clean energy, they risk overpaying for assets and in turn affecting the value of such assets.
Overall, it’s clear that the positive arguments towards sustainable investment are much more powerful and, having turned mainstream, will be a strong source of performance for investors in the future for decades to come.
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