Please see the below article from Invesco received over the weekend:
Innovation is not just about technology
Not a one size fits all approach to finding opportunities
ESG and innovation are both driving change
Innovation in emerging markets is no longer about applying technologies and techniques from developed economies to play catch to the levels of productivity, income and wealth that took centuries to achieve in the United States or Europe.
Instead accelerating innovating is becoming a driver of growth. Our panellists in the ‘Emerging Markets: Innovation Unleashed’ webinar discuss what is underpinning the fast pace of innovation and how it is evolving.
Many emerging markets countries have a strong track record when it comes to innovation. China has overtaken both the United States and Japan in the number of patents being awarded and for many years, Russia has exceeded the number of patents won by Germany and the UK, while India has recently surpassed them as well.
“Innovation has also shaped consumption patterns in Asia and China,” said William Yuen, associate director of investment at Invesco in the Asia Pacific region.
Yuen has put this down to the rapid adoption of the Internet across Asia. Enormous opportunities have opened up for companies wanting to create innovative products for a digital consumer audience.
On the back of this wave small social media platforms, digital payment platforms and entertainment companies have been turned into mega companies.
But the concept of innovation expands much wider than technology and the Internet. Yuen explained companies are not just innovating for digitalisation, rather research and development has evolved and other consumer broad themes have emerged that are driving change and creating investment opportunities. These include premiumisation, experience, urbanisation and wellness.
“A lot of the spending nowadays is no longer just about getting things done or day-to-day survival,” said Yuen. “It is a lot about experiences.”
As consumers demand more, companies are converting existing products into more sophisticated ones to get a higher margin for the return on their businesses.
To find the companies disrupting the market, Bhvatosh Vajpayee, director of equity research at Invesco specialising in emerging market equities, pointed out there are four major ways investors could do this.
First is to look at the scale of the market. For example, India, South East Asia and Latin America have large pools of consumers. Second is to understand how user adoption and developmental gaps can create leapfrog opportunities.
Third is to find localised solutions as countries differ widely on adoption curves and regulations. Lastly is examining local talent and ecosystems. In China, India and Russia local talent pools in science and engineering are particularly strong.
“Every country, every region is very idiosyncratic,” said Vajpayee. “The one lesson that we have learned over the last few years is do not take the template from one country and try to fit it in some other country.”
Innovations were also driving the adoption of ESG principles at the country level and at a sector level.
“These address decarbonisation, clean water and sanitation, climate change mitigation and digitalisation of course,” said Claudia Castro, director of fixed income research in the Invesco global debt team.
For example, as gas demand fades over the next decade, Russia will potentially have a problem as its pipeline capacity becomes redundant, pointed out Castro. Carbon capture and storage facilities have been looked into as a solution to this.
Speaking about the trend of ESG related innovation, Castro said: “We will not see it reversing, but accelerating.” Climate change is a global issue and countries need to recognise it at a local level.
“You have issues of infrastructure damage, displacement of people, food insecurity from disruptions from climate,” said Castro. “It is really important you have local solutions as well.”
This article again highlights what we have been talking about for the past year, ESG innovation is accelerating.
Emerging Markets is a section of the global markets that can offer the potential for real growth. These markets and the developing countries also have an opportunity to be ahead of the curve when it comes to ESG too by each playing to their own strengths, whether this be market size or technology advances.
Emerging Markets is definitely a sector to watch and include in your portfolio for the potential for some good long term returns.
Keep checking back for our usual market updates, insights and ESG related content.
Investors are focusing too much on certain sustainability areas, without paying attention to the broader – or even counterproductive – effects. Invesco partnered with The Economist to explore the topic in more depth in their ‘The art of the possible’ series.
Sustainability is the new investment ‘must-have’. It’s estimated that about 20% of investments are badged environmental, social and governance (ESG) of one form or another, and that proportion grows continually. That’s a lot of money: about $20trn and counting.
This has generated a ‘green rush’—what’s now the largest trend in investment. But it isn’t a silver bullet to make money and do good. Although the positive aspects are very real, there are also challenges: how the benefits and costs of such investments are apportioned—indeed, even down to how they are calculated.
There is, for instance, a persistent disparity between where environmental investments are going—largely towards established technologies such as wind and solar—and integral parts of the sustainability puzzle that remain underinvested. A recent survey of large investors globally conducted by The Economist Intelligence Unit found that electricity and heat generation, followed by industry-related investments, represent the lion’s share of sustainable investments. Jason Tu, cofounder and CEO of ESG analytics company MioTech, is seeing a lot of investor interest in “energy generation, transmission or storage, or usage such as electric vehicles”. He also cites farming technology as a particularly hot topic among investors.
Conversely, buildings, transport and agriculture, despite being major sources of greenhouse gases (GHG), have relatively low uptake.
How useful is ESG?
“The starting point for ESG is flawed,” argues Aswath Damodaran, professor of finance at New York University’s Stern School of Business. “We’re trying to substitute company behaviour for laws we should be passing as a society.”
However, others object that pushing this back onto society or the individual is a distraction from the role large corporations play—and sometimes an intentional distraction at that.
“Professor Damodaran is quite wrong to think that anyone in ESG actually thinks voluntary action is a good substitute for good laws,” says Mark Campanale, founder and executive chairman of the Carbon Tracker Initiative. “Quite the opposite. What ESG does however recognise is that the law is a minimum and we should all aspire to higher standards. When governments abrogate their responsibilities—for example by allowing themselves to be lobbied by powerful business interests to block certain standards—then shareholders can step in and take action.” He points to the recent removal of senior executives at Rio Tinto over the mining violation of indigenous Australians’ historical sites as a good example of this.
Technology is playing an increasing role in exposing these sorts of abuses. Mr Tu cites the use of satellite imagery “to see whether there’s any decrease in greeneries at the plantation, or any kind of signs of pollutants around a 30 km radius of a factory”.
This helps investors ensure that their sustainable projects are actually doing good—and choosing projects where they care about their success is exactly how Professor Damodaran suggests approaching green investing. “My advice to investors is pick your dimension of goodness,” he says. “Each of us has something we think is most critical to us, and invest based on that dimension, which means ESG scores are completely useless.”
How well does a company perform on gender diversity, water usage, emissions and so on? Distilling all these factors and more to one ESG number is obviously problematic. Some investors want as low fossil fuel exposure as possible—while others will intentionally be targeting more carbon-intensive companies—to finance a transition from the brown to green economy. ESG scores cannot resolve this; it’s only the starting point.
Mr Campanale takes a different approach: “ESG scoring is neither an investment thesis nor a strategy. What’s more compelling is to find areas that can demonstrate a valuable impact on society, for example investing in the clean energy revolution, or medical technologies. ESG-led investment research strategies that allow you to invest in a spread of high social impact enterprises is really at the heart of responsible finance.”
Pedal to the metal
Such strategies can’t be summed up in one number. A single ESG score—one number encompassing diverse factors—arguably doesn’t tell you much. A fund or stock can have a high ESG score by being in an industry with a low carbon footprint, such as finance, for example, or simply by reporting on lots of metrics that ESG ratings agencies score on. Some large oil companies, for example, score well on transparency, compensating low E with high G.
A positive impact in one area, earning a good ESG score, can also have a negative impact in other areas, which may not be highlighted by some ESG metrics, and so asset owners may be unaware of important consequences of some of their investments. One example of this is the knock-on effect of low-carbon technologies on metal extraction. These technologies use much larger amounts of metal than fossil fuel-based systems, creating an exponentially rising demand. An electric car typically contains 80 kg of copper, four times as much as a petrol-fuelled one. Both wind and solar power plants contain more copper than their fossil fuel equivalents: a typical solar plant contains about 5 kg of copper per kilowatt versus 2 kg per kilowatt for a coal-fired power station, points out economist Frances Coppola.
“It’s surface level ESG, because you think about carbon footprint, you think people who produce gas cars create this huge carbon footprint,” says Professor Damodaran. “If you create electric cars, you’re good. But electric cars create their own costs. And if you start digging into those costs, the question you have to ask is, are we really trading one devil for another?”
Given the reliance of the green energy transition on poorly regulated mining in these regions, does this not risk minimising the S in ESG? And is this not creating wilful blind spots to other forms of environmental degradation? It leads to the accusation, expressed pointedly by charity War on Want, that this green rush threatens a “new form of green colonialism that will continue to sacrifice the people of the global south to maintain our broken economic model”.
That the developed world has used the available resources, then pulled up the ladder to the global south, is echoed by Invesco’s The 21st Century Portfolio report, authored by Paul Jackson, which notes “the developed world has got rich by using up the CO2-absorbing capacity of the atmosphere, leaving little room for the rest of the world to develop”.
For Professor Damodaran, addressing the issue cannot rest at the door of the corporation: “Much of the ESG literature starts with an almost perfunctory dismissal of [founder of monetarism] Milton Friedman’s thesis that companies should focus on delivering profits and value to their shareholders, rather than play the role of social policymakers,” he says.
This article highlights one of our key points about ESG which we have repeatedly stated over the past year throughout our ESG related content, that ESG is a journey.
It isn’t a ‘one size fits all solution’, its about aspiring to do better.
As the ESG trend continues to grow, fund managers and investors alike, are learning more and more every day. Companies are having to adapt to the increasing ESG standards that are set.
Whilst a company may only score well on one aspect of ESG, it may be lacking in others, however over the next few years, ESG isn’t going away so it’s important to remember that every company will have a starting point and should continue on their journeys to improve in all aspects. If they don’t, they will be held accountable by their clients and fall behind the rest who will be actively trying to improve their ESG ratings.
Keep checking back for our usual market updates, insights and ESG related content.
Please see the below piece from Invesco received late yesterday afternoon:
As demonstrated by environmental protests against asset managers accused of “funding destruction”, the investment industry remains broadly perceived as uninterested in the existential challenges facing humanity.
Contrary to such perceptions, asset managers have taken a lead in promoting sustainable policies and practices – especially through active ownership of and engagement with the companies in which they invest.
It is vital that this “quiet revolution”, as the University of Cambridge has described it, builds wider recognition and that stakeholders of all kinds appreciate that their interests may be aligned with those of asset managers.
More than a decade on from the global financial crisis, the investment industry is still popularly perceived as a self-serving entity with little or no regard for the greater good. Before the COVID-19 pandemic curtailed mass gatherings, environmental activists’ demonstrations – including several against financial services companies said to have “funded destruction” – provided a clear reminder of how negatively this sphere is viewed by many of those outside it.
Former President of Ireland Mary Robinson, now a UN Special Envoy on El Niño and Climate, even suggested that Extinction Rebellion protesters should specifically target asset management firms. This tactic, she said, would lessen the likelihood of the group alienating members of the public.
Such a sentiment underscores the degree to which asset managers, routinely cast as essential cogs in the machinery of “big business”, are deemed complicit in many of the world’s ills. Yet it also implies that they can bring about positive change; and what appears to be consistently overlooked, at least in the mainstream narrative, is that this is exactly what they are doing.
The first decade of the 21st century exposed the limits of capitalism as we long knew it. There is no disputing this, just as there is no disputing that the resulting backlash against sections of the investment industry was deserved. Yet capitalism always has been and still is a work in progress: it has evolved substantively in seeking to avoid the errors of the past, and asset managers have been at the heart of the unfolding shift.
This is because responsibility, sustainability and long-term thinking are becoming norms for the sector. Asset managers are spearheading what the University of Cambridge has described as a “quiet revolution”, and the reality – unlikely though it might seem to some critics – is that many investment professionals have a deep and even long-held commitment to the future of the planet and its inhabitants.
A passion for the environment is not some sort of obligatory extension of work for such individuals. Quite the opposite: work is a potent augmentation of their passion for the environment. This should be acknowledged far beyond the industry – not because asset managers yearn to be loved or are tired of being harangued by climate campaigners but because stakeholders of every kind need to comprehend that there is a massively important alignment of interests here.
Contrary to widespread assumptions, asset managers are not fiercely determined to thwart efforts to make the world a better place. In fact, many want to be central to such endeavours. In this paper, drawing both on our own experiences and on insights from leading researchers, we seek to show that the quiet revolution is well under way; we attempt to highlight a more “human” side to the people behind it; and we try to explain why it merits much broader recognition.
Along with the investment industry in general, asset managers have attracted considerable criticism in recent years. With past sins still largely informing mainstream opinion, the scorn of the broader public – from environmental protesters to media commentators to the proverbial man and woman in the street – seemingly remains as strong as ever. Overturning such firmly entrenched disdain and distrust will not be straightforward. The investment industry as a whole has often made headlines for the wrong reasons, and the popular realisation that it has a much more admirable side will unquestionably take time to emerge.
The quiet revolution has been under way for several years. Maybe now is the time to make more noise about it – not for the sake of asset managers’ self-esteem, not because we demand due recognition, but because how we and our efforts are regarded and understood is likely to determine our effectiveness in helping plot a truly responsible course for the future.
This article is another indicator of the direction of travel within the industry. ‘Ethical’ and ‘Socially Responsible’ investment themes have always been there in the background, but over the past two years and especially since the onset of the pandemic, it no longer seems to be in the background.
Almost every fund manager now has to take into account ESG factors within their investments and portfolios whether they are doing so because they believe its right or because they now see that they have to in order to keep up, either way, its still a good push in the right direction.
People are waking up to making the world a better place, be it via social issues or climate issues.
Investors now seem to take comfort in the fact that they can help and ‘do their bit’ to help make the world a better place.
Please see the below article from Royal London received over the weekend:
The majority of our assets just over 90% – are invested with Royal London Asset Management (RLAM), and their responsible investment team is doing great work to help drive the move to a low carbon economy and leading the way on the Just Transition. What is the Just Transition?
Just Transition ensures that social issues are taken into account in moving to a low carbon economy. Rapid climate action that limits global warming to below 1.5ºC prevents the worst human and economic costs of climate change. A Just Transition ensures this climate action also supports an inclusive economy and avoids exacerbating existing injustices or creating new ones.
We care about Just Transition in the industry, because without adequate considerations of the social impacts of accelerating the path to Net Zero, there is a risk that people will not be willing to make the hard choices we need in order to limit the impacts of climate change. This can lead to policy delays and uncertainty. Companies that acknowledge this challenge and plan for a Just Transition, will be more likely to deliver on their commitment to low-carbon growth. We believe energy utility companies should develop formal Just Transition strategies to manage social risk and ensure they continue to deliver good value for society and their investors.
A just transition for Scottish and Southern Energy (SSE)
SSE is an energy utility company that helps produce and distribute gas and electricity to our homes. It is one of the largest producers of wind power in the UK and has committed to become ‘net zero by 2050’ – which means that by 2050 the amount of greenhouse gas emissions produced by SSE will be equal to the amount it removes from the atmosphere.
RLAM’s responsible investment team has been champions of SSE’s strategy to move to wind power and reduce its reliance on coal and gas, which will have a big benefit for our climate. However, they’ve also been talking to SSE about the Just Transition – what the company is doing to ensure that its transition to lower carbon energy also considers any negative social consequences like significant job losses or making energy bills unaffordable. Solving the climate crisis is not straightforward, and the responsible investment team is asking companies to take a more holistic view and look at both the social and environmental consequences of taking action.
Please continue to check back for a range of blog content, from ESG focused pieces like this one to market updates and insights from a variety of the worlds’ leading investment houses.
Please see the below article from Tribe Impact Capital received yesterday afternoon:
Driven by changing consumer behaviours, increasing choice and affordability, recent net-zero pledges by governments and the desire to ‘Build Back Better’ after the pandemic, the demand for electric vehicles (EVs) continues to grow. According to Bloomberg New Energy Finance, EV sales will rise to nearly 60% of the global auto market by 2040, a huge shift from almost 0% in 2010. With consumer consciousness on the rise and market forces gaining momentum, EVs are quickly becoming the future of the automotive industry and a target market for investors.
However, before any serious adoption of EVs can take place there needs to be significant investment in the infrastructure that supports EVs. This includes the charging points but also the entire electricity grid.
EV charging points
The issue of suﬃcient access to electric charging points for those who don’t have the access to oﬀ-street parking needs to be addressed if there is to be widespread adoption of EVs. A report by the European Automobiles Manufacturers association in October 2020 showed that while EV sales in Europe had increased over 100% during the last 3 years, the number of public charging points had grown by just 58%. Similarly, in the UK, all-electric cars went from 1.6% of the market in 2019 to 6.6% in 2020. The report found the UK is likely to need around 400,000 public charge points by 2030, a considerable increase from the existing 35,000. The current installation rate of 7000 a year is not enough to meet requirements if the UK is to be ready for the ban on sales of cars with an internal combustion engine in 2035. Installation will need to occur five times faster at a cost of between £5 billion and £10 billion by 2030.
Providing enough residential on-street charge points and charging facilities in public spaces will be critical in high-density residential areas where it’s simply not feasible for every property to have cables running from their electricity supply to their vehicle. National Grid points out that with 20 million EVs on the road there will be at least 8.6 million vehicles that will not have the facilities for charging at home.
This is not just an issue for the UK though. The quantity of public chargers is growing the fastest in China, followed by Europe and then the US. China still has the largest network of public chargers. They had more than 500,000 chargers by 2019, accounting for more than 50% of the global total. However, a large number of chargers does not mean an ideal vehicle-to-charger ratio. While China’s passenger electric vehicle-to-public charger ratio (8.5 to 1) is lower than that of the United States (17 to 1), some European countries have even lower EV to public charger ratios (France: 7 to 1; Germany: 5 to 1; and the Netherlands: 4 to 1).
The second major infrastructure to consider is the supply and distribution of the electricity itself. At their current trajectory EVs are set to double domestic electricity demand. At scale, this would present significant challenges to the distribution network. As we see increased adoption of intermittent renewable energy sources we might start seeing large imbalances between supply and demand in terms of power provision. Not only do we need to build out our existing network capacity and reinforcement we need to get better at managing system stability, energy storage and smart charging.
What does this mean for investors?
The UK government recognises that widespread adoption of EVs is key to achieving their climate goals with the Chancellor announcing in the government’s spring Budget that £500 million will be invested into a rollout for charging hubs. Whilst this investment will help play a role in piecing together the UK’s fragmented infrastructure and easing the pressure on public sector organisations, more capital for wider and faster deployment of a national charging grid is needed. Many supermarkets are now providing electric charging hubs in their car parks in partnership with others. Many supermarkets in the UK have increased their commitments to sustainability and investors are now starting to look at these companies with renewed interest.
Despite the noise and potential in companies like Tesla, Nio and others, for example, Volkswagen, the EV story also represents plenty of opportunities for investors outside the main car manufacturing segments. Charging points are the next logical step but looking at the sector more broadly there are opportunities in smart metering, battery storage, network improvement, smart cities and core technology (for example semiconductors, and artificial intelligence). The shift to EVs will have major implications not just for the way we travel, but the way we build cities and our consumption of electricity itself. With this in mind, the opportunities for investors further increase.
For example, smart meters (electronic devices that accurately monitor electricity use and send this information to the user or the utility company to effectively manage and optimise energy consumption) are key to driving efficiency in energy usage. They can potentially manage the demand on the grid by notifying consumers of the best time to charge, helping reduce consumer costs. Renewable electricity providers are also starting to provide ‘free’ tariffs for EV owners to manage potential cost implications.
The market for smart meters is growing rapidly and in 2019 US electric companies installed over 98 million smart electric meters, covering more than 70% of US households. The global smart meter market size was valued at $21.13 billion in 2019 and is projected to reach $39.20 billion by 2027, an annualised growth rate of 9%. Utility companies are keen to install meters, they enhance the energy grid’s resilience and operations and help provide visibility into the system operations, thereby avoiding outages.
Similarly, the battery storage market is set to double over the next 5 years. Batteries provide a critical role in our future power systems as they provide the flexibility required by the grid to support the variability of power generation from renewables when environmental conditions are not favourable for power generation. Not only is demand going up, but input costs are coming down. By 2030, total installed costs could fall between 50% and 60% (and battery cell costs by even more), driven by optimisation of manufacturing facilities, combined with better combinations and reduced use of materials. Battery lifetimes and performance will also keep improving, helping to reduce the cost of servicing. Improved batteries will help support the grid by providing flexibility to store energy and release it when demand for EV charging is high.
With all investment opportunities, however, comes risk. The widespread adoption of electric vehicles comes with some stings in the tail, most notably the use of rare earth and precious metals used in the battery and technology embedded in the vehicles themselves. Complex supply chains, sometimes in politically unstable geographies and/or where the rule of human rights may be less robust, increase the risk of human rights abuses, as well as environmental degradation. As investors it is essential to be aware of and manage these risks. Doing so can uncover solution opportunities, for example, in businesses dedicated to the recycling of these rare earth minerals at end of life in many rechargeable battery applications.
Global governments have built widespread adoption of EVs into their carbon neutral plans which will have major implications not just for the way we travel but the way we build cities and our consumption of electricity itself. For investors, it’s important to look at the bigger picture and recognise that the opportunity set is much wider than a few automobile names.
This is an interesting look at the investment opportunities within the electric vehicle landscape looking beyond just investing in the vehicles themselves or the big EV companies (i.e. Tesla), but looking at the infrastructure around this, charging points, smart metres, clean energy etc.
The pandemic not only changed the world itself, but how people think about the world, the environment and what the future will look like.
This is a growing investment space and another key indicator that ESG has gone mainstream.
Please see the below article received from JP Morgan this morning:
‘In our view regulatory interventions will increase, and these interventions will underpin carbon prices not only in Europe, but also globally.’ – Vincent Juvyns
European policymakers have been focused on tackling climate change for many years. The launch of the European Union’s (EU’s) Emission Trading System (ETS) in 2005, the first carbon market in the world, has been the cornerstone of the bloc’s policy efforts. Since then, the ETS has been upgraded several times to reflect the EU’s growing climate ambitions and changes are now accelerating further since the EU has agreed to reduce its greenhouse gas (GHG) emissions by at least 55% by 2030. These regulatory initiatives at least partly explain why prices for CO2 emissions allowances in Europe have recently reached an all-time high of 56 euros per tonne of carbon dioxide equivalent (tCO2e).
The EU’s example is being increasingly copied, with several individual countries launching their own emission trading systems. At present, global carbon prices remain well below those seen in Europe. If they fail to move in line with what the EU deem to be acceptable, the subject of carbon taxes at the EU border will be an increasing reality. This is why we believe investors should be aware of the impact of higher carbon prices on their portfolio.
What drives carbon prices? Europe case study
There are two main types of carbon pricing mechanisms: a carbon tax, which is the most direct way to set a price on carbon, but which doesn’t set a pre-defined emission reduction target; and an emissions trading system, which caps the total level of GHG emissions, but doesn’t set a pre-defined price.
The EU chose the second approach when it created its ETS in 2005. The EU’s ETS is the world’s first and also the largest emissions trading system as it covers 45% of the EU’s GHG emissions produced by three sectors within the European Economic Area: electricity/heat generation, energy-intensive industry, and commercial aviation.
Companies in these sectors are allocated a free emissions allowance. Those with lower emissions than their allowance can sell their “unrequired” emissions to other companies in the sector (Exhibit 1). The balance between supply and demand for emissions creates a market price.
The EU can influence supply and demand dynamics to raise the carbon price in three ways: by reducing the emissions cap; by increasing the industries subject to the scheme; and/or by reducing the allocation that is deemed free.
In its recent directive, the EU decided that the aggregate emissions cap will fall by 2.2% per year from 2021 onwards (vs. 1.74% before). The EU is still deciding whether to include new sectors, such as transportation and buildings. The percentage of free emissions allowances, which had already fallen from 80% in 2005 to 43% in 2020, is to gradually decrease to 30%.
As a result, while some of the recent surge in the carbon price may reflect strong demand for emissions allowances as firms meet rising demand, there is a structural underpinning to higher carbon prices from regulatory interventions.
The balancing act between internal drive and external competition
EU authorities are mindful of the delicate balancing act they face between meeting domestic climate ambitions while at the same time not damaging corporate profitability and competitiveness compared to international competitors that are not subject to similar regulatory standards. Encouraging international peers to keep up with the EU’s efforts is bearing some fruit: other regions are beginning to launch their own emissions trading schemes and 25% of global GHG emissions are now covered by carbon pricing initiatives compared to just 5% in 2005 (Exhibit 2). However, the carbon price in these regions is much lower than in Europe (Exhibit 3).
Coverage of global emissions trading schemes and the impact on carbon prices
Exhibit 2: Global emissions covered by carbon pricing initiatives
% of global greenhouse gas emissions
Exhibit 3: Emissions trading system prices
USD per tonnes of CO2 equivalent
Carbon prices internationally are not only lower than those in the EU, they are also below those required to meet the global climate objective of reaching net zero emissions by 2050 according to many climate scientists and policymakers. Although the estimate is wide, a range of between USD 40 and USD 80 per tCO2e is often argued as necessary to limit global warming to less than 2°C.
Carbon prices will no doubt be a key topic of conversation when global leaders convene at COP26 in November. If the EU, China and the US cannot agree on a path towards a common carbon price, the EU may need to find a short-term solution to ensure that its climate efforts do not disadvantage European businesses.
One solution that appears to be growing in appeal is a carbon border adjustment mechanism (CBAM). This import tariff would be designed to ensure that the environmental footprint of a product is priced the same whether it is manufactured locally or imported. The CBAM is one of the key measures discussed as part of the EU’s Green Deal. The proceeds of the tax would form part of the EU’s budget, which would be used to finance the EU’s recovery and green transition.
At this stage the CBAM is a threat to international peers, but the credibility of that threat has been strengthened given the legislation that would be required has been approved by the European Parliament. It is now up to the European Commission to decide whether to use it.
In our view regulatory interventions will increase, and these interventions will underpin carbon prices not only in Europe, but also globally. The result will be an increase in the cost base of companies in a growing number of sectors.
One of the key investment implications is that increased business costs may serve to raise consumer prices, adding to growing inflationary pressures from loose monetary and fiscal policies. If firms are unable to pass on higher costs the higher carbon prices may dent profitability.
If the CBAM is activated, companies that export a lot of their carbon-intensive products to the EU may suffer from higher carbon prices, even if their home country does fairly little in terms of carbon regulation. The price of carbon is therefore a risk that needs to be monitored.
On top of traditional financial analysis, investors may look to evaluate non-financial parameters, such as the carbon intensity of companies, as we believe that minimising the carbon intensity of a portfolio should help improve its risk/return profile over the long term. This is what we have already observed over the last couple of years when comparing the MSCI World index with the MSCI World Climate Change CTB Select, a Climate Transition Benchmark under the EU Benchmark Regulation, which reweights securities based upon the opportunities and risks associated with climate transition risks.
Indeed, the MSCI World Climate Change CTB Select Index has a Weighted Average Carbon Intensity (which represents the number of metric tonnes CO2 equivalent emissions per USD million enterprise value including cash) that is almost 40% lower than the MSCI World Index, while it has also outperformed the latter by 150 basis points since its inception in November 2013, and has a better Sharpe ratio over the last three and five years.
With global carbon prices set to increase further in the future, minimising the GHG emissions of a portfolio should not only contribute to the fight against global warming, but it should also lead to better risk-adjusted returns in the long run.
Please continue to check back for a range of blog content, from ESG focused pieces like this one to market updates and insights from a variety of the worlds’ leading investment houses.
Please see the below article from JP Morgan received yesterday, 26/04/2021:
The concept of sustainability is rapidly rising up the agenda within the fashion industry. Yet while consumers are increasingly interested in sustainable fashion, they are not willing to pay a premium for it. Still, sustainability can be a competitive advantage. We have seen companies delivering a sustainable message, but identifying the true leaders from the potential greenwashing takes research.
Consumers care about sustainabilty, but not at any price
As the global population grows, the negative environmental impacts of our demand for fashion are becoming more apparent. The industry is responsible for 10% of global carbon emissions and 20% of global wastewater, as well as producing significant amounts of waste. The equivalent of one garbage truck of textiles is dumped in landfill or burned every second.
75% of consumers view sustainability as ‘extremely’ or ‘very important’ in their fashion purchasing decision. And over 50% of consumers would switch for a brand that acts in a more environmentally and socially friendly way. But in practice, are consumers really willing to pay? Not yet, it seems. Only 7% of consumers say sustainability is the most important factor in their decision making.
Exhibit 1: Consumers care about sustainabilty, but not at any price – most important factors in decision making
Consumers continue to rate ‘high quality’ and ‘good value for money’ as the most important factors in their decisions. This is backed up by our engagements with fashion companies, who claim that consumers are not willing to pay a premium for sustainability, although at the same price point they would choose the more sustainable offering.
To us, this signals that consumers have a preference for sustainability and it can be a competitive advantage for retailers. But companies need to see it as a way to maintain or grow their market share rather than a way to increase prices. Sustainable leaders should be investing in innovation and scale for sustainable solutions to bring prices down and maintain their brand position.
Case study 1
Re:NewCell: Driving down costs for sustainability in fashion
Re:NewCell is a Swedish company driving down the costs of sustainable materials through innovation. The company has developed and patented Circulose, a high quality material made from recycled clothes. We expect Circulose – which has already been adopted by the likes of H&M and Levi’s – to see increasing uptake within the fashion industry, helping to lower the cost of sustainable materials and improve the industry’s environmental footprint.
Case study 2
Adidas: Leading the charge on sustainability
Adidas, the well-known sportswear brand, is at the forefront of sustainability within the fashion industry. The company particularly stands out on circularity, which is embedded in its strategic priorities: by 2024, Adidas has committed to replace virgin polyester with recycled polyester. The company already partners with the environmental organisation Parley for the Oceans to use recycled polyester made out of plastic collected from the coastline. All of Adidas’s cotton is sustainably sourced via the Better Cotton Initiative, earning Adidas the top spot in a 2020 independent ranking on sustainable cotton sourcing. Adidas has committed to reducing greenhouse emissions across its entire value chain by 30% between 2017 and 2030, and then achieving climate neutrality by 2050. As a further validation of Adidas’s sustainability efforts, these goals were submitted for external verification by the Science Based Target initiative in February 2020.
Sources: Adidas and the Sustainable Cotton Ranking 2020 (77 companies).
The companies above are shown for illustrative purposes only. Their inclusion should not be interpreted as a recommendation to buy or sell.
Distinguishing the real from the fake
The fashion industry is highly fragmented, and sustainability standards are still in their infancy. More and more companies are reporting on both their environmental and social impacts. But with different companies focusing on different disclosures, metrics and measurement methodologies, how can we identify the best? For us, fundamental research and company engagement are key, allowing us to assess whether fashion brands are paying lip service to sustainability or whether they are truly committed to it.
What do we look for in a sustainable fashion leader?
Has the company signed up to measurable targets to reduce its negative environmental footprint?
Is the company abiding by external certifications to demonstrate the sustainability of its products?
Is the company accurately measuring and reporting its entire carbon footprint?
The last of these requires particular research focus as only about 5% of a fashion retailer’s carbon footprint comes directly from its own operations (scope 1 emissions) or indirectly from generating the energy used by the company (scope 2). The vast majority of carbon emissions occur in the company’s value chain (scope 3). This includes production, processing and transportation of fibres and fabrics, transportation of the end product to its final destination, and emissions related to use, care and disposal. Unsurprisingly, this complexity means that emissions are currently underreported, with many companies only reporting on transportation of the end product. Fundamental research is therefore key to understand the supply chain picture and determine what companies are really doing to reduce their total emissions.
While price sensitivity remains key for consumers in the fashion industry, evidence points to sustainability becoming more important in purchasing decisions and ultimately to long-term brand value. This implies a material opportunity for sustainable leaders to stand out while unsustainable fashion brands lose out. Yet the potential for greenwashing is rife in the industry, making it difficult to distinguish between leaders and laggards in the transition to sustainable fashion. Company research and engagement is key.
This is another example of sustainability and ESG themes filtering down to everyday life.
The fashion industry, particularly the problematic ‘fast fashion’ companies seem to hit the headlines on a regular basis for all sorts of issues, from waste to poor working conditions so the sustainability of the fashion industry is starting to be questioned more often.
With fund managers now also becoming increasingly more concerned with ESG and sustainability issues, the fashion industry will have to also adapt to these changes in the way consumers and investors are thinking and what it is they are looking for when investing or purchasing their products.
Shopping for items such as clothes became pretty much an online only occurrence for a large proportion of the past 13 months, I have myself noticed that sustainability is being used a selling point, whether it be statements on the companies website or even noted in the products description. Some companies plant a tree for every item of clothing purchased.
As this article highlights, a lot of people would consider switching to more environmentally and socially friendly brands, but they may not be willing to pay an extra premium for it. Personally, I don’t think it will be long until paying extra won’t be an issue, as the world changes and now has ESG principles under a microscope, these companies will have to adapt to remain competitive in the marketplace.
From a personal experience perspective, I recently purchased an item of clothing having no idea it was part of a ‘sustainable’ line until I was checking the label for the washing instructions only to find out that the item was made out of 100% recycled plastic bottles and textile waste that had been processed and melted down into new fibres in an effort to save water, energy and reduce greenhouses gases.
The item was no more expensive than a ‘non sustainable’ item and the quality was probably better than products that use ‘virgin’ or non-recycled materials.
As consumers, if you don’t have to compromise on cost or quality, then why wouldn’t you choose more sustainable options?
Please see the below ESG case study article from Invesco:
The below case study pertains to engagement within our UK equities team, which are a part of the Henley Investment Centre. While guided by our central ESG team, all of our investment professionals ultimately have discretion in their ESG decisions, and do not all follow the same approach. Learn more about how we integrate ESG across our wide range of strategies here.
Responsible oil and gas companies have a critical role to play in being part of the solution to environmental problems: in helping enable the global economy to successfully transition as rapidly as possible, and in a sustainable manner, towards targets for much reduced global emissions.
This can be achieved through actions taken by companies to successfully manage down a sustained decline in output of oil & gas, while at the same time maximising cash flows from operations for investment in new low carbon energy businesses.
Investing in oil companies that set out to achieve these objectives – and holding them accountable – is we believe entirely consistent with true responsible investing, which incorporates environmental, social, and governance (ESG) criteria into the investment process.
Whatever the moral burden that should fairly be borne by UK-listed companies, such as BP and Shell, for their historical actions, what is important for investors to understand is how the oil companies themselves now fit into the global industry. Investors want to know what the impact of oil companies will be on that industry and on society, going forward: what role they have to play in the future.
How BP and Shell are transitioning towards a greener future
Although many investors focus on oil & gas producers as large Scope 3 emitters of carbon, if the world is to achieve net zero emissions in 2050 it ultimately requires reform of demand, and not just supply.
Supply in the industry (in the long run) very closely mirrors actual demand (the easiest place to store oil is still in the ground!). It is important here to also reflect that the global publicly quoted US and European oil companies only account for around 12.3 mb/d out of total current production of approximately 100mb/d, with US privately owned production around a further 8mb/d.
Put another way, state owned oil production (including Saudi Aramco) accounts for almost 80% of global production. The reality is that any cuts in production by any of the publicly quoted oil majors does not in itself affect global oil demand.
BP turning off the taps tomorrow would have a negligible effect on global carbon emissions. The same emissions will still be made but fuelled by output from another supplier who is less accountable to investors.
Responsible oil companies do, though, have a very significant role to play in accelerating a sustainable transition to low carbon alternatives that can reduce demand for fossil fuels by providing a viable substitute product.
For example, BP and Royal Dutch Shell are both actively involved in promoting the transition through defined strategies that look to maximise cash flows from existing carbon resources, and then re-allocate cash flows to low carbon alternatives.
Because of the many and varied uses for oil as a fuel, as a key component in a wide range of everyday products, and the practical limitations associated with various alternatives currently available, the process of transition is likely to be gradual. It is clearly both necessary and highly likely that demand for oil will reduce over time, however we do not foresee at any time in the next ten years at least, a “Kodak moment” for oil.
Our role as responsible shareholders will encourage positive change
An investor in BP or Shell who is willing to support, encourage and also hold the company to account during its transition period is, we believe, able to be well rewarded financially, through dividends and share buy backs, as well as by the prospect of owning a new “low carbon” and retail business whose growth has been fully funded from existing company resources.
Responsible oil & gas companies such as BP and Shell therefore have a critical role to play in being part of the solution: in helping enable the global economy to successfully transition as rapidly as possible, and in a sustainable manner.
This objective can be achieved through actions taken – with the support of shareholders – to successfully manage down a sustained decline in output, whilst at the same time maximising cash flows from operations for investment in new low carbon energy businesses.
We believe, investing in oil companies that set out to achieve these objectives, and holding them accountable, is entirely consistent with our philosophy of responsible investing, which focuses on engagement and dialogue with portfolio companies, and not simple divestment if there is something that we don’t like.
We expect big companies in this sector will be investing capital at scale in renewable energies and are well placed to manage large and complex engineering projects in hostile natural environments. Again, the sector is part of the solution rather than just part of the problem.
Our engagement and dialogue – in practice
As active fund managers, ESG integration and dialogue is an important consideration for us. Over the past three years we have regularly engaged with various members of the Boards and Management Teams of both BP and Shell, on ESG matters in general, and on carbon emissions in particular.
In the case of BP, for example, we have had meetings with the BP Chairman to discuss the risks and opportunities associated with their carbon transition plan.
We have also provided feedback to the chair of the remuneration committee to ensure management incentivisation is aligned to group strategy and their environmental targets.
Furthermore, we have engaged with independent board members and attended company strategy sessions. The enhanced monitoring of our BP position over the last three years means that we believed that the strategy and objectives the company was setting were achievable.
Our engagement enables us to measure the board and management against their strategy and objectives. We believe there are good returns to be made from businesses which transform to become fit for the future.
When it comes to ESG or socially responsible investments, its important not just to use the traditional ethical investment screening (i.e. staying away from certain companies/ sectors etc), but to engage with companies to help deliver positive change.
By engaging with companies and holding them accountable, it forces them to think about the future, their practices and operations and helps to guide them into a better way of thinking.
It’s not about steering clear of companies or disinvesting if something happens investment managers don’t like, but about engaging with them, providing feedback and guidance about how they want things to work.
Positive engagement will help everybody to learn and adapt to what seems to becoming (or will become) an industry standard in how ESG processes are embedded into companies and the industry as a whole.
Keep checking back for more ESG related content from us along with our usual market commentary, planning points and other key issues we like to keep you up to date with.
Please see the below article from AJ Bell received late yesterday afternoon:
German auto maker has grand plans for global EV market
In August 2020 we flagged German auto maker Volkswagen as a value play at €139, since when the stock has gained more than 40%.
Its shares have been particularly strong this year as the firm rolls out its electric vehicle strategy, culminating in this week’s ‘Power Day’.
In contrast, electric vehicle specialist Tesla has had a torrid time this year with shares tumbling from $900 in January to a 2021 low of $563.
VW has grand plans for a big electric vehicle push. As well as reducing the cost of ownership in the space it is investing heavily in new battery technology to improve range and in new charging networks to improve ease of use.
The company aims to reduce battery prices to below €100 per kilowatt hour through a combination of advanced cell design and lower manufacturing costs, all while using green energy.
Beginning with a €14 billion investment in Sweden with partner Northvolt, VW aims to have six gigafactories in Europe by 2030 with a combined capacity of 240 gigawatt hour.
More significantly, VW has partnered with BP, Spanish utility Iberdrola – a world leader in green energy – and Italian utility ENEL to install 18,000 new high-power charging stations across Europe.
The current lack of infrastructure is seen as a key reason for the slow mass adoption of electric vehicles. By working jointly to create a network of renewable-powered rapid-charging stations, each company gets closer to its net-zero goals to boot.
However, VW has even grander plans. All of its electric vehicles come with a home-charging station called Elli. When parked and connected to the Elli Cloud, a VW ID.3 becomes a ‘mobile power bank’ capable of feeding power back to the house for up to five days.
Using intelligent management systems, energy could be transferred to the vehicle during off-peak hours and transferred back to house when needed.
Not only would this save wasting renewable electricity – last year Germany wasted 6,000 gigawatt hours of renewable energy due to lack of storage – when rolled out to commercial and industrial customers it could drastically reduce the cost of expanding transmission networks.
Renewable energy is likely to be an area of rapid growth over the next few years. As the world navigates its way out of the Covid-19 pandemic, the world has been left with food for thought about how to make the planet better and how to sustain it. Companies around the world are adapting to renewable energy sources.
We regularly post a variety of ESG content, both our own and articles from a range of fund managers, and renewable energy is a key consideration in this (the E in ESG, E – Environmental).
This is definitely an area to watch!
Keep checking back for a range of blog content from us, from ESG outlooks, to market updates and insights, both our own original content and input from a wide range of fund managers and investment houses.
Please see the below article from Invesco which we received late yesterday afternoon:
Investing in stocks which have the right ESG momentum behind them can be a positive way for our funds to potentially generate alpha
We draw upon ESGintel, Invesco’s proprietary tool, which helps us to better understand how companies are addressing ESG issues
Engaging with companies to understand corporate strategy today in order to assess how this could evolve in the future
Our focus as active fund managers is always on finding mispriced stocks and ESG integration underpins our investment process at every stage.
The incorporation of ESG into our investment process considers ESG factors as inputs into the wider investment process as part of a holistic consideration of the investment risk and opportunity, from valuation through investment process to engagement and monitoring.
The core aspects of our ESG philosophy include materiality; ESG momentum; and engagement.
Materiality refers to the consideration of ESG issues that are financially material to the corporate or issuer we are analysing.
The concept of ESG Momentum, or improving ESG performance over time, indicates the degree of improvement of various ESG metrics and factors and help fund managers identify upside in the future. We find that companies which are improving in terms of their ESG practices may enjoy favourable financial performance in the longer term.
Engagement is part of our responsibility as active owners which we take very seriously, and we see engagement with companies as an opportunity to encourage continual improvement.
Dialogue with portfolio companies is a core part of the investment process for our investment team. As such, we often participate in board level dialogue and are instrumental in giving shareholder views on management, corporate strategy, transparency, and capital allocation as well as wider ESG aspects.
ESG integration is an ongoing strategic effort to systematically incorporate ESG Factors into fundamental analysis. The aim is to provide a 360-degree valuation of financial and non-financial materially relevant considerations and to help guide the portfolio strategy.
Our investment process has four stages. In this note we go through in detail how ESG is integrated into each stage of our process.
Ideas come from many sources – our experienced FMs, other team members or investment floor colleagues, various company meetings, and by exploiting the intellectual capital of our sell side contacts. We see it as important to spread our nets as wide as possible when trying to come up with stock ideas which may find their way into our portfolios. We remain open minded as to the type of companies we will consider. This means not ruling out companies just because they happen to be unpopular at that time and vice versa.
ESG can create opportunities too – for example, the benefits of moving towards more sustainable sources of energy like wind, solar and hydroelectric power generation. This was one of the reasons we became interested in some of our utility holdings which are held across several portfolios. This highlights the importance of opportunities brought about by ESG and not just the risks. ESG can also influence the timing and scale of a mispricing being corrected in the market.
To be clear, at this early stage of the investment process we typically would not rule out companies with a sub-optimal ESG score. Investing in stocks which have the right ESG momentum behind them – by focussing on fundamentals and the broader investment landscape – can be a unique way for our funds to potentially generate alpha.
Fundamental Research & ESG Analysis
Research is at the core of what we do and is what the investment team spends most of its time doing. The key is to filter out those ideas which aren’t aligned with our investment philosophy and concentrating on those where we see the strongest investment case. Our fundamental analysis covers many drivers, for example, corporate strategy, market positioning, competitive dynamics, top-down fundamentals, financials, regulation, valuation, and, of course, ESG considerations, which guide our analysis throughout. The key drivers will differ according to each stock.
We use a variety of tools from different providers to measure ESG factors. In addition, at Invesco, we have developed ESGintel, Invesco’s proprietary tool built by our Global ESG research team in collaboration with our Technology Strategy Innovation and Planning (SIP) team. ESGintel provides fund managers with environmental, social and governance insights, metrics, data points and direction of change. In addition, ESGintel offers fund managers an internal rating on a company, a rating trend, and a rank against sector peers. The approach ensures a targeted focus on the issues that matter most for sustainable value creation and risk management.
This provides a holistic view on how a company’s value chain is impacted in different ways by various ESG topics, such as compensation and alignment, health and safety, and low carbon transition/ climate change.
We always try to meet with a company prior to investment. Based on our fundamental research, including any ESG findings, we focus on truly understanding the key drivers and, most importantly, the path to change. This helps us better understand corporate strategy today and how this could evolve in the future. Today, the subject of ESG is increasingly part of these discussions, led by us.
We aim to create a well-diversified portfolio of active positions that reflect our assessment of the potential upside for each stock weighted against our assessment of the risks. Sustainability and ESG factors will be assessed alongside other fundamental drivers of valuation. The impact of any new purchases will need to be considered at a fund level. How will it affect the shape of the portfolio having regard to fund objectives, existing positions, overall size of the fund, liquidity and conviction?
We do not seek out stocks which score well on internal or third party research simply to reduce portfolio risk. We ask the question, “Why does the idea deserve a place in the portfolio?” We ask this because there is a competition for capital, a new idea will require something else to be sold or reduced so that it can be included.
Our fund managers and analysts continuously monitor how the stocks are performing as well as considering possible replacements. Are the investment cases strengthening or weakening? Are their valuations reflecting the companies’ prospects appropriately? Is the company performing from an ESG perspective and are the valuations fairly reflecting the progress being made or not? Are the anticipated key drivers playing out or not? These questions, and their answers, are all of equal importance to us.
How do we monitor our holdings from an ESG perspective? Again, the same resources used during the fundamental stage are available to us. Our regular meetings with the management teams of the companies we own provides an ideal platform to discuss key ESG issues, which will be researched in advance. We draw on our own knowledge as well as relevant analysis from our ESG team and data from our previously mentioned proprietary system ESGintel which allows us to monitor progress and improvement against sector peers. Outside of company management meetings we constantly discuss as a team all relevant ESG issues, either stimulated internally or from external sources.
Additional ESG analysis is carried out by the team, when warranted, on particular companies. Depending on the particular case this is often in conjunction with the ESG team. Such cases would be those that are more controversial, considered to be higher risk and viewed poorly by ESG providers, resulting in a valuation discount. We don’t just look at the specific issue considered to be higher risk either, for example the environmental risk of an oil company, but all areas of ESG. This means undertaking extensive analysis of social and governance policies and actions at the same time. We would note that this analysis is an ongoing process, typically involving multiple engagements with the company over a long period of time. All ESG discussions and interactions are written up – including our views and thoughts – with a section solely dedicated to ESG. Likewise, research undertaken by the ESG team is available to the entire Henley investment floor, and wider business. Further analysis could be warranted as a result of these discussions.
Challenge, Assessing & Monitoring Risk
In addition to the above, there are two more formal ways in which our funds are monitored:
There is a rigorous semi-annual review process which includes a meeting led by the ESG team to assess how our various portfolios are performing from an ESG perspective. This ensures a circular process for identifying flags and monitoring of improvements over time. These meetings are important in capturing issues that have developed and evolved whilst we have been shareholders. It is our responsibility to decide if it is appropriate, or not, to investigate these issues in more detail. We may ask the ESG team to assist in undertaking more analysis or discuss such issues with the company themselves or external brokers.
There is also the ‘CIO challenge’, a formal review meeting held between the Henley Investment Centre’s CIO and each fund manager. Prior to the meeting, the Investment Oversight Team prepare a detailed review of a portfolio managed by the fund manager. This review includes a full breakdown of the ESG performance using Sustainalytics and ISS data, such as the absolute ESG performance of the fund, relative performance to benchmarks, stocks exposed to severe controversies, top and bottom ESG performers, carbon intensity and trends. The ESG team review the ESG data and develop stock specific or thematic ESG questions. The ESG performance of the fund is discussed in the CIO challenge meeting, with the CIO using the data and the stock specific questions to analyse the fund manager’s level of ESG integration. The aim of these meetings is not to prevent a fund manager from holding any specific stock: rather, what matters is that the fund manager can evidence understanding of ESG issues and show that they have been taken into consideration when building the investment case.
The regulatory landscape is rapidly evolving, which increasingly compels organisations and investors alike to clearly demonstrate their awareness of ESG issues in their decisions. Landmark initiatives such as the European Union’s new Sustainable Finance Disclosure Regulation (SFDR) are at the forefront of this shift.
We believe that our approach is honest, coherent and pragmatic. The principles behind ESG deserve to be embedded in an investment framework which encourages positive change. Coupling this with a focus on valuation is, to our minds, the best way to deliver strong investment outcomes for our clients’ long term. This reinforces our fundamental belief that responsible investing demands a long-term view and that a stakeholder-centric culture of ownership and stewardship is at the heart of ESG integration.
This is a good article and insight into how Invesco integrate ESG into their investment process. We would expect more fund managers to start publishing their ESG process (if they haven’t already!).
Please keep an eye out for further ESG related content from us, along with our usual market commentary and blog updates.