Long-term social, demographic, environmental and resource challenges are creating plenty of opportunities, writes Pengana Capital’s Adam Myers – as well as growing risks for sectors that deplete human and natural capital.
Broadly speaking, the companies providing solutions to these challenges grow at a faster rate than the rest of the economy due to the underlying support created by these structural changes.
However, the same forces of change also present obvious dangers to many traditional sectors of the economy.
There is increasing evidence that the sectors of the economy that create negative social and environmental impacts are at most risk of a permanent loss of value.
Examples include the Deepwater Horizon disaster, the Volkswagen emissions scandal and the collapse in the value of coal investments around the world.
Investors focusing on the companies that provide solutions to sustainability challenges are able to construct diversified global share portfolios that exhibit strong growth characteristics.
By avoiding the companies in unsustainable industries or with unsustainable business practices, the portfolio will be better insulated from the losses that may result from structural change.
Quality as an investment factor
Most investors look for ‘quality’ companies as part of their investment process.
High quality companies are expected to create long-term value and become category leaders.
They are also more likely to be resilient, with lower volatility and reduced risk. However, most investors are heavily influenced by short-term catalysts and have a narrow focus on backward looking accounting analysis.
Long-term fundamental investors should take a more holistic view of companies when analysing investment value.
Understanding how companies address environmental, social and governance challenges and opportunities therefore should be incorporated in the analytical process as they can provide signals of that elusive ‘quality’ that investors strive to find.
This works both ways. It helps to find good companies that have strong management teams and are creating long-term value for shareholders.
Such analysis also reveals lower quality investments, where the short-term numbers look good, but the business is under-invested, or lacks management controls, leading to the risk of a future loss in value.
This approach makes particular sense in the context of a longer-term average holding period.
ESG analysis generally doesn’t identify catalysts, but a deeper understanding of the quality and outlook for a business gives an investor a much stronger background against which to assess value.
Built in, not bolted on
In order to effectively implement this approach, sustainability issues should be fully integrated into the investment process and not bolted-on as an additional set of criteria that can be applied once the ‘traditional’ process has been completed.
Avoiding controversial sectors, investing responsibly, undertaking ESG analysis and long-term corporate engagement are all natural aspects of this philosophy, and should be built in to the process.
Finance for a positive purpose – creating impact
Finance and investment originally operated as a utility; a transmission mechanism to put idle savings to work in service of building a better economy.
Over the past 30 years, the finance industry has evolved to become an end of itself, rather than the means to that original aim and objective.
In more recent history, sustainable, ethical and responsible investment clients have begun to challenge the status quo – asking slightly different questions in pursuit of slightly different objectives.
These objectives all had a common thread, which was the desire to invest not only for the future, but in the future as well.
Adam Myers is an executive director at Pengana Capital.
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