George Crowdy explains why Royal London Asset Management’s sustainable funds have lower exposure to the sectors that have struggled in the pandemic.
In earlier articles, we have talked about why sustainable investing has thrived in the pandemic, explaining that it is about identifying companies that provide solutions to global challenges, rather than those that exacerbate these problems.
In recent months, certain sectors have stood out. Technology and healthcare have performed particularly well as they have been providing such solutions. We have significant overweight positions in these sectors. But relative performance is also driven by what you don’t invest in and we’ve also benefitted from low or zero exposure to sectors that have struggled.
One of the worst-performing sectors in 2020 has been energy because of lower demand for oil from locked-down economies and the price war earlier in the year between Russia and Saudi Arabia. While it may seem obvious that sustainable funds wouldn’t hold oil & gas stocks, there’s more to this than you might imagine. We have zero weighting in the sector because we don’t believe in the long-term viability of fossil fuels, as well as their negative environmental impact.
With the widespread acceptance of climate change and the need to reduce carbon emissions, renewable energy is the future. Through economies of scale and technological advances, wind and solar power costs have fallen around 80% over the last decade, while battery technology (which is crucial to the success of renewables) is making huge advances. The low-carbon energy transition won’t be an overnight shift but it’s definitely happening. Indeed, European governments have raised their green targets during the pandemic, directing investment to these outcomes, while China has just committed to ‘net zero by 2060’.
Banking is another sector that has underperformed this year, as the risk of loan defaults has risen and yields have fallen to record lows. We have long been underweight in banks, as we struggle to identify a net benefit to society in many banking activities, particularly in trading and investment banking. The often opaque nature of banking revenues makes it difficult for us to have conviction in the sector.
There are exceptions, particularly in mortgages and business loans in emerging markets (as long as the lending is responsible). But as with energy, technology is driving disruption as ‘fin tech’ companies seize market share by providing solutions that change consumer behaviour.
The pandemic has emphasised the importance of embracing the disruptive power of technology. E-commerce has increased hugely this year, dramatically expanding the demographics of online shoppers. For retailers, this has underlined the existential importance of a high-quality, scalable online strategy. While traditional retailers have struggled, those with ‘omni-channel’ distribution, such as Adidas, have thrived.
In case it sounds like sustainable investing is only about tech-based futurology, our funds have also benefitted from the emphasis that we place on strong financials alongside ESG factors. We favour companies with good long-term growth potential and strong balance sheets. Value creation and valuation are key factors in our investment process. It is understandable that companies that meet these criteria have done better in a period of deep economic stress.