The rise in popularity of sustainable investment products provides capital for companies that are developing new technologies and methods of conducting life, and this disrupts the business models of incumbent companies.
The area where this is most apparent right now is in cars, with electric auto-makers winning a greater share of consumers’ wallets and investors’ portfolios, at the expense of those more traditional companies producing cars powered by the internal combustion engine.
Mike Fox, who runs sustainable equity portfolios at Royal London Asset Management, says the impact on traditional companies is becoming more stark because “the nature of [environmental, social and governance investing], and what it is, has become more defined in recent years, and companies are getting asked about it more.”
Quite simply, technology is driving change in all industries David Harrison, Rathbone global sustainability fundCraig Bonthron, global sustainable equities fund manager at Kames Capital, says many of the more popular companies in the global sustainable equity space right now are companies “that are quite simply providing something which is better than the traditional competitor.
“We own Tesla in the portfolio. Elon Musk has said he will only build something if it is better than what is there already.
“From a long-term investing point of view, lots of the more innovative companies coming to the market are software companies, and the cost of increasing production for a software company is basically zero, whereas for a traditional industrial company that might have to invest more in a factory, which carries a huge extra cost.”
Supply and demand
Louis Florentin-Lee, portfolio manager of Lazard’s Global Sustainable Equity Select fund, says there will be a move to a more sustainable future, and this will affect demand across all sectors.
Some effects will be clear – such as the shift from fossil fuels – while others might be less obvious, such as the need to make manufacturing processes more efficient.
Key points
- Technological advancements are assisting sustainability
- However, they could cause a lot of disruption
- Companies need to adopt more ESG-focused policies
However, Mr Florentin-Lee says this shift will bring with it more eventual changes, which fund managers will need to consider carefully.
He explains: “For example, if new technologies enable the more efficient use of raw materials and energy to manufacture a car, will this result in lower prices for cars, which in turn boosts overall demand for cars and thus ultimately an increase in raw material and energy consumption?
"Or will car manufacturers retain that production efficiency for themselves in the form of higher profit margins, along with lower raw material and energy consumption?
“Simply adding a sustainability overlay on top of the standard analysis will not work.”
While such technological advances might create opportunities for some companies, this could prove disruptive to others.
As a result, he says the active fund manager can create value by navigating these trends.
Driving growth
David Winborne, global equity fund manager at Impax, is another investor who sees the pace and scale of technological change as a fundamental driver of the growth of sustainable investing in the years to come.
He says: “Technological improvement is a critical enabler of the transition to a more sustainable global economy.
“Firms are able to achieve often quite profound efficiency improvements by harnessing such innovations, including rising productivity, more operational flexibility, lower energy consumption and reduced waste.
“This is increasingly being recognised by equity markets, with common outperformance for well-positioned firms appropriately utilising such technology.”
Tech here to stay
David Harrison, who runs the Rathbone Global Sustainability fund, says: “We view technology as a key driver of sustainability in the medium and long term.
“Sustainable technology companies represent a significant exposure in our fund. Every business will continue to become more digitally focused and we believe it is still very early in this process. Areas such as design technology play a pivotal role in reducing waste, carbon emissions and improving safety.”
He notes one area is in automobile testing – by using automation better, car manufacturers can reduce the need for physical crash tests.
Mr Harrison adds: “Quite simply, technology is driving change in all industries.”
Cash flows
Michael Crawford, chief investment officer at Chawton Global Investors, says: “The value of an equity is based on the future cash flows generated by the underlying company with the majority of that value comprised from flows many years into the future.
“If the trajectory of those cash flows is perceived to fall or rise, it will have a significant effect on the current share price. We have already seen the impact of this on the values of fossil fuel producers where cash flows may decline materially.
“In contrast, companies with technologies that enable energy efficiency are increasingly considered to have greater longevity and growth, resulting in perceived rising cash flows.
“This can be the case even where the actual technology deployed by companies is equally advanced.”
Many companies, particularly in the technology sector have benefited from the low interest rate and benign economic conditions for much of the decade prior to the Covid-19 crisis, and while interest rates have subsequently been cut further, the availability of capital for loss-making or early stage companies is likely to be constrained by the deteriorating economic outlook.
Colin McLean, equity fund manager at SVM, says the present crisis will have a negative impact on all sorts of companies with high levels of debt, but adds the political and societal change that will come as a result of the virus will be beneficial to sustainable companies.
He says: “Stock markets will help with refinancing distressed listed companies, and banks will feed finance to badly hit small and medium-sized businesses in the broader economy.”
And, as the job of incentivising sustainable business structures is a political one, there will soon be the opportunity to make change.
Mr McLean says: “Investors must take to task boards that incentivise bad behaviour and companies that have behaved badly during the crisis. Some businesses have been much too quick to dump employees onto state support, when other adjustments might have been made.”
Data from Morningstar (see table) shows that sustainable equity funds have outperformed non-sustainable funds during the Covid-19 crisis.
Morningstar’s Hortense Bioy, director of passives and sustainability research, says: “The fact that sustainable funds on average held up better during the sell-off can be explained by a combination of factors.”
Firstly, being underweight in traditional fossil fuel industries, or airlines, will have helped ESG-aligned portfolios to avoid the significant losses incurred by these sectors in recent weeks.
She adds: “Traditional factors including quality, minimum volatility, and size would also have played a role. Companies that score high on ESG tend to be large well-run businesses that treat their stakeholders well, address their environmental challenges, enjoy more conservative balance sheets, and have lower levels of controversies. Many such companies tend to be more resilient during market downturns.”
David Thorpe is special projects editor at FTAdviser and Financial Adviser
