Sustainability Revolution can be the biggest driver of investment returns
Current economic model is not sustainable so it is necessary to transform how investment is conducted with the use of ESG criteria and tough evaluation of companies
Sustainability will drive future returns. We are on an irreversible path towards a more sustainable economic model that will fundamentally change how our economies work, reshape sectors and industries, and determine which companies survive and which fail. We believe this is now a reality all investors must face across their whole portfolio, regardless of geographic, sector or asset class exposures.
Sustainable investing is not a matter of product; it is a matter of investment philosophy, and we believe it needs to be embedded at the very heart of that philosophy. We are convinced that sustainability will be the best source of future returns for all investment portfolios, and therefore investing along these lines will be in their best interest.
Why sustainability matters
Our current economic model is simply not sustainable. Today, our approach to generating the economic growth that ultimately drives investment returns has a disproportionate impact on our social structures and the planet we rely on to survive.
We consume roughly 170% of Earth’s natural resources every year, and, given our population is set to increase by another 2 billion people by 2050, it is clear that we need to change our approach to economic growth.
This means we have to change how we do things, how we use natural resources, and what we expect to consume. And that transition will affect every region, country, industry, company and asset class.
This transformation is already underway and gathering pace. There is no hiding from this transition, which we refer to as the Sustainability Revolution. As stewards of the world’s capital, the investment industry must work more closely with the corporate sector to move towards more sustainable business models and practices.
A sustainable investment approach
When it comes to integrating sustainability into portfolios today, we take a three-pillar approach under which these pillars are interlinked and interdependent. If one pillar is taken away, the whole system will be much more vulnerable.
Our first pillar assesses the sustainability of the financial model which evaluates whether a company can continue to generate sustainable returns over the long-term.
The second pillar looks at the sustainability of companies’ business practices. How well is the company run in the context of its broader ecosystem of stakeholders? This is where environmental, social and governance (ESG) criteria is employed. In this respect it is critical that we collect, verify and aggregate huge amounts of high quality and diverse data.
This is the only way we can root out biases in the system, and get a true understanding of whether companies are genuinely transitioning to more sustainable business practices.
However, sustainability goes beyond just ESG. This is why the third pillar looks at the sustainability of companies’ business models.
As our economies continue to transform, how are different sectors likely to benefit? How do they need to change? Can coal continue to compete in a world where the cost of renewables is rapidly decreasing? How big is the stranded asset risk incurred by the company? What are the energy sources of the future?
Given the scale and pace of the Sustainability Revolution, we are constantly reviewing and improving our processes in order to identify the companies we believe are best-placed to benefit as our economies continue to transform. After all, the sustainability of a portfolio is only as robust as the data and analysis it is built on.
Driving change and delivering results
Historically, the dominant approach to sustainable investing has been to exclude certain sectors or activities from a portfolio. This is a values-based approach that remains valid where investors have a strong ethical belief they want to reflect in their portfolio.
For example, we have group-wide exclusions on unconventional weapons and essential food commodities because we just don’t believe these activities have a place in capital markets.
We have also seen a marked increase recently in the divestment movement around tobacco and fossil fuels, for example.
But it is important to realise two things: firstly, that values are not commonly shared across the global investment community. Because of this, there will still be someone else willing to buy the stocks another investor might want to exclude for ethical reasons. This has clear implications for the performance of the portfolio relative to a broad benchmark, for example.
The second aspect to bear in mind with exclusions, and this is perhaps particularly pertinent to fossil fuels, is that much of the innovation we need to drive the sustainability revolution will come from sectors and companies that are under the greatest pressure to change.
Of course, we have to be very careful that we are selecting companies that are genuinely aligned with the transition, which is what our three-pillar approach is designed to do.
In these cases, a best-in-class approach may be more effective in terms of positioning the portfolio for the transition, but also in signalling to companies what we as investors expect in terms of sustainable business practices and future-proof business models.
Thinking sustainably – finding people to power the revolution
To make the three-pillar approach work, we need both analytical skills as well as strong convictions. We also want people who have investment experience and who can bring us new methodologies and tools.
Data management expertise, and the ability to apply new approaches to gathering, verifying and analysing data, is becoming increasingly important.
Sustainable investing also means having answers to the qualitative and not just quantitative aspects to a company or issuer. A critical mind as well as strong judgemental capability are highly desirable qualities.
Therefore, we look to complement legal, economic, technological or quantitative backgrounds with competencies in history or philosophy. These skills can bring valuable perspectives on how companies will adapt, where and how consumer demand will emerge and how sustainability will be communicated.
When we put all these together, it becomes easier to see the sustainability revolution for what we believe it is - the biggest driver of investment returns in modern history. It will require us to fundamentally rethink sustainability, rethink investment and, in fact, rethink everything.
Patrick Odier is senior managing partner, Lombard Odier.
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