How to find sustainable growers in healthcare, mining and energy

Whether you believe in climate change or not, a growing group of investment leaders continue to trumpet the enormous opportunity offered by the transition to net zero (and are pivoting their portfolios, strategies and funds as a result). 

In fact, it's very likely the next generation of stock market winners will hail from this area of the market, with Mckinsey predicting that US$9.2 trillion is needed in average annual spending if we have any hope of reaching the Paris Agreement - US$3.5 trillion more than is being spent today. 

However, not all companies are created equal, and assessing potential ESG and climate winners can vary from sector to sector, State Street Global Advisors' Yvette Murphy said. 

"What is financially relevant and ultimately more likely to impact a company's long-term performance may differ depending on which industry that company operates in," she said. 

So in this Expert Insights video, she shares how to assess long-term sustainable growers with an ESG framework in mind, and opens up on how recent headwinds (such as rising rates and the war in Ukraine) have impacted the alpha of the world's climate change winners.

Note: This interview took place on Tuesday 2nd August 2022. You can watch the video or read an edited transcript below. 

Edited Transcript 

How does SSGA approach ESG investing?

At SSGA, we believe that ESG investing is about considering financially material elements in the investment process. And that can transcend styles. It can be active or passive, quant or fundamental or equities and fixed income. What may be material for one sector might not be material for another. 

The State Street Climate ESG International Equity Fund is not a high-octane green technology fund. This strategy is designed to own all sectors in the market with a prudent mis-weight to stocks and sectors that deliver core returns to investors. Climate investing is a long-term theme and we want investors to stay engaged and invested in the fund through this transition.

How does ESG relate to share price performance?

The one thing to remember about ESG investing is that it never occurs in isolation within an investment product. ESG is always considered in the context of a company. It's about the decisions a company makes with respect to its sustainable practices, its governance practices, and how it runs its business. 

What is financially relevant and ultimately more likely to impact a company's long-term performance may differ depending on which industry that company operates in.

So to give you a few simple examples: 

Energy companies

Energy stocks are very vulnerable to climate transition. And so measures such as what their greenhouse gas emission targets are, what their decarbonization trajectories are, and how they are investing in new technology - all these elements are likely to meaningfully contribute to how they return over the next five to 10 to 20 years.

Healthcare companies

Healthcare companies, on the flip side, have elements like data security, product quality and product safety, as well as access and affordability. Healthcare companies that score well on those metrics tend to outperform peers that don't. 

Mining companies 

Mining is another interesting example. Greenhouse gas emissions and transition plans are really important, particularly if they are at risk of having stranded assets, but as are things like ecological impacts and the relationship with the communities in which their mines operate. 

These types of things present severe potential ESG risks if not managed appropriately, and those risks can ultimately impact shareholder returns.

How does climate change impact financial risk? 

I think as we think about climate though, there are a number of clear transmission drivers that take climate risk and translate it into financial risk. I think let's unpack that a little bit. When we think about mitigation in climate, there is a number of transition mechanisms that impact company valuation, company earnings and company share price performance.

So let's start with countries setting global climate policies. We saw the events of COP-26, the big climate summit in Glasgow last year, really mobilise countries globally to formally set and commit to these climate targets. 

That results in stricter greenhouse gas emission targets for companies operating in those countries. That impacts operationally the companies that are there. That then impacts earnings and growth, which then can impact share price performance.

The easiest example to think of here is companies in either the mining or the energy sectors that have exposure to fossil fuel reserves. These fossil fuel reserves, the ore in the ground, they're considered potentially stranded assets, so that in 5, 10, or 20 years time when we move off those supply sources, those assets are worthless. So those types of companies, their price-to-book ratio is starting to look cheaper as the market discounts the value of those potentially stranded assets.

On the flip side, we have green technology companies, growth companies that have certainly recently attracted high price-to-book valuations. So let's think about the transmission mechanism here. We have countries setting incentives for green technology development. We saw US President Joe Biden release his green energy bill recently. So what does that do? That helps companies start or accelerate the building of green technology. It helps those companies then generate more green revenue, increase earnings growth, positive impact on share price. So these are very much long-term drivers of return. 

How have recent headwinds impacted ESG alpha? 

It would be remiss for me to not talk about the more recent experience. At the start of 2022, where we had a lot of short-term macroeconomic and geopolitical forces driving ESG performance. So I think that's really important to remember both the long-term and the short-term influences on assessing whether ESG adds alpha or not.

The Russia/Ukraine war and the resulting energy supply crisis were really positive for energy companies. They significantly outperformed the market and all other sectors. So many climate strategies that tend to be underweight energy lagged the market, they underperformed. 

Likewise, green technologies, the darlings of the transition, had a really supportive run in 2019/2020. But these are growth companies, and so in the rising interest rate environment that we find ourselves in now, growth companies tend to underperform because the future value of their earnings is discounted at a much higher rate. So we've seen those types of companies also lag the benchmark over the recent period.

Seeking climate exposure and capital growth?

State Street gives investors access to the most efficient trade-off between climate targets, ESG improvement, tracking error and diversification while seeking long-term returns broadly in line with the Index. 

To learn more visit their website.