Two companies ticking all the right boxes for this investor

If there is one acronym (and three letters) that can divide the investing community, it's ESG. Those in favour argue that you can make a positive impact on the world and achieve strong returns that are competitive even against non-ESG oriented investments. Those against the movement argue there is not enough standardisation in the space, and that these investments attract a premium which could be best described as debatable. 

What proponents and dissidents cannot disagree on is the inward looking nature of ESG investing. This, in large part, explains why Hari Balkrishna prefers to invest with an impact-oriented lens. 

Balkrishna, the portfolio manager of the T. Rowe Price Global Impact Equity - I Class fund argues that impact investing is a far more effective way to generate alpha and create positive, lasting change on the planet. 

In this edition of Expert Insights, he is going to share not just why but how the T. Rowe Price team work to achieve those goals on behalf of clients. And to prove he's not all-talk, he will share three companies which tick all the boxes.

EDITED TRANSCRIPT

LW: What is the difference between impact investing and ESG investing?

Balkrishna: Put simply, impact investing is investing with the mindset of generating positive environmental and social impact alongside a financial return. Make no mistake, it's not a philanthropic activity. It's about trying to find alpha in companies that generate positive environmental and social impact. 

The reality is these are companies, in my view, that have the winds attached to their sail in their business models and so a lot of them are incentivised from a consumer preference standpoint. If you think about consumers wanting more electric cars, their homes powered by renewable energy or governments incentivising these end markets. And a lot of these companies, in my view, have better top-line and bottom-line growth prospects in the index. 

And if we can pick those stocks well over time, I believe we can generate a positive environmental and social impact as well as generate a financial return. In terms of the difference between ESG investing more broadly and impact ESG investing is more inward looking.

So it's more looking at a company's own operations and the difference it makes in its operations and it takes more of a risk lens when investing, whereas impact is more about finding ESG opportunity. How can a company make a difference to the planet around it or how can a company make a difference to society around it? So it's more outward-looking from that standpoint.

LW: How do you see the outlook for impact-oriented investments?

Balkrishna: I couldn't be more excited on a multi-year view for impact-oriented investments. I think 2022 actually resulted in a lot of valuation compression in the market across the board. What I'd say is when you look at impact investing, we obviously traffic in some sectors more than others. 

And when you think about the broader market backdrop, my view is with interest rates remaining somewhat elevated for a period of time because I do think that wage growth still remains in pretty inflationary territory. So we've got that kind of interest rate backdrop with central banks, and I would expect pretty choppy waters in markets over the next year or a couple of years. 

In that backdrop, actually having companies that have very idiosyncratic levers, because they're delivering positive environmental and social impact, can generate 10, 11, or 12% earnings growth for years to come. 

I think that creates a very attractive backdrop for investing, and a lot of these companies are now trading at valuations that make them really interesting. 

So to give you an example, one of the companies we have a meaningful bet in, Thermo Fisher Scientific (NYSE: TMO), trades on 19x earnings for what we believe will be high-single-digit organic growth on the top line, low double-digit earnings growth on the bottom line, and again, has a really attractive valuation for something that can last for a long time. It's also pretty idiosyncratic and somewhat macro-independent as well. 

LW: What metrics do you use to evaluate potential investments for its impact?

Balkrishna: When we wanted to find something as an impact stock, it actually goes through a really rigorous test. So it's effectively a four-pronged test. 

Materiality: Is the company delivering a material impact to its business model? Material is defined as majority of revenues or profits aligned with one of our impact pillars. That's really important when it comes to greenwashing. So when you think about some oil and gas companies that might be investing in renewables for example, it's still a very small sliver of their overall revenue base. For us, it's really important to find companies that actually have at least the majority, and in many cases, it's 100% or 90% of revenues aligned with delivering positive and environmental and social impact.

Measurability: Can we actually measure the impact from these investments? So if it's a healthcare company, how many patient lives are getting impacted? If it's a renewable energy company, how many metric tons of CO2 equivalent are getting mitigated? 

Before we even invest, we would try to measure the impact and we would run these stocks through a pretty well-accepted framework that we call the five dimensions of impacts, looking at five aspects to find what the impact measurement actually is. And then we also publish an annual report where we attempt to measure the impact from every single stock that we've invested in. 

Additionality: The third test we look for is can we engage with the company and improve the impact through our investment? So we call that additionality, and the fourth test is about finding impact that's durable, resilient, and can go through market shocks. 

LW: What is a company that ticks all of these metrics?

Balkrishna: So when you think about a good example would be a company called Linde (NYSE: LIN). Linde operates in the industrial gas space. When you think about heavy industry across the globe, so whether that's manufacturing, or general heavy industry and factories, a lot of them need to decarbonise and that's actually one of the easiest way for us to get towards net-zero. 

Linde helps a lot of these companies decarbonise. So if you look at those tests we walk through from a materiality perspective, we classify roughly 60 to 65% of Linde's revenues as aligned with reducing greenhouse gases.

From a measurability perspective, 88 million metric tons of CO2 equivalent are mitigated by Linde and its customers operations. 

It's additional in the sense of we can actually work with the company and impart our views on them getting more ambitious on how much carbon can actually get mitigated and it's resilient because it operates in an attractive industry structure which we believe allows for the preservation of that impact and as a result, preservation of economic returns. 

From a stock standpoint, make no mistake like when we talk about impact investing, this is not philanthropy. So we genuinely find very attractive alpha opportunities in these companies. In Linde's case, there is a $50 billion clean tech opportunity lying ahead of it because of the US Inflation Reduction Act and the EU Green Deal. It trades on a low 20s P/E multiple for what we believe will be very defensive and resilient, possibly 10% earnings growth from here in addition to obviously getting some dividends. 

And so again, looking at the traditional tenants of investing around industry structure, good management, allocating capital well, and I firmly believe as a stock it really stacks up as well as delivering a positive impact.

Looking for more than just returns from your investment?

The T. Rowe Price Global Impact Equity Fund targets specific companies that not only make good economic sense, but also focus on making the world a better place for all. Find out more.

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