Why ESG is where the smart money is heading

December 08, 2021 07:00

Livewire Markets

The trillions of dollars being spent every year on global sustainability will be one of the biggest factors driving investment returns for the next decade or more, says Alphinity global portfolio manager Jeff Thomson.

In this episode of Expert Insights, Thomson discusses who has been getting ESG wrong — he puts Activision Blizzard and Facebook/Meta in the naughty corner — but, more importantly, the inspirational stories of companies that are getting it right.

Neither of his examples — Schneider Electric and Partners Group — is well known yet in Australia.

The two companies operate in very different spheres but demonstrate innovative ways of aligning incentives and driving change while meeting investor demands.

Schneider, a French multinational, makes the electronic components at the heart of the technological revolution and has built ESG incentives into the remuneration of most of its employees.

Partners Group, based in Switzerland, is a private equity business driving ESG improvement through capital allocation.

Watch this short video or read the transcript for more on why Thomson is excited about finding the companies that are driving progress in ESG.

Edited transcript

Why should investors care about ESG and sustainability? Are they really losing out by ignoring them?

In our view, ESG is going to be one of the most significant drivers of returns over the next decade at least, and that, I think, comes in two aspects.

I guess there's a risk aspect of it, where avoiding companies with poor ESG is going to be critical. And I think there's probably two aspects, again, to that: One is a hygiene factor — companies operating well — and there's an underlying social licence to operate.

I think if you look back in the recent past, Activision Blizzard (NASDAQ: ATVI) is an example of a company perhaps that's got on the wrong side of that.

I think it started about six months ago when the CEO was awarded a $150 million pay package, which is quite generous, and obviously that raised questions for us.

More recently, there's been various harassment issues around the labour force, et cetera, and you've seen the stock underperform significantly. I think it's off about 25% this year.

I think you underestimate those risks at your peril. I think the other aspect is unsustainable businesses. I guess the most topical at the moment is fossil fuels.

The way we like to think about fossil fuels and oil prices is, if you think about a ping-pong ball bouncing down the stairs as being the oil price, and it has those periodic periods of strength — you're seeing one now — we know the end destination is the bottom of the stairs.

These are stranded assets, probably with a zero value, if not a negative value.

I think avoiding those is going to be really critical, but I think what is really exciting about ESG investing is the positive aspect, really, is just finding those companies that are leaning forward and trying to do something sustainable, and really innovating and driving the changes that we're looking to see in society.

As you know, we've got two strategies at Alphinity that seek to do exactly this, sustainable strategies, and whether that's in renewable energy, electric vehicles, et cetera.

There are some really exciting things happening at the moment, and there's trillions of dollars.

If you've been watching the COP26 news over the last several weeks, there's lots of really large figures, but the ranges vary between $2 trillion and $6 trillion per annum that needs to be spent to transition the economy, so that presents really exciting opportunities.

Which companies are doing it really well?

I think the one that I'd call out that's really impressed us is a company called Schneider Electric (XPAR: SU). French-based, it's a multinational company.

Schneider is a very large diversified manufacturing distributor of electrical products, which doesn't sound that exciting. But when you think about markets being EV charging and the transition of the grid into smart-grid, distributed storage, they've developed an innovative eco-structure platform which leans into the internet of things: sensors, cloud-based.

It comes with a very exciting value-add proposition. They claim this can cut carbon emissions by 50% and maintenance costs by as much as 75%.

Beyond that, we really like the operational ESG aspects. One thing I'd call out is, this is fairly unique as a company. They've got 58,000 of their employees, about 40% of their workforce, on an incentive scheme which has explicit KPIs around ESG.

These are disclosed and measured every quarter and drive as much as 20% of your remuneration, or your incentive remuneration. That's one company we are very impressed with.

Are many companies offering those sorts of incentives?

It's relatively rare. It's something that's very topical, and probably is the start of every conversation we have with a company.

And many companies are in various stages of looking at this, and in our experience, where companies have introduced it, it's generally at that top exec level.

It's very rare that you see those incentives permeating right down, and it's clearly something that we really look for, because I think we're all aware of the dangers of greenwashing, or even green wishing — where people tell a great story, but it's not really embedded in the culture.

So that's probably the first question we ask in terms of just how ESG looks in terms of corporate governance, and to the extent that it's actually driving incentives for employees, it's really critical.

Who's doing ESG well and who's doing not so well?

Generally speaking, the European companies are best in our experience. In my area, they're companies like Partners Group (SIX: PGHN), which is a private equity business, alternative capital business, Swiss-based.

Clearly, the asset management industry and financials generally have not done a great job at ESG and sustainability investing, but it's not that they can't.

I think there's a tremendous opportunity in terms of allocating capital and really driving that change, and Partners Group is one company we've been very impressed with. They're taking that very seriously, and particularly in that sort of private market, with that unlisted capacity, where they're taking long-term positions on companies.

They've got the ability to impact outcomes through being on the board, actually participating in management, and again, that's working really well.

On the negative side, I will caveat this by saying this is an active discussion and debate we're having. But at this point in time, we think Facebook — or Meta Platforms (NASDAQ: FB) as it has recently been renamed — is one that's perhaps on the wrong side of a lot of these debates.

I think that is due to various issues in terms of corporate governance. It's one of the few large tech companies that still has a sort of joint chairman-CEO in Mark Zuckerberg, but obviously also has also been associated with various controversies in terms of misinformation, product safety and health in terms of Instagram, and mental-health issues and data privacy. That's probably one that we think has got work to do, and we're fairly cautious about at the moment.