Sustainable investing’s new frontier

Freddie Woolfe, equities analyst, sustainable investing at Jupiter Asset Management, looks at how it is possible to generate long-term returns through sustainable investing and why biodiversity will be the industry’s new frontier.

1. How can sustainable investing drive investment returns?

The fundamental philosophy behind our global sustainable equities strategy is that those companies that actively seek to minimise their impact on the environment and maximise the value they create for society by promoting a more inclusive and equitable world are better positioned to generate long-term returns for their shareholders. Essentially what we are looking for is companies that are well-positioned to navigate the social, regulatory, legislative and technological shifts that are shaping the world we live in over the long term, and lead in the transition to a more sustainable world through what they sell and how they behave.

When we think about sustainability we do so from an understanding that investment returns are a function of a company’s relationships with its stakeholders and the world around it, and look to focus on those issues that have correlations with alpha generation and could present risks to future cash flows. Key to our approach is financial sustainability. Indeed, the first step in our process is identifying companies with fortress balance sheets, excellent cash flow profiles and durable franchises that result in consistent profitability. And we believe it is precisely those characteristics that provide the most solid foundation on which environmental and social sustainability is built.

2. How do you ensure that the companies you are investing in are having a genuinely positive impact on the world?

This is an extremely important topic and one which will only grow in importance as sustainable investing becomes more prevalent and scrutiny is rightly increasing on claims of sustainability.

Given that these topics are central to our investment cases, as you would expect we spend huge amounts of time to understand companies’ products and services as well as how their behaviours are contributing to sustainable outcomes, as part of our fundamental analysis in the second stage of our investment process. In order to ensure that our investment process is delivering the sustainability outcomes we seek, the third stage is essentially a sense check, where we make sure that every company in the portfolio contributes to three key sustainability frameworks: the temperature goals of the Paris Agreement, the UN Sustainable Development Goals and the UN Global Compact.

Now, one thing that we are saying is we do this work, but we know we need to be able to demonstrate it as well. So every year we publish an extensive Impact Report to provide transparency to clients about the outcomes for planet, people and profit, proofing that their savings are aligned with the strategy and allowing them to hold us accountable for the authenticity of the approach.

3. How do you ensure your investment process is robust, reliable, and repeatable?

We treat sustainability analysis with the same rigour as we do in any other aspect of our investment process, after accumulating decades of experience in sustainable investing. So in order to best deliver consistent outcomes for our clients, our approach to understanding the key sustainability topics and impacts for each company is embedded within the fundamental analysis we conduct and is core to our investment theses. The quality of our product depends on the robustness and repeatability of these processes.

One thing we do not do is rely on ESG rating; we use ESG as a tool, not for screening. We find it impossible to distil all the intricacies and nuances of sustainability analysis into one number or score, or at least not in a way that is useful for investment. Our proprietary analysis does not result in ESG scores, and we do not outsource any of this analysis to third parties either internally or externally. For this work to have the biggest impact, it has to be undertaken by those responsible for capital allocation - the investment team.

4. What do you hope to see from COP26?

There is a huge amount of changes riding on COP26. This is the decade for getting climate policy right, globally, and these negotiations are likely to set the tone for the next nine years.

One key area that we would like to see, and that will undoubtedly have a major impact on emissions, is carbon being priced more widely. Causing companies to pay for the costs of their carbon emissions, which are currently borne by society, is going to be crucial in incentivising them to switch to lower carbon and more energy-efficient operating practices as well as reduce the carbon emitted in the consumption and use of products. Having more concerted policymaking on pricing carbon is a key aspect of the Paris Agreement that needs to be finalised and put into operation. Combined with policies to support the development of low carbon technologies and require decarbonisation strategies for high-carbon industries, this should help to significantly direct more financial flows into areas that support a more sustainable world.

5. What do you think will be the next big topic in sustainable investing?

Biodiversity will be the next frontier for sustainable investors and it’s a topic which if we get it wrong, the impacts will likely be catastrophic globally. We know that 50% of global GDP depends on biodiversity, yet we continue to use nature’s resources much more quickly than they can be replenished. As the price of offsetting carbon becomes more expensive, I expect that companies’ impacts on nature will increasingly be seen as a cost they need to bear, causing changes in the way they operate and the impacts of their products. It is an exceptionally complex topic, touching upon many sectors and activities, but my hope is that many of the learnings from climate change negotiations will be able to be directly applied to natural capital, meaning that the policy landscape will shift much more quickly. We are already starting to see this with the rapid development of the Taskforce for Nature-Related Financial Disclosures (TNFD).

While all eyes are on COP26 for cutting carbon emissions, the less reported COP15 in China is crucial to setting out a new framework for a co-ordinated response to biodiversity. There will be much stronger efforts than before in promoting biodiversity, while former targets have broadly failed to have been achieved. This will, just as with carbon, present significant risks to some businesses but also some excellent investment opportunities in those companies that are seeking to lead the transition to a more sustainable world.

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