What a decade this was.
Filled with missed risks and misrepresentations, from Enron to credit default swaps, through rogue traders at Societe Generale to Tiger Woods, from internet and real estate asset bubbles to Worldcom, not to mention two wars, ongoing terrorist threats and on and on. That’s some of the bad news. The good news, of course, is that sustainability has risen as a methodological context that can guide us towards corporate and personal behavior that can lead us out of this age of excess and bloat, into a new age of managed growth & success. Of course, the other bad news is that science tells us that we are reaching the limits of environmental patience with our extractive ways. Again, the good news is that turning to sustainable practices is the way out. And so what does this mean for investors?
On the one hand, normal, mainstream investing, not surprisingly given all these minefields, has not performed well through this period. The S&P 500 is down for the decade just past, after a long, slow procession of upward movement for decades prior. Ten years starts to become a significant period of time to examine and consider. This, combined with the excellent recent performance of the BRIC (Brazil, Russia, India, China) markets, which have provided the outperforming funds of the last 5 years by far, focusing especially on China and Latin America, and we enter a world where the US is no longer the world’s single economic superpower. Rather, we are now one of three dominant regions, along with Europe as a whole, and developing nations (which unto themselves splinter into two blocs -- BRIC and the G77 -- as seen at Copenhagen). And so we now enter an increasingly competitive world, where innovation and education will drive future success.
Looking at the investment philosophies of the majority of assets under management in the United States, it is clear that there is a desire for business as usual, but this desire is not matched by this new global reality at hand.
We last wrote for GreenBiz.com on our vision of Sustainability 2.0, whereby sustainability can be seen as a contemporary risk factor across ESGFQ (environment, social, governance, financial (mainstream) and quality of management) factors, each of which can take away from the investable nature of companies. Combining this with using sustainability as a way of finding opportunities through innovation, and you start to develop a winning investment formula.
Yet looking at the largest fund managers, the so-called experts, including theoretically long-term investors Fidelity, Vanguard, TIAA-CREF, State Street, BlackRock/iShares, Capital Group, Wellington, AllianceBernstein, etc., and little to no focus goes on sustainability from an investment standpoint at these firms.
Rather, these investors as a group seem stuck on investing methods that brought them success, but in a very different world that we are now leaving behind.
And this is just a list of those who focus on long-term returns, or are supposed to. Hedge Funds and Quantitative investors beyond that, also do not largely factor in sustainability in investing, nor do sovereign wealth funds by and large.
Why is this the case? A generation of financial success, at least before the recent crisis, combined with built-in relationships and high fees is part of the explanation, but also the fact that sustainable investing is not well understood also clearly does not help.
All Things Considered
Sustainable Investing, as we wrote about for our book Sustainable Investing: The Art of Long Term Performance, and as reiterated in our recent UN PRI Academic Conference paper, represents an investment discipline that explicitly considers future social and environmental trends in financial decision making, in order to provide the best risk-adjusted and opportunity-directed returns for investors. By anticipating these trends ahead of the market, sustainable investing seeks to identify ‘predictable surprises’ that can help ensure shareowner value over the long-term.
This is in sharp distinction from the first wave of SRI (socially responsible investing) that is more values-based than focused on value (also see the UN PRI Academic Conference paper from Watson Wyatt for more on this) and has not led to outperformance. Classic SRI practice remains the largest block of SRI assets, hence the somewhat understandable meme that has risen that you can’t make money if investing to your morals. Yet other studies, such as ours, as well as Matthew Kiernan’s recent book, and studies from the more forward looking fund managers in Europe such as Robeco, show consistent outperformance from factoring in sustainability.
In our view, sustainable investing remains the investment opportunity of the coming decade, which, if switched to en masse, would unto itself create a race for capital among companies that would also ensure the innovations and efficiencies that the world now clearly requires. All good news.
As per our book above, we took a look at sustainable investing in practice on a global basis, and found outperformance for the 1, 3, and 5 years leading up to the end of 2007 vs. mainstream indices, and so in effect before the recent crisis.
Likewise, for the UN paper presented in Ottawa this fall, we found outperformance for the 5 years leading up to the end of 2008 (though 2008 was disastrous unto itself for all equity investment of course) as well as in the first half of 2009, and so before, through, and after the crisis, sustainable investment as a philosophy has begun to truly emerge.
Building a Sustainable Portfolio
And so, this past fall, we set out to teach the first half of a course within the finance track of the CERC (Center for Environmental Research and Conservation) unit of Columbia University, to discuss how one could best fuse the risks and opportunities inherent from aspects of sustainability into investing, with the overall goal of the class to build, interactively with students, a most sustainable portfolio. We believe this class’s positive focus on sustainability as an investment factor represented the first time a class like this has been given, which we are proud of, and thanks to CERC & Columbia for providing us with this platform, and especially to the students who contributed so much to the process. We hope to see other learning institutions follow suit.
The course brought interested Columbia Business School students, together with a wide swath of adults looking to learn how to best factor sustainability into investment strategies, while being mindful of environmental and other factors, again taking on sustainability as a positive potential influence. This therefore included individuals with a focus on conservation, as well as Hedge Fund, utilities, fashion industry and global supply chain professionals among others. This amalgam of backgrounds turned out to be ideal for the purpose of the course – building this consensus, maximally sustainable portfolio.
After an introductory session, setting the framework, the students were tasked to present the most sustainable company they could think of. We also had guest speakers ranging from the excellent Dave Stangis, head of Sustainability for Campbell Soup, to Dr. James Salo & Alex Lamb from Trucost & KLD respectively, who discussed their leading roles in creating the landmark Newsweek Green Rankings, as well as shareholder and sustainable investing advocate Steve Viederman, each of whom also contributed their thoughts regarding what a most sustainable company is or could be.
Little did they know it, as this was not at all the goal of the exercise, but the aggregate most sustainable companies presented and discussed, formed a portfolio that has outperformed the mainstream in 2009 by a wide margin. The idea was to select companies that are well run, innovating, and risk averse, as a learning exercise. Clearly, we were on to something.
The aggregate portfolio looks as follows (as of the morning of December 31):
| Ticker | Company | 2009 Returns |
|---|---|---|
| US Equity | ||
| AMZN | Amazon.com | +166% |
| AXP | American Express | +121% |
| AAPL | Apple | +149% |
| AMAT | Applied Materials | +39% |
| KO | CocaCola | +29% |
| FSLR | First Solar | –3% |
| GPS | Gap Inc. | +58% |
| GE | General Electric | –7% |
| IBM | Intl Business Machines | +59% |
| ITRI | Itron Inc | +7% |
| JCI | Johnson Controls | +53% |
| PLL | Pall Corp | +29% |
| TTEK | Tetra Tech | +15% |
| WMT | Walmart | –4% |
| Non-US Equity | ||
| 0494 | Li & Fung (HK) | +129% |
| RHAYY | Rhodia ADR (France) | +181% |
These 16 companies returned +63% as an aggregate portfolio in 2009 versus the S&P 500’s +25%, for an outperformance of a whopping 252%
Of course, this wasn’t the goal of the exercise, which was rather to identify most sustainable companies regardless of performance. However, it is these types of companies who may well be best positioned to drive the changes that the world wants & needs now. This portfolio is technology heavy, but that became a clear conclusion – that while looking for companies figuring to help drive the changes required, it is technology that figures to be a driver, as well as companies able to best innovate across the sectors.
We also put a few additional companies in a watchlist, and discussed other methodologies including identifying companies positioned to benefit from a new focus on sustainability, such as fund manager Parnassus performs with success, as well as going short companies that may be poorly positioned with little hope of success.
Jumping Jupiter
The global fund most considered a model sustainable investing practitioner was UK-based Jupiter Ecology Fund. This fund rose 53% over the last 5 difficult years, is up 376% from its launch, and most importantly, has had consistent management and focus. The largest two positions of this fund are Vestas Wind Systems and Cranswick – which were the same exact largest two holdings of this fund back in 2002, when I first started watching this fund, and this fund was co-founded by Tessa Tennant, a founder of the SRI industry, and someone who contributed to our book. We have found before that sustainable funds with low turnover tend to outperform those changing course, buying and selling frantically, or otherwise not picking stocks with successful consistency, and so while other funds take a sustainable approach, Jupiter Ecology seemed to best fit the concept, though our own efforts as above were not too shabby, Thanks again to the students for their contributions, and if you want an introduction into any of them, please let me know. They are an impressive bunch.
Sustainability is a shifting concept, without well defined global standards and practices, so any portfolio as above needs to be managed and reviewed constantly and carefully. This is good news, as a trained, watchful eye investing in and finding the answers of tomorrow, will ultimately benefit from being ahead of the curve. Is it any wonder that Warren Buffett has at last started investing in electric car companies and advanced battery technologies, after ignoring technology companies that he has long not understood, regardless of his significant investing acumen.
Of course, assets need to be examined and factored in beyond equity. The second half of our class will include additional leading guest speakers, and look at carbon as an asset class post-Copenhagen, water as a burgeoning asset class, alternative energy, energy efficiency financing, ecosystems, biodiversity, private equity implications, green real estate, all of which will continue to shape our portfolio from an asset allocation standpoint.
We believe sustainable investing represents the way forward and this is only a first demonstration of how this can be most successful. Bubble formation needs to be watched carefully. Any sustainable portfolio also needs to be mindful of the complete set of global opportunities and likely refocused at least a bit more overseas as a result. Going short on companies such as GM, which in mid 2008, traded for 16-18 dollars a share, had unsophisticated ownership (indexes only, no smart hedge funds, etc) and a doomed business model, made them in a word, literally, unsustainable.
And so why has the mainstream investment community not focused more on sustainability as a driving factor? You might want to ask your financial advisor that question. It seems clear that this is an opportunity waiting to happen for the likes of Fidelity, Vanguard, TIAA-CREF et al. They can be seen as the drivers of changes required and to the benefit of themselves and their fund holding clients. Or they can continue with business as usual, in a changing world that may leave their old ways behind.
And as we wish you a very Happy New Decade, the only question for these investors may well be – what are they waiting for?
Cary Krosinsky is vice president for Trucost, which has built the world's most extensive time series database of more than 700 emissions and pollutants as are generated by more than 4,500 public companies around the world. Cary is also co-editor of "Sustainable Investing: The Art of Long Term Performance," with Nick Robins, HSBC's head of Climate Change.