ESG-related investments have been attracting attention and inflows amidst the coronavirus crisis. What might this mean for portfolios in a post-pandemic world?
Jens Peers, CEO & CIO of Mirova US and Portfolio Manager on Mirova’s Global and International Sustainable Equity strategies, shares his views on why ESG-related equity strategies held up well against global equity market indexes during the crisis, trends he is focused on post-pandemic, and ways his team’s investment process generates alpha.Why do you think ESG strategies performed relatively well during the COVID crisis?
I think by having a longer-term view, considering factors like governance and climate change, generally trying to avoid high environmental and social risks, you don’t tend to invest in some sectors that have significantly underperformed during the crisis – such as fossil fuels, aviation and tourism.
Likewise, we tend not to invest too much in banks in general either, as many banks still cause systemic risks which may also affect long-term performance. Also, we aim to avoid those companies that take irresponsible risks with their balance sheet by taking on too much debt. On average, that means ESG-focused managers may do quite well during a crisis.Have ESG scores been correlating with company performance?
There are many ways to look at ESG and there are many methodologies, too. So it is difficult to say whether a company is an ESG company or not, right? If you look at the big providers of ESG ratings, including MSCI, Sustainalytics and ISS, they all use the same data, but they all get to different conclusions. This makes it difficult to say if companies are really good ESG companies or not.
On average, the ones that score well on most of those methodologies have actually done very well during the COVID-19 crisis. That's also translated into the performance of many ESG-focused equity strategies, including ours.Could this resiliency lead to greater investor demand?
Yes, we are already seeing more allocations to ESG-related strategies. People are now more aware of the fact that ESG strategies can actually generate good performance. We've also seen that, during the crisis, ESG equity strategies have actually seen inflows while the non-ESG strategies on average have experienced quite significant outflows.1
At Mirova, we’ve had the same experience throughout the crisis, seeing our assets increase against some of our competitors that don't take an ESG approach.What investment themes look attractive for a post-COVID-19 world?
My view is that the world is still aging and we still have urbanization and climate change – even though we have seen the air quality and CO2
emissions improve as a result of a lot less economic activity during this pandemic. But those long-term themes are still going to be very important.
There are a few things, however, that we believe will change. We think we're going to see an acceleration of the digitalization of our economy. People are now familiar with video conferencing, working from home and ordering goods and services online. In addition, businesses that have not actually been very active online are starting to plan for that much more.
Supply chain management is another key factor. We have seen that Wuhan is a major global production center for many different industries, including many basic components for pharmaceuticals and the car manufacturing industry. Centralizing all your production centers into one specific city may actually lead to very important disruptions in your supply chain management. Companies that have a wider distribution or sourcing network compared to others will continue to benefit.
Furthermore, globalization from an emerging markets point of view could be under some pressure. Poorer countries, as well as the bigger industrialized countries, are going to focus more on local production and local consumption, going forward.What’s behind the resiliency of Mirova’s Global Sustainable Equity Approach during the selloff?
Because of the thematic choices that we make, the strategy has a few biases in terms of sectors and styles. From a style point of view, we have a small growth bias and a significant quality bias. In addition, we don't want to invest in companies that take irresponsible risks. We are significantly underweight in companies with high levels of debt, and in a crisis those debt levels are obviously bad for performance.
Secondly, we have no classic energy or fossil fuels, which has been one of the worst performers in 2020. The concurrent Russia–Saudi Arabia oil price war obviously pushed that sector down, as well. We also stayed away from aviation, tourism or luxury goods, which are all sectors that were very badly hit.What sectors have been the biggest contributors?
Healthcare is a sector we are very focused on due to major global trends under way. Because of this, our strategy has names that produce testing equipment used for COVID-19, and firms that are involved in finding a vaccine to eradicate the pandemic, as well as suppliers to hospitals for treatments and hygiene/sanitizer items. Within IT, we saw strong performance from companies active in cloud computing and the digitization of our economy, particularly from companies such as those offering online payment infrastructure. Additionally, while demand for energy has been lower, we’ve seen our renewable energy players involved in wind power do quite well relatively.Can you describe your investment philosophy?
First, we want to outperform the broad global equity market. We measure global equities by the MSCI World index. But we also want to do that with a much better environmental and social profile. In terms of performance, we think equity markets are taking too much of a short-term focus. As a result, they don’t see or don’t integrate enough of the growth opportunities. Yet they are supported by important long-term trends that are reshaping our economy and generating long-term return opportunities.
We also believe that ESG risks are not properly priced into the market. Indeed, unfortunately, we’ve seen too many examples of well-known companies with poor environmental, social and governance practices, where that risk had materialized and led to significant underperformance. Think about Volkswagen with its fraud, or Tokyo Electric Power with Fukushima – or BP in the Gulf of Mexico. There are many others across the world.How does your approach look to generate alpha?
There are four key distinct steps in our process. The first is to identify the long-term trends that will reshape our economy and the way we live over the next decade or so. Those companies that are well positioned in those transitions will outperform the ones that don't. We focus on demographic, technological, environmental and governance-related transitions.
After identifying the companies that we believe offer solutions for those long-term transitions, and that are well positioned to benefit from them, we analyze investment opportunities in great detail to make sure they have the right characteristics that we believe will create long-term value. These include high barriers to entry, strong competitive advantages, a well-diversified and strong management team and a strong financial structure.
We also focus on the ESG characteristics of a company during this process. Not only do we want to avoid investing in companies that take irresponsible risks, we are also convinced that by having the right ESG characteristics, a company may be able to generate even better returns. Many investors are ignoring this ESG information, which means that not all the information is fully factored into current valuations. We also invest only when we believe a stock is trading at a significant discount to intrinsic value and build high-conviction portfolios, focusing on our fundamental conviction and liquidity and upside potential of companies. This approach gives us many opportunities to generate alpha and outperform.Why doesn’t a company like Tesla fit?
Tesla is a difficult one to get through all the steps in our investment process. It’s a very thematic stock. There’s no doubt that our economy will be electrified going forward. Many of the products that have used fossil fuels in the past, like heating, transportation, autos, will actually move to more electric solutions rather than using fossil fuels directly. Tesla has been a fantastic company from the point of view that it has been a very important disruptor. It has changed the whole automotive industry. Where I do have a bit of an issue is on valuation and governance. We don’t believe Tesla is a very well-run company. It's been a company that had great vision from Elon Musk but has very poor social practices and governance around the management team. It's improving, but it's not to the standard that I would like to see.
1 Source: Mirova. Morningstar Data as of 06/30/2020.
Mirova is operated in the US through Mirova US LLC. Mirova was previously a division of Ostrum AM and benefits from around 30 years of experience in Environmental, Social and Governance (ESG) investing through Ostrum AM.
Investing involves risk, including the risk of loss. Sustainable investing focuses on investments in companies that relate to certain sustainable development themes and demonstrate adherence to environmental, social and governance (ESG) practices; therefore the universe of investments may be limited and investors may not be able to take advantage of the same opportunities or market trends as investors that do not use such criteria. This could have a negative impact on an investor's overall performance depending on whether such investments are in or out of favor.
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