Since the emergence of “Modern Portfolio Theory” and the “Capital Asset Pricing Model” in the late 1960s, institutional investors have taken a quantitatively driven approach to portfolio construction, looking to create portfolio diversification and obtain better risk-adjusted returns by balancing their asset-class exposures. This journey has seen several important advancements in thinking about how to optimally achieve desired results.
Funds that want to take the total portfolio approach first need to get the total portfolio view. To do that they not only need data – and lots of it – but a rock-solid understanding of exactly how they’re going to use it.
‘Shiny objects and empty calories’ in sustainable investing
“There’s a lot of shiny objects out there,” says Brent Newcomb (pictured), president of US/UK-based sustainable manager Ecofin. “Sustainable investing is a very wide definition. Most managers, especially those that are of significant size, are approaching it by investing on the public side in companies that are cutting their carbon footprints and doing things sustainably. The top holding in most sustainable or ESG funds is Apple.”
“Many funds out there are allocated to Microsoft, Apple, Visa because these companies are doing things sustainably. But there isn’t anything about shareholder performance that’s going to come from sustainability. We’re far more interested in companies that are helping Apple decarbonise its global footprint than Apple itself.”
Ecofin – named for the “intersection of ecology and finance” – was founded in the 1990s in London as an environmental advisory firm before it began managing its own sustainable strategies across public and private equity, focusing on climate and social impact, as well as the water value chain. It was one of the first managers to win an environmental transition mandate from Norges Bank Investment Management (NBIM), the largest sovereign wealth fund in the world, in 2006.
“The connection between policy, government, sovereign wealth plans and even asset management frameworks in the Nordics is more intertwined,” Newcomb says. “It’s quite unusual for us in the US to see. But there was a lot of action in that space to make sure they were taking these proceeds and investing them for the benefits of helping the planet on the other side of all this.”
NBIM ultimately took that mandate in-house, at the end of a long process that saw nearly all investment management internalised. Environmental strategies were the last to go as pressure expanded from the environmental orientation of the mandates to simply bringing costs down. It’s a process that Australia’s biggest super funds are going through themselves, and that’s a tough proposition for managers like Ecofin, which has aspirations for the Australian market – it’s now represented Down Under by Rob Harrison and Steven Larkin of third-party marketer 3PD – but Newcomb argues that sustainable investing is a specialised area and requires a specialised touch.
“We’re an active manager so I’m a bit biased, but passive investing in these areas – climate-related investing, and particularly water investing – is not for the faint of heart,” Newcomb says. “There’s all sorts of empty calories and fool’s gold out there and investors are starting to see that. Things are never linear, and we’ve avoided the pitfalls of assuming that things are going to be linear.”
One example is the Inflation Reduction Act (IRA) in the United States. It has “massive tentacles” that extend into nearly every part of the economy, and its proponents argue that a rising tide will lift all (renewable energy powered) boats. But any time there’s an overstep in government policy and capital floods into a new space, Newcomb says, there’s going to be unintended consequences; companies and sectors and industries that won’t benefit “the way you think, or it will take significantly longer than you otherwise may think”.
Six months on from the passage of the IRA, green hydrogen companies – some of the most obvious winners from the legislation – have been some of the worst to own. While that might well change, obvious winners that could turn into unmitigated losers isn’t a phenomenon limited to just one part of the energy transition.
“There are great examples of solar manufacturing companies in China that, on the surface seem like terrific companies that have long pipelines,” Newcomb says. “In reality they’re some of the worst investments you can find. There’s nothing special about them; there’s no moats, poor management and very, very fierce competition.”
“You have to learn a new language. We have a lot of competitors that have come from oil and gas investing but in a lot of ways, climate-related investing is about understanding electrons and the economics associated with renewables and with batteries. Just general electrification is very new territory for people. It’s a space that will burn you if you don’t understand the history.”
“Climate change, global warming, water, pollution, diversity – we invest in solutions to all of them, we just happen to view them as great sources of alpha. If you’re a company or a project solving those issues it should be lucrative business for you. Either investors agree with us or are fiercely opposed to what we think.”
