Question: Is there a metric for determining where the maximum value lies in a sustainable asset value chain e.g. water supply versus treated water delivery?
Christophe: Good question. We think it’s really important for investors to understand the dynamics of an industry’s value chain, instead of looking at businesses in isolation. However, there is no single metric that can determine where the maximum value-added lies. There are a number of indicators that can give you some insights though. The first step is to identify the main segments of an industry’s value chain and the key players in each segment, looking at market-share for example. Once you’ve established proper peer groups, you can start to look at the return characteristics of each segment. One great indicator is to identify the ones that display the highest level of return on invested capital and free cash flow generation. These are two of the most important drivers to sustainable shareholder value creation over time. Other items you want to consider include pricing power, scalability at a low-cost and barriers to entry.
Also bear in mind that the value-added might migrate from one segment of the value chain to another over time. For example, what we are currently seeing in the wind space is pricing power moving away from component manufacturer (i.e. wind turbines) to windfarm operators. This is due to a slowdown in new wind installations and an over-supply of wind turbines. As a result, an increasing share of the value-added is shifting downstream for the next two to three years.
Question: This area is full of high risk start-up companies, many of which will fail. How do you decide which is the next big thing and which are pie in the sky?
Christophe: Thanks Marc, that’s a very important point. The three funds we recently launched in Ireland are long-only equity investments in publicly-listed companies, so our level of risk tolerance for unproven, emerging technologies is very low. That is to say we are not venture capitalists or private equity investors, who seek to take on a much higher level of risk to maximise returns. We would find it unacceptable and totally unjustifiable to our clients to be invested in companies that have a significant risk to go bankrupt. Still, that is not to say there are no risks involved in investing in public companies in sectors such as water and energy technologies.
In order to mitigate the technological risk, we only invest in companies that have a proven technology, a commercially-viable offering and a solid track record of commercialising its products/services. It’s also really important for us to understand the technology well. One of the things we aim to do systematically is to talk to the main customers to get their views on the product and understand how it creates value for them. This type of screening ultimately leads to a focus on mature technologies that have been around for decades, such as wind, solar and geothermal in the renewable energy space. Other technologies such as fuel cells, cellulose-based bio-fuels and tidal and wave power are examples of technologies that are firmly on our radar, but in which we would not invest at present given their current stage of development and risk profile.
As far as assessing the risk profile of companies, we obviously spend a lot of time looking at business fundamentals, balance sheet strength and management quality.
Question: When I think sustainable investing, I automatically think that it must be ethical investing too, but perhaps this isn't always the case (for example, I'm sure some of the oil corporations have sustainable investment interests but I wouldn't consider many of those companies to be ethical). What's your take on sustainable = ethical?Christophe: Over the years, market participants have used so many different terms that there’s bound to be some confusion about what really characterises this investment philosophy. All these terms - ethical investing, socially responsible investing, and sustainable investing - share common elements, but also have some key differences. A bit of historical perspective might be helpful here. The roots of this investment philosophy go back to the 1920s, when the first ethical funds were established in the UK and the US by religious groups, to avoid ‘sin-stocks’ such as tobacco, alcohol and gambling, to name a few. Companies engaging in such activities would simply be excluded from the investment universe on ethical grounds. In the 1970s, ‘socially responsible funds’ started to emerge. These introduced new exclusionary criteria that extended from purely ethical considerations to now include a sense of corporate social responsibility. In the context of the Vietnam War, such funds aimed to exclude companies that had direct dealings with the war. A decade later, they focused on corporations doing business in apartheid South Africa.
There are two main differences between ethical investing and sustainable investing. The first is a move away from purely ethical considerations to a broad range of issues that impact the creation of shareholder value in the long-run. And for us, that’s really what sustainable investing is all about. Making sure that we invest in companies that manage their business in order to maximize long-term returns. And increasingly companies are starting to understand that this doesn’t simply include financial considerations. It also includes things like corporate governance, how you manage your key stakeholders (employees, communities, suppliers…), how efficiently you utilise scarce resources and how you remunerate your management teams, amongst many others things. We make the general section of our assessment questionnaire publicly available on http://www.sustainability-indexes.com/07_htmle/assessment/infosources.html
The second difference is a move away from exclusion criteria to a method of positive screening. Instead of excluding certain sectors, this type of screening aims to select the ‘most sustainable’ companies in all sectors.
Coming back to your original question, we would argue that ethical investing and sustainable investing are really two distinct investment philosophies that use different methods and serve somewhat different purposes. However, investors should note that these two approaches are very much complementary to one another and exclusion screens are still the best way to put an ethical overlay on an investment universe. Let me know if you’re interested in knowing more about this. I could go into more details about why we favour positive screening versus exclusions, but I don’t want to bore you!
Question: Does investing in sustainable companies provide lower returns in a time of volatility such as now, relative to perhaps more established methods of investing?
Christophe: The first thing to mention here is that sustainable investing is still a fairly nascent investment philosophy and there is little empirical analysis that’s been done on its performance versus other investment styles in different market conditions. Bear in mind that most empirical research in finance generally uses 30+ years of stock returns, whereas the longest track records for sustainable funds barely go 10 years back. So, just a word of caution about drawing conclusions prematurely. Still, we can obviously get some insights from looking at the performance of sustainable funds over the past 12 months, a period of unprecedented volatility.
Below I’m showing the performance summary of the 3 funds we recently launched in Ireland; namely our water, energy, and climate funds. On that table, you can also see the performance of the MCSI World (total return in EUR terms), which is a good proxy for the wider equity market. The table displays performance figures year-to-date and then trailing 1 year, 3 years, and 5 years (when applicable). The performance figures are as of August 31st 2009.
As you can see, our thematic funds have had a tendency to underperform in bear markets, as shown by the trailing 1 year performance figures. However, our funds have outperformed substantially in up markets. Our energy fund, for example, is up more than 40% year to date, whereas the wider market gained nearly 12% year to date.
Overall, we’re very confident that our investment strategies will continue to outperform the wider market in the long-run, although they may suffer periods of underperformance, especially in bear markets. Coming back to your original question, it seems the jury is still out on whether sustainable investing outperforms or underperforms other investment styles over time.
Question: As equity markets have experienced a fair degree of turmoil over the last 18 months or so, how sustainable on long term basis are the sustainable investment products that are available to investors? What kink of returns have these funds been making, and what particular sectors are hot at the moment?
Christophe: Hi John. I’ve already answered the first part of your question above so I’ll focus on the sectors that we feel are particularly ‘hot’ at the moment in the energy space, the product that I work for. Within renewable power generation, many solar stocks have rebounded strongly over the past couple of months, and we feel many have reached fair valuations at present.
In the wind space, we’ve increasingly focused on the downstream (windfarm operators) as opposed to equipment manufacturers, due to a slight slowdown in new installed capacity. One area that we’re particularly excited about right now is geothermal power, a space that is currently undergoing a period of consolidation, which is supportive of valuations. Recent IPOs such as Magma Energy and Ram Power have also attracted an increasing amount of investor’s attention, something which is always positive for early movers. Another space we’re very interested in at present is electrical infrastructure and energy storage. Within the energy efficiency space, we’re still seeing a lot of investment opportunities in efficient lighting (LEDs) and insulation materials.
In fact, we’ve recently written a short document outlining the investment thesis for each of the key sectors we invest in within the energy space, and why we think their respective growth prospects look promising going forward. This can be made available upon request by contacting info@RaboDirect.ie
Question: What do I need to take part in SAM’s sustainable investing program? Can I do it if I am a citizen of Poland?
Christophe: Hi there. I believe there are no such restrictions to get into SAM’s investment products. Provided you’re an Irish Resident you should be able to set up an Investment Account with RaboDirect and start building up your sustainable investment portfolio. If you’ve any questions, you can always call the RaboDirect contact centre on 1850 88 22 22 or drop them an email at info@RaboDirect.ie and they’ll be able to answer your queries.
Question: Do these funds invest in green / not so green (nuclear technology) or are they all classed in the sustainability criteria?
Christophe: Thanks, your question comes close to that of Eddie’s about ethical versus sustainable investing. As I previously mentioned, we generally don’t put exclusion overlays on top of our investment universes, rather opting for the so-called ‘best-in-class’ approach. That is to say, we want to look at all sectors and identify the firms that are best positioned to manage sustainability issues versus their peers. Having said that, as far as both our Energy and Climate funds are concerned, we don’t invest in nuclear power. We might have a very small exposure to nuclear via some of the investments we make in utilities, but we limit those to a very small % of these firm’s revenues (less than 10%). The reason we don’t invest in that space is that there clearly are some serious concerns about nuclear power (e.g. waste management, security …) and we haven’t been able to identify any best-practices in managing such risks. So, the best-in-class approach we favour is hardly applicable in this case. And that leads me to the same conclusion as for Eddie’s question: exclusions and best-in-class approaches can be complementary to one another.
Question: What would a €5,000 annual investment generate in SAM at present trends?
Christophe: Hi there. Take a look at the two tables below. The first table displays the cumulative gain one would have been made by investing €5,000 in each of the three funds from inception. The row directly beneath each fund displays the cumulative gain one would have made by investing the same amount in the MSCI World instead, at the same date.
The second table displays precisely the same information, but expressed in average annual returns instead of cumulative returns. All return figures are as of August 31st 2009.
Question: Sustainable investing program is a great initiative and it is better to do something now rather than later. What are the costs of adapting key industries (i.e. oil) to new ways of producing the final product? Should G20 create\boost a ‘green fund’ pursuing new and greener initiatives?
Christophe: Good question. It’s quite a difficult one to answer without generalising though. Let me use an example to try to answer your question. When we think about climate change and all the technologies that are currently available to us in order to reduce greenhouse gas emissions, it’s quite important to realise that some technologies are more economically-viable than others. Have a look at the graph below from a McKenzie study. On the vertical axis, it shows the marginal cost of abating 1 ton of CO2 equivalent over the life-time of the installation. The horizontal axis shows the abatement potential of these technologies (i.e. how much CO2 emissions can we save by using these technologies by 2030).
As you can see from the graph above, there are quite a few technologies that have a negative marginal abatement cost. This means that over the life-time of these installations, you will actually save money. In the case of building insulation and efficient lighting for example, your savings will come from reduced energy consumption. In the case of fuel-efficient transportation, your savings will come from lower gasoline consumption. So, the point is that in making sustainable development a reality, we need to keep in mind that some technologies are more economically-viable than others. Investors and policy-makers alike should focus on these first. Now, that is not to say we should not consider the other technologies. As you can see from the graph above, most technologies are above the 0 cost line, which means putting these technologies to use in reducing our carbon footprint will cost money. And this is where economic regulation comes in. There are many types of economic regulation, some more pro-active than others. Hudson (2006) clearly summarises the different types of economic regulation below:
We favour the more ‘active’ types of economic regulation, and in the case of climate change this refers to the creation of a market for GHG emissions, on the basis of a global cap-and-trade system.
So, quite a difficult question to answer but my main points are as follows:
economics matter, even when dealing with sustainability, and
economic regulation can certainly play a part. We believe finance (i.e. sustainable investing) can be a very efficient mechanism in making sustainable development a reality.
Question: Does de-salinisation constitute sustainable water production?
Christophe: I’m not an expert in this field, but my colleagues tell me that at present, desalination is not really an option for sustainable water production because it is too energy-intensive. Currently, desalination operations only make economic sense if they are located next to power plants and use waste heat/power for the desalination process. There are also some issues related to the waste water from that process, which is extremely salty. But if we can make desalination less energy-intensive, it could well become a process to produce water in a sustainable way.
Question: Does de-salinisation constitute sustainable water production?
Christophe: At RaboDirect the minimum investment amount is only €100 and they’re offering free entry to all our funds until the end of 2009 (normally 0.75%) so you’ll get 100% allocation.
Question: Is there any guarantee against losses and are the funds covered by the government guarantee on deposits etc?
Christophe: You would be investing in an equity fund and the returns would be based on the underlying assets of the fund. That means there would be no guarantee as funds are not covered under the government guarantee scheme in the same way savings are, but you would be covered under the Dutch Investor compensation scheme in the very unlikely event of RaboBank going bankrupt. You can click on the this FAQ for more detailed information.
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