Last updated: 12:21 / Friday, 17 April 2020
Pictet Asset Management

Global Environmental Opportunities: Transforming Sustainable Investment

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Thanks to the emergence of a thriving environmental products industry investing to safeguard the planet no longer means sacrificing returns.

When it comes to investing in rapidly-evolving industry such as environmental products and services, identifying the most promising opportunities isn’t straightforward.

That is why investment managers of our Global Environmental Opportunities (GEO) strategy have developed a process that deploys both a scientific, rule-based framework and traditional company-by-company research to build their portfolio.

The first step in the process is to identify firms with the strongest environmental credentials. These are companies that neither make excessive use of raw materials nor generate disproportionate amounts of waste. Then, from this group, we seek businesses that specialise in the development of products or services that mitigate environmental damage.

In order to identify firms with these characteristics, we perform an ecological audit that establishes the environmental footprint of more than 100 sub-industries. This audit incorporates two novel measurement tools – the Planetary Boundaries (PB) framework and Life Cycle Assessment (LCA).[1]

The PB is a model that defines the ecological “safe operating space” within which human activities should take place.[2]

Developed by a team of leading scientists and economists, the PB framework sets ecological thresholds for nine of the most damaging man-made environmental phenomena (see chart). The model quantifies a set of boundaries, which, if breached, would endanger the environmental conditions that have been instrumental to human prosperity over thousands of years. For example, if the world’s supplies of freshwater are to remain stable, humanity’s total consumption of water must remain below 5,000 to 6,000 cubic kilometres per year. Similarly, the PB states, if carbon dioxide emissions are to remain within acceptable levels, the proportion of CO2 in the atmosphere must not rise above 350 parts per million.

Fig. 1 planetary boundaries

Pictet AM

Source: Stockholm Resilience Centre, Pictet Asset Management, as of 29.12.2019

The LCA, meanwhile, is a framework that is used to calculate the waste emissions and resource usage of each industry that makes up the global economy. The model analyses every activity in the production of a good or service: the extraction of raw materials, manufacturing processes, distribution and transport, product use, and disposal and recycling.[2]

In our process, we combine the LCA with the PB to construct a lens that can pinpoint industries with the smallest environmental footprint.

Here is an example of how the process works:

The planetary boundary states that the ozone layer should be 276 millimetres thick. For the ozone hole to begin to close, the world’s total emissions of ozone-depleting substances should remain below 6.6 billion tonnes per year. At the corporate level, this means that the threshold for the emission of such substances is set at 2.48 kg per USD1 million of revenue per year. Only companies whose entire LCA-based emissions stay within the Planetary Boundaries are eligible for inclusion in our investment universe.[3]

Such analysis is necessary because we believe most of the environmental reporting that is carried out today is too narrow or too subjective. The majority of environmental footprint models focus exclusively on manufacturing processes; they fail to take into account the wider ecological impact of, say, suppliers, or of the products and services over their entire lifespans. Take the car industry as an example. A car’s lifetime emissions are four to five times higher than those stemming from its manufacture alone. Just measuring the level of emissions during the car production process does not give a true assessment of automakers’ overall ecological footprint.

Once the LCA-PB audit is complete, the second phase of the process involves taking a deeper look at the core business of each company that is identified in step one. Here, our goal is to determine which firms are developing products and services that make a real difference in reversing environmental degradation. For each company we assign a proprietary “thematic purity” value, which indicates what proportion of a firm’s enterprise value (EV), revenue or EBITDA is derived from environmental products and services. For a company to qualify for inclusion in the portfolio, its purity value must be at least 20 per cent.[4}

These filters narrow down our investment universe to about 400 companies. Here, we then carry out an additional analysis to determine which companies in the universe meet the criteria defined by the PB. We then conduct detailed company-by-company research to identify firms with the most attractive risk-return characteristics. We use a proprietary scoring system, which takes into account the strength of the business model, management quality, valuation and operational momentum metrics. The ESG analysis is systematically integrated in this stage as well.

The result is a concentrated portfolio of around 50 stocks - each investment combining an attractive risk-return profile with a small ecological footprint.

Sizing the environmental footprint: Planetary Boundary-Life Cycle Assessment

Pictet AM

Source: Stockholm Resilience Centre, Pictet Asset Management

But our investment process does not end there. Our aim is to be an active owner of the companies we invest in. For this, we exercise voting rights through a proxy voting platform and engage with the companies to ensure they have the best possible governance structure in place. We believe this responsible form of capitalism not only mitigates risks but also leads to sustainable long-term capital returns.

Investors have long appreciated the need to protect the planet but also have harboured misgivings about the financial trade-offs that might involve. Now, thanks to emergence of thriving environmental products industry, those concerns should quickly fade. Protecting the environment and investing for capital gain can indeed go hand in hand.

Fig. 2 Actively engaging

Example of how we've engaged with a UK-based environmental utility company

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Source: Pictet Asset Management

 

Opinion by Luciano Diana, Senior Investment Manager in the Thematic Equities Team running the Pictet Global Environment Opportunities at Pictet Asset Management

 

 

[1] We use Carnegie Mellon University’s Economic Input-Output Life Cycle Assessment (EIO-LCA) database to quantify the environmental impact of 157 corporate sub-industries, defined by MSCI and S and P Global with its Global Industry Classification Standard methodology. For more, see http://www.eiolca.net/ and https://www.sci.com/gics

[2] Steffen et al, Stockholm Resilience Centre, September 2009

[3] We remove companies that are on our “black list” – consisting of companies commercialising controversial weapons, such as anti-personnel mines, chemical or cluster munitions from the investment universe

[4] The portfolio has an average purity score of at least 60 per cent

Read more on our thematic strategies

 

 

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About Luciano Diana

Luciano Diana, Senior Investment Manager in the Thematic Equities Team and running the Pictet Global Environment Opportunities at Pictet Asset Management

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