As an industry, we are quick to label terms. We create barriers from our overt willingness to embrace jargon. The asset management world thrives on distilling ideas into marketable propositions. Asset management's widely accepted definition of sustainability is integrating ESG factors into company analysis, with the emphasis largely on Environmental. The absence of an overarching responsible approach undermines the importance of both the S and G. Stripping away said jargon, fundamentally it's about what a company does, and how it does it.
Sustainability requires broader and deeper analysis of what product or service the company is providing and how this output will affect society in the long term. Whether it's increasing our resource efficiency, reducing our enormous waste footprint, or managing workforce transition to a low carbon economy, there are often multi-faceted issues to address.
Combatting creative marketing
It's critical to assess both the materiality and intentionality of a company's approach, as well as the effectiveness of the firm's broader strategy and execution. Conversely, we need to guard against box-ticking and creative marketing, by holding both ourselves and companies to account for overstating the sustainable nature of an offering.
Sustainable products and solutions provided by our target companies address challenges likely to persist over years. Put simply, companies successfully providing solutions or products to some of the biggest global challenges are more likely to see demand profiles in excess of the broad economy, through the cycle.
No one-size-fits-all approach
All other things being equal, if the product or service is seeing above-trend demand, there is a greater chance of having a degree of pricing power - and with it, superior profitability. Moreover, we have regularly found companies with robust environmental policies that are enabling accurate measurement and effective management of their cost base, leading to superior and less volatile margin structures. You could say where it's measured, it's more often managed.
In terms of financial performance, back-testing data over long time horizons can be particularly supportive of this investment case. However, just because a company is creating a sustainable product or solution does not necessarily make it an attractive investment. While we would expect companies providing sustainable solutions to grow in excess of the economy over the long term, how well the market consensus anticipates this, and values the company accordingly, is a critical determinant in delivering superior, risk-adjusted investment returns. Often, high-profile sustainable leaders can trade at excessively full valuations, and hence be susceptible to multiple contractions if there is operation or competitive disruption.
Against the herd
Using our contrarian approach, we aim to identify those companies not yet recognised as sustainable leaders. This often takes us into areas where sustainable characteristics are under-researched. Typically, this leads to opportunities outside the large-cap universe and in regions, such as Asia, where there is a nascent focus on sustainable investing.
The demand for sustainable investment has increased significantly of late, but the suggestion from some quarters this is merely a passing phase or fad is misplaced. We are just beginning a journey to much wider adoption. What was originally seen as niche is now seeing significant client-led demand. We expect this dynamic to increase further as wealth transfers to a younger generation that has grown up with a values framework aligned with sustainable investing.
It's now not just a question of how much my portfolio will return, but how my portfolio is being invested. It's incumbent on us as responsible and sustainable investors to deliver superior outcomes on both fronts to clients over the long term.
David Osfield, portfolio manager of the EdenTree Amity International Fund