Value has faced several well-known challenges in the past decade. Low interest rates and weak economic growth have pushed valuation multiples higher for growth companies, due to both the duration effect and the growth scarcity effect.
These two macro trends worked in the opposite direction for value stocks, as did a third; ESG investment flows.
Goldman Sachs estimates that year-to-end of October ESG funds “received $120bn net inflows globally, while Broad Equity Funds experienced net outflows of over $125bn”[1]. This latter trend had the net effect of selling value stocks to buy growth stocks.
In the US, some of the biggest beneficiaries are ETFs following the MSCI USA Extended ESG Focus Index. Within this index, information technology accounts for 29%, a figure that does not include stocks like Amazon, Facebook, Alphabet or Netflix. Add in the internet/technology stocks and the index technology weight rises to c. 40%. Meanwhile, energy accounts for 2% and materials 2.4%[2].
As value investors we can have absolutely no influence on macro trends such as interest rates and economic growth. We are at their mercy. I do not believe this is true on ESG flows.
Value investors have ceded ground on ESG to ‘growth’ and ‘quality’ investor voices, but our approach needs to change. In my opinion, value investors should be playing a leading, activist role in promoting sustainable behaviour among corporates, and conveying this pivotal position we hold to the wider investor audience.
While many of the polluters are in the sights of value investors, thanks chiefly to the fact they are often ‘old economy’ stocks, they are far removed from receiving any of the ESG capital flows we see today. It is therefore value investors who have a huge opportunity in terms of impact investing, particularly in the crucial next decade when considerable action needs to be taken if we have any chance of meeting the aims of the Paris Agreement.
We have the potential to be a major part of the answer to climate change in financial terms because here, frankly, is where the capital resides and thus influence. The AUM controlled by value investors dwarfs that held in the official Impact Investing category, and these value assets can and should make a big difference.
Even more importantly, because of the industries in which we are involved, value investors are in a unique position to push for change. Take the extractive industries; with mining and energy it is much easier to follow the divestment path than to make a case for remaining invested.
The latter is what we need to do though, because a world in which we all divest from these companies, starving them of capital, won’t solve the problem.
If we take the mining example further, as it stands generating clean energy from wind and solar will require four to six times the amount of copper than fossil fuels require, while a medium sized electric vehicle contains two to three times the amount of copper than a comparable car with an internal combustion engine. Mining companies will need to deliver annual supply growth of around 4% to meet this copper demand arising from the energy transition, in an environmentally and socially responsible manner.
Meanwhile, while we long for the day when society can completely switch from fossil fuels and rely purely on wind, solar and green hydrogen, realistically this is many decades away, if ever wholly possible.
Energy companies must continue to meet our energy needs and they will do so, particularly the European majors, while moving to clean energy as they attempt to meet the goals of the Paris Agreement. The transition requires massive investment from the sector in the proven areas of wind and solar, and the majors are committing further vast sums for development areas, such as green hydrogen and carbon capture.
This isn’t about giving energy and mining companies a free pass to continue polluting in the interim. Now it is the job of shareholders, and those entrusted to represent shareholders, to ensure company managements remain on track with their plans, and to encourage them to go further and faster where possible.
There is a place for an immediate divestment focus within these industries, on coal, oil sands and in general those hydrocarbon assets located in the most environmentally sensitive regions.
In the medium term, the divestment focus should shift to how fast energy companies can switch their portfolios away from conventional oil and gas, while meeting energy demands. Companies like BP, which in September announced a plan to reduce hydrocarbon production by 40% come 2030[3], are making such moves.
Starving well-run companies like that of capital, when they are trying to be more responsible, is not the answer. In a world of soundbites and tweets, it is a commercially easier and less controversial route for fund managers and asset owners to take, but it may very well undermine the transition we need to make.
It may also cause those responsible companies to push those assets onto more unscrupulous owners who aren’t trying to adhere to the green agenda, a particularly unattractive outcome.
What we need instead is a grown-up conversation now. The world needs energy and metals, and it needs to combat climate change. The companies which generate the energy and mine the ore now, and have done so for decades, may have been responsible for much of the pollution we are trying to combat, but they are also at the heart of the solution. Cutting them out simply won’t work.
[1] Goldman Sachs Global Markets Division, November 2020.
[2] MSCI USA Extended ESG Focus Index data (factsheet as at 31 December 2020) www.msci.com/documents/10199/0bd7923e-e2d0-f83a-701b-2f9bfc03eb65
[3] https://www.bp.com/en/global/corporate/who-we-are/our-ambition.html
