Sixth Industrial Challenge Poses Asset Allocation Challenge

Investors may have to view the transition to a zero-carbon economy as an overarching asset allocation decision.

George Latham, managing partner at WHEB Asset Management, was speaking to delegates at the WM Nexus’ virtual event ‘Multi-Asset Class Strategies in ESG and Impact’.

Latham said ‘the transition’ may increasingly elevate the decision to invest in impact to a strategic level, concerned with identifying which parts of the economy will thrive after the transition.

He said: “You need to think about which part of the economy will survive and thrive. That needs to be a strategic asset allocation decision, which you take before you think about what part of the capital structure - equity, bonds, infrastructure etc, to invest in.  For example, infrastructure investments can involve windfarms and railways, or motorways and nuclear power stations.”

“It means elevating the decision on which part of the economy to invest in from a tactical level to a strategic decision looking at total wealth, whether for a pension fund, an endowment or family office and whether protecting capital or seeking return over the long term.”

Bringing total wealth to bear

Latham suggested that in recent years, many philanthropic organisations, which have previously used traditional investment strategies to generate income to fund grants, have now realised that they can deploy their full financial firepower to make an impact.

“It has moved from five per cent working towards your mission and 95% either doing nothing or even working against your purpose, to instead bringing your total wealth to bear in pursuit of your mission.

“From grant giving to loan making to making investments. You can now ask - how can I bring impact investing to every asset class?”

For those not countenancing such a radical shift yet, there are other approaches.

The single strategy offered by WHEB has a very high active share, which Latham says can sit alongside a passive strategy while impact can also be a theme in a core-satellite approach.

The mission of the firm and fund is “to advance sustainability and create prosperity through positive impact investments”.

Setting this in wider context, Latham said: “At the core of our strategy is our belief we are in the early stages of an industrial transformation.

“We have seen successive waves of change since the industrial revolution. We are still experiencing aspects of the IT and Telecoms revolution, but the 6th will be the transition to zero carbon and sustainability.

“That is a necessity, with eight billion people and growing, who all aspire to higher standards of living. Growth has been linked with increased levels of resource consumption. We need to break that link and reshape the whole global economy.

“We invest in companies enabling and benefiting from this major economic change. We want companies that are part of the solution.”

He said the modern world has now experienced what a societal crisis feels like which is not only driving the search for treatments and vaccines for Covid-19 but also solutions to the climate crisis and other global challenges.

“By focusing on companies solving long term sustainability challenges and having a positive impact on the environment or society around the world, we tap into a universe with structural exposure to growth.”

The firm applies filters to take the universe from 28,000 stocks available on the main global markets to around 700 and 800 consisting of those whose products make a positive impact.

At least 50% of revenues must come from products and services delivering positive impact to make this list, though the impact for stocks eventually selected for the portfolio sits at around 85% of revenues.

Looking at that broader universe of shares, head of research and partner Seb Beloe divides it into three groups. In the impact bucket, firms provide solutions and that is where WHEB selects stocks.

The biggest bucket involves companies that are transitioning and includes acknowledged ESG leaders such as Unilever or Apple.

“Yet ultimately Unilever are selling soap and ice cream and they do not provide a solution to sustainability,” he said.

The final group including fossil fuel stocks comes with a warning that they are at risk of “permanent loss of capital”.

They make up a considerable 20 per cent of available shares, though that percentage may be falling added Beloe.

Themes and SDGs

He said the fund focuses on a range of environmental themes – cleaner energy, environmental services, resource efficiency, water management, and sustainable transport with broader societal themes of health, safety, wellbeing and education.

The current 49 stocks held will not necessarily cover all of them at any one time – for example - education does not always have a stock of the right profile.

The investments also directly address seven of the UN sustainable development goals with some cross-over to others.

Holdings include Aptiv, which sells components for electric vehicles, Arcadis on climate adaptation while TPI composites make wind turbines and bodies for electric buses. “The key dynamic is companies enabling and benefiting from the transition, and revenue growth in lock step with that change,” said Beloe.

As part of its research, the asset manager uses five questions to assess impact adapted from the increasing body of research into impact investing. These are -

1. Who is the client and how vulnerable are they?

2. How critical is the impact to the client’s future fitness?

3. How central is the product or service in delivering the impact?

4. How large is the positive impact?

5. How unique is the company’s contribution?

It scores the categories to create an impact intensity score.

It is also shared with investors in several ways in maps, reports and a calculator on the WHEB website that allows an investor to calculate the impact achieved for the investment they have made in terms of energy generated, clean water distributed, emissions avoided and more.

WHEB also applies ESG factors partly to find good quality management teams and well-run firms, though it eschews ESG ratings.

Beloe said: “We also look at ESG but we don’t have a separate ESG rating, which we think are rather spurious, but the underlying data is interesting and we score it 0-10 to give a quality score and another data point.”

It also combines this with more conventional analysis to understand how a stock is performing and whether it offers sustainable growth at a reasonable price - a discipline to ensure they are not overpaying.

“We don’t have price targets but use this to compare and understand the context, how does the pe multiple compare to its peers, what is the history compared to the wider market and we use this to triangulate and determine whether the valuation is reasonable. If it is reasonable, then we will look closely. If it is expensive relative to history and the market, we are less interested.”

Long holding period boosts engagement

On engagement, the firm says it has a lot of firepower partly due to the fact that its average holding period is five to seven years.

Latham added: “We have four analysts, each responsible for 12 to 13 firms. Each person covers the stocks for 18 months and they are responsible for the engagement as well. Those making buy and sell decisions should also be involved in the engagement process so that it is a holistic conversation.

“We vote our share every year. If we vote against, we explain why and that may lead to more engagement. If our policy isn’t followed, we can vote against the chairman. We assess our engagement as either successful, partially successful or unsuccessful and report that.”

Delegates then questioned the managers.

Where do you think the fund sits in relation to the EU’s taxonomy?

Beloe said: “I have mixed views on the taxonomy. It is very reductionist. You end up with 700 pages and it gets out of date, because the tech becomes out of date, and the new tech hasn’t been captured. Yet it is going to be important. We are looking at what proportion of our fund will be taxonomy-eligible. One analysis tool currently tells us we score 47. But with a lot of social impact stocks held, we don’t think it will be near 47. I hope it will be between 20 and 30 which actually would be a high number.”

Latham also questioned some of the taxonomy. He said: “Within our sustainable transport theme, we want to invest in some companies that make all types of vehicles more efficient, for example with a company that makes start stop tech that improves efficiencies. None of that will qualify. It is only EV. Smurfit Kappa making packaging more efficient won’t be included.”

How can you be distinctive given the big moves into impact and ESG?

Beloe said: “We have been doing this for what seems like forever. It certainly feels more crowded now. The way we differentiate is summed by the phrase that doing the thing right is ESG, but doing the right thing is Impact. For WHEB, it is not one or the other. We live and breathe this. Most managers are offering this as a niche. Though they see the wind has changed.”

Latham said: “We are a certified B Corporation, running a single strategy. We are not throwing mud against a wall to see what sticks or saying here’s a fashionable strategy to get AUM.

“Our independent advisory committee challenge the investment team on every holding in the portfolio. We have to justify the impact in front of that body and what is utterly unique is we publish the minutes.”

John Lappin is Contributing Editor at WM Nexus