Cary Krosinsky, vice president of Trucost and co-editor and author of Sustainable Investing: The Art of Long Term Performance, recently presented at an Audubon-hosted event alongside Libby Cheney of Shell. Here he writes for conexust1f.flywheelstaging.com drawing on his presentation about the intersection of energy, the environment and the economy, and the implications for asset owners.
The intersection of Energy and the Economy – so was the title of the presentation given by Shell, at the September 29th, Audubon-hosted event on Future Scenarios: Energy and Economy, in Greenwich, CT. This event, to be available via delayed webcast shortly, addressed a wide range of topics, but fascinatingly enough, resulted in less disagreement than might have been expected on the paths ahead, when it comes to how we meet the world’s energy needs, while maintaining a sustainable planet, all of which create investment risks and opportunities.
Shell’s presentation was provided by Libby Cheney, now representing the oil and gas giant from a sustainable development standpoint, after introductions were provided, by Bill Baue of Marlboro College and Sea Change Media, who was the event organizer. Shell spoke to their 2050 scenario analysis (http://www.shell.com/home/content/aboutshell/our_strategy/shell_global_scenarios/shell_energy_scenarios_2050/shell_energy_scenarios_02042008.html), showing likely fuel mix required, in effect making Carbon Capture and Sequestration (CCS) a priority, much as questions remain on the effectiveness of such technology.
Interestingly, their scenarios did not call for a higher percentage from nuclear – something being debated heavily in the US Congress right now, as a way of forwarding a cap-and-trade bill. This projected future fuel mix, of course, is something which should be examined closely, when it comes to likely related government regulation, related funding whether stimulus focused or not, and how this will affect companies.
All of these scenarios create a variety of opportunities, as well as risks to consider, which was the focus of my presentation, which looked first at our book on Sustainable Investing, as well as the environmental/carbon risk analysis work we do at Trucost.
As we reiterated in our recent UN PRI paper available here http://www.unpri.org/academic09/agenda.php sustainable investing is an investment discipline that explicitly considers future social and environmental trends in financial decision making, in order to provide the best risk-adjusted and opportunity-directed returns for investors. By anticipating these trends ahead of the market, sustainable investing seeks to identify “predictable surprises” that can help ensure shareowner value over the long-term.
Deeply embedded in the ability to assess these risks, is garnering an understanding of the environmental impacts of companies that are owned by portfolios. Understanding the future carbon and other environmental risk scenarios that are playing out, and that will very clearly manifest in valuation and profit modeling going forward, is now essential, yet strangely neglected by many asset owners. Trucost has the only comprehensive database, covering over 4,500 global public companies, assessing the Scope 1 (direct operations), Scope 2 (purchased electricity) and Scope 3 (procurement and travel) of these companies, and goes into great depth in understanding the costs of these impacts, and how they will affect the future bottom line.
It is important to stress that we see these impacts as being potential generators of future alpha. We apologize in advance to quants who insist on backtesting our data to try and find alpha, which, in our view, is a futile exercise.
There has been to date no true global price on carbon emissions, but as that is to change in future, previous ways of finding alpha do not apply in this case, but will going forward.
The good news is that investing with carbon efficiency in mind has not affected performance negatively to date. In fact, as we demonstrate in our book and subsequent paper, sustainable investing has outperformed the markets for five years ending 2007 (pre-crisis), five years ending 2008 (mid-crisis) and through the first half of 2009.
All of this and more is why S&P has formed a US Carbon Efficient Index using Trucost information. In effect a carbon optimized S&P 500, this index takes these 500 companies, strips out the 100 least efficient on carbon, and then attempts to be as sector neutral as possible (maximum correlation to sector benchmark weighting, which necessitated some of the 100 being brought back in to the index).
The goal was a maximum 1 per cent tracking error, and this was achieved with 48 per cent carbon savings. For any large asset owner with a significant passive allocation in the US, we believe this is a compelling risk-adjusted, low-cost strategy. This index already has an ETF listed in London, and such is scheduled to be listed in the US once getting through the usual SEC red tape.
Similar work is underway with the IFC on emerging markets, which will result shortly in a carbon optimized S&P/IFCI Emerging Market carbon efficient index and related ETFs, which as you may suspect, is attracting interest from large asset owners for the same reasons.
Our Carbon Counts Asia report, issued in late 2007 in Bali, demonstrated clearly that there was a large variation on carbon intensity between Asian funds and companies as well, more so than in the US, and pending government regulation will put increasing pressure on the least efficient companies, hence the interest in carbon optimized passive strategies in the developing world.
Perhaps also interesting to note, while might seem slightly tangential, Trucost recently participated in Newsweek’s Green Rankings of the largest 500 US companies, and when looking at the bottom 10 in these rankings, an interesting investment pattern emerged, as first reported by Joel Makower of GreenBiz.com.
These bottom 10 companies were not owned to any significant degree by insiders, and the institutional ownership was largely passive. In effect, the smart guys have left town – leaving the unwitting trapped passive investors to ride the same path down that GM experienced.
GM had the same ownership profile in summer 2008, at a time when it was trading for $18 a share. Needless to say, shorting GM at that point would have been one of the all-time successful investments. We see variations on this theme emerging through not only long/short strategies in place with Deutsche Bank’s CROCI platform, but also hedge funds like GLG and others performing market neutral strategies with our environmental impacts data.
On the opportunities side, environmental services and related innovation is driving companies like IBM to outperform the S&P 500, so it is important to ensure that the investment perspective considers active opportunities with passive risk protection via allocation.
Our presentation went on to highlight the significant pressure on EBITDA that we see from a looming global price on carbon. If the Stern Report (widely considered the most respected mainstream analysis on global climate change to date) is to be believed, a global price on carbon would result in a change of business model for many industries, ranging from coal burning utilities, oil and gas and more.
See www.trucost.com for our free recent Carbon Intensity assessment of UK funds, performed with Mercer & WWF, as well as our other recent pieces of research on the carbon intensity of US funds performed with Lipper, and many others published over the years.
For example, in 2005, The Carbon 100 analyzed the carbon intensity of the FTSE100 companies, and found that six of the companies had over 2/3 of the footprint of the entire index. Trucost has been in business since the year 2000, and has up to seven years of comprehensive environmental impacts information on the companies it tracks, and stands ready to perform analysis for any asset owner concerned with risks it does not have a baseline understanding of in this rapidly changing world. This analysis covers not only carbon dioxide, but eight other greenhouse gases, water abstraction, and a litany of waste and pollution impacts including acid rain precursors and much more. Water is often considered the next carbon, but it isn’t frequently factored in by investors, much as the C-suite of companies in sectors such as food and beverage, have this right at the top of their minds. A lack of fresh water in the developing world is known to be hindering companies such as Nestle, Coca-Cola and others from maximizing profit levels, as they cannot expand as originally planned.
With environmental impacts creating other realities such as local resistance to new coal burning power plants, competition for alumni funding and students focused more and more on environment and opportunity/risk versus university endowment investment practice, lack of sustainable investment DC options for public company employees otherwise focusing on “going green”, and so much more, new questions clearly emerge. But most relevant for this readership is perhaps whether asset owners who rode the Great Recession down are ready for what may be the next “predictable surprise?”