Investors face challenges finding opportunities among companies that don’t have a clearly defined transition pathway. But it can made more effective by a focus on the tangible investments being made by those companies, rather than listening too closely to pledges and targets that exist only on paper.

Investors that want to address the low carbon transition as a potential investment theme should build an investment process that helps them focus on tangible investments being made by companies, not just pledges made on paper, the Fiduciary Investors Symposium at Stanford University has heard.

Affirmative Investment Management sustainable credit specialist George Barnard told the symposium the first pillar of a research process for doing that is deep company-level expertise. The second pillar is a systems or whole-economy approach; and the third is “making sure that all of this is integrated into the investment process”.

Barnard said a deep research approach involves integrating often overlapping areas of investment expertise.

“The first and most familiar to us as investors is company-level expertise,” he said.

“This is an understanding of the company. Rather than from a fundamental credit perspective [it’s understanding it] from a transition perspective. We need to understand the plans, the targets…beyond just are they targeting X percent emissions reductions?”

Barnard said one of the hurdles to the low-carbon transition is scepticism about timeframes being unrealistic, or targets set and pledges made insincerely.

“We’ve seen a lot of net-zero pledges which functionally aren’t really worth the paper they’re written on,” he said.

But if that’s the elephant in the room of the transition debate, the key to solving it is to eat that elephant one bite at a time.

“One of the problems is that we’re dealing with a very large problem and we’re not breaking it down.

“When you look at transition as a theme, and it’s just this massive economy-wide problem, it’s very hard to engage with. It’s very hard to identify a company and say, you know, yes, this is a good candidate for the low carbon transition.

“So we also need to understand the tangible investments, the capital being deployed [and] the R&D going on in the background that will actually get that company to those targets.”

Barnard said some companies, industries and sectors have relatively clear transition paths but for others it’s less clear and considerably more challenging.

As an example, the production of aluminium can use renewable energy as an input to the manufacturing process, But on the other hand, it uses anodes that decay and release CO2 into the atmosphere.

“We know there’s a solution, in anodes which don’t degrade and therefore don’t release CO2 into the environment [but] we don’t know how to make them,” he said.

Barnard said engaging with companies in “in a constructive and robust way with respect to their transition plans” is key to identifying opportunities and investment targets and supplying the capital those entities need to make the transition.

“That requires an understanding of what those risks and opportunities are, it requires an understanding of what the potential future solutions are going to be, and whether they’re realistic, and in what timeframes. And that’s really the idea behind transition analysis.”

Barnard said a core component of any company analysis is the tangible investments being made and committed to, which can’t be rolled back or reneged on.

“We like to see robust targets and strategies, but they’re not as good as seeing that this car company is building a dedicated EV plant like they’re not going to not going to knock it down in five years, that it’s locked in,” he said.

“We like to see JVs with battery producers to build huge amounts of capacity. That’s the kind of thing that allows us to be confident in the longevity of that particular strategy.

“There is always uncertainty, and we have seen companies roll back on commitments, but we aim to be as confident as we can with the information that we have at the time.”

Affinity approaches transition finance from a fixed-income perspective, because that’s its background as a manager, but Barnard stresses that the strategy need not necessarily be restricted to bonds. The genesis of the strategy was to consider what a 2050 economy looks like, and a realisation there are hard-to-abate sectors in the economy that re not receiving the investment they needed to effect a transition.

“We were looking at portfolios and thinking, there’s a need to address here,” he said.

“But when we were building that strategy to address that need, it wasn’t from the perspective of let’s go into a new asset class. It was [that] we do this, and we want to support our clients to generate the most impact they can, and to provide innovative new solutions to generate that impact. And that’s really where the strategy stemmed from.”

Barnard said the strategy has started to shift into private asset classes but is moving slowly as it gathers and assesses the quality of the data it needs to support its deep-research approach

“You’ve got to work out, okay, how do I digest this new type of data, this new availability of data?” he said.

“What levers can I pull to increase the availability of that? And so that process is ongoing, but it will, [and] there are there are challenges to solve that.”

A foundation stone of the transition to renewable energy is paradoxically a major contributor to the problem it’s helping to solve. How asset owners think about investing in a solution that is also part of the problem is a challenging and complex task.

Semiconductors are integral to the transition to renewable energy and the development of AI. But investors face a paradox when semiconductor production itself has such a large environmental footprint.

The energy transition and the growth of AI is inconceivable without semiconductors, Pictet Asset Management senior portfolio manager Luciano Diana told the Top1000funds.com Fiduciary Investors Symposium at Stanford University.

Diana said the question facing investors is whether semiconductors are a very simple enabler of the energy transition, or whether they a growing environmental problem, “and the answer is both, actually”.

“We do have a paradox, because they are crucial for the green transition,” he said.

“They enable electrification, decarbonisation and energy efficiency. At the same time, they have an environmental footprint which is growing very rapidly in-line with our data economy.”

That footprint includes the use of large quantities of water, and (perhaps ironically) energy consumption.

“Should an investor like me, a responsible investor, allocate capital to this important and growing industry? Should I avoid it altogether? It’s a very complex topic,” Diana said.

Diana said calculating the footprint of semiconductor manufacturing is complex and bedevilled by incomplete data and, in any case, only tells part of the total story. But the energy transition can’t happen without increased semiconductor production so Pictet applies two conceptual frameworks to its investment decisions. The first is the concept of planetary boundaries, originally developed by the Stockholm Resilience Centre.

“It comprises nine dimensions [including] climate change, biodiversity, freshwater, chemical pollution,” Diana said.

“These are all interconnected, it’s really crucial to understand this. And each dimension has a boundary that shouldn’t be crossed if we want to avoid nonlinear and irreversible change.”

(The Stockholm Resilience Centre reported earlier this month the six of the nine boundaries have already been crossed.)

The second conceptual framework is lifecycle analysis, which is an estimate of energy, water and raw material-related emissions that are associated with a product’s lifecycle. And the lifecycle analysis gives rise to the concept of a company’s “handprint”.

Diana said a company generates a handprint when it offers its customers a solution that has a lower footprint than business as usual. It is a positive environmental measure, and the bigger the better, and there’s theoretically no limit to a company’s handprint.

“This is the opposite concept to that of the footprint, where with the footprint we want to reduce it down to zero as much as possible,” he said.

“Here, we want to maximize it. And because it’s a difference between a baseline and a counterfactual scenario, measuring a handprint inherently is complex and cannot be done very precisely.”

This approach can, and does, give rise to scenarios whre an investor commits capital to a company it knows has a large and often growing environmental footprint, but for the sake of the role the company plays in reducing the footprints of others.

Diana says the aim is to identify and invest in companies that “only want to minimize their own footprint, but they also at the same time want to maximize their handprint on the rest of the economy”.

Semiconductors are a good example of this approach, and there are others. And while there’s been significant focus on the production of semiconductors, particularly as a result of heightened public interest in renewable energy and AI, Diana says it’s important to keep the environmental issues in perspective for two reasons.

“The first reason is that the emissions from semiconductor manufacturing alone are around 100 million tons of CO2 equivalent per year,” Diana said.

“That’s 0.2 per cent of the global total. But more importantly, this footprint of an industry doesn’t tell the whole story about the environmental impact that it has on the rest of the economy. It’s important and essential I should say to also look at the handprint.”

After a slow and steady research and development phase, the “big bang” moment of last year’s ChatGPT launch will kick off a slew of innovations that could rival the internet for their profitable application to investible businesses, says tech equity analyst Owen Hyde of Jennison Associates.

After a slow and steady research and development phase, Owen Hyde of Jennison Associates expected a slew of investible artificial intelligence innovations to come to market.

The New York-based tech equity analyst told the Fiduciary Investors Symposium at Stanford University on Wednesday that the launch of Microsoft-backed OpenAI’s ChatGPT tool in November last year was a “big bang” moment for institutional capital to begin flowing to artificial intelligence ventures.

“The question is how fast we go from R&D to production,” Hyde said. “I think it can be as big [as the internet] because it’s a new platform, in the same way the internet was a new platform you can build on top of.

“There’s fundamentally new capabilities that you can have when you’re able to generate text or generate images, and I’m not smart enough to be able to guess what all those applications are going to be. But I know we’ve seen some interesting stuff early on.”

Hyde, who was previously an analyst at JPMorgan, said the AI sector was on the cusp of a major innovation as “multimodal” applications – i.e. tools that can take multiple inputs and generate multiple outputs – begin to launch to the public, possibly before the end of 2023.

“Right now, we can see a handful of pretty clear opportunities in the app space but we think we’re also going to find out that there’s stuff that we haven’t thought of yet. And that’s where I am getting really excited because there’s opportunities.”

He anticipated that enterprise-facing AI applications would be the first serious investible proposition, singling out existing software providers who are able to help clients boost productivity by harnessing AI technology would be obvious early winners. But he said there were also plausible consumer use cases in the near to medium term, including personal assistants who might answer questions or assist with administrative tasks such as booking travel, although he added there may be a “behavioral” hurdle to consumer take-up of AI tools.

However he said the sector faced considerable regulatory risk, given its nascent status and government concerns about AI-generated misinformation or “hallucinations”.

“I worry about something happening that creates an issue for the whole industry and gives it a bad name,” he said. “And that regulation has to come in after the fact and goes over the top.”

He dismissed concerns that AI may replace many human jobs, which may create populist obstacles to its rollout, saying any serious discussion of replacement technologies for existing parts of the workforce were at least five years’ away.

And, even if it were to replace some menial tasks, Hyde suggested some economists and investors may welcome that development anyway.

“Employment growth may slow … but that’s somewhat healthy,” he said. “That might be a deflationary force in what has been a very inflationary environment.”

Breakthroughs in understanding the function of the brain have opened up a host of possibilities for expanding humanity’s perception of the world around us – and investable commercial opportunities are following the Fiduciary Investors Symposium at Stanford heard.

Humanity is on the cusp of being able to choose how it interacts with the physical world, raising the possibility that science can creating new senses for humans that will radically change how we perceive our cosmos.

Neuroscientist David Eagleman, adjunct professor in the Pysch/Public Mental Health and Population Sciences department of Stanford University, says every living organism has what’s known as “umwelt” – or the way in which it perceives the world around it.

Eagleman told the Top1000funds.com Fiduciary Investors Symposium at Stanford on Tuesday  that our interaction with the physical world is constrained by our biology. Our eyes, for example, convert photons into electrical signals, and the biology of the eye means it is receptive to only a small portion of the light spectrum. Eagleman says the colors we can perceive are only about one ten-trillionth of the available spectrum – which includes, microwaves, radio waves, x-rays, and gamma rays.

Eagleman’s insight is that the human brain is fundamentally a receptor of electrical signals, and that it doesn’t matter where the brain gets its those signals from, it will always be able to process them into something that enables us to interact with the physical world. But even though we think we see or hear the world around us, “the whole secret is you your brain is not directly hearing or seeing [anything]”, Eagleman says.

“Your brain is locked in silence and darkness inside the vault of your skull and all your brain ever experiences are electrochemical signals running around in the dark,” he says.

“And that it turns out the brain is really good at this, at figuring out patterns and extracting information this way, and eventually building your entire subjective cosmos out of that.

“The key point I want to make is that your brain doesn’t know and doesn’t care where the data come from, because whether that’s photons getting captured in these spheres in your skull, or air compression waves getting picked up on your vibrating eardrum, or pressure or temperature on your fingertips, it all gets converted to spikes – just these little electrical signals that are running around. And it all looks the same in the brain.”

Eagleman says the brain is an extremely good “general purpose computing device” – even though it is the most complex thing we have so far found in the universe, and still well beyond our capability to fully understand it.

“Whatever information comes in, just figures out what it’s going to do with it,” he says.

Eagleman says once the brain is understood in this way, it’s then possible to regard organs such as eyes or ears or the tongue as peripheral devices that convert interactions with the physical world into data inputs for the brain. And it’s a short leap from there to realise that other peripherals can then be created, which exploit the brain’s ability to make sense of the signals it receives.

These insights have already been commercialised, and there is more to come. For example, Eagleman created a jacket that could be worn by hearing impaired people, with converts sounds in their environment into vibrations they feel though their skin. It took a surprisingly short period of time – measured in mere hours – for an individual’s brain to start interpreting those vibrations as other people would interpret signals received from the ears. Smaller devices, such as wristbands, have now been created that do similar things. And Eagleman says the cost of producing a device that helps a deaf person “hear” is a fraction of alternatives such as cochlear implants.

A similar approach has been taken for people with sight impairments, and to help people who have had, for example, a leg amputation, to walk again more quickly by providing sensory feedback to them from an artificial leg.

“So those are some of the clinical things we’re doing, but what I’m interested in is how can we use a technology like this to add a completely new kind of sense to expand the human umwelt?

“For example, could we feed somebody real-time data from the internet and have them actually come to understand and have that become a direct perceptual experience for them?”

Eagleman says he has conducted experiments in which a subject feels a real-time feed of data from the internet for five seconds, and then two buttons appear on a screen.

“He has to make a choice…and he gets feedback a couple of seconds later, either frowny face or smiley face”, Eagleman says.

“And what he doesn’t know is that we’re feeding in real-time data from the stock market, and he’s making buy and sell decisions. We’re seeing if he can develop a direct perception of the economic movements of this planet.”

Eagleman has already commercialised some of his research, establishing a company called Neosensory to produce a wristband, used to address hearing loss and tinnitus.

“Neosensory spun out of my lab a while ago,” he says.

“We’re on wrists all over the world now. It’s been really exciting.”

The chief investment officers of three global pension schemes have told the 2023 Fiduciary Investors Symposium at Stanford University they are re-evaluating or reducing their exposure to the world’s second largest economy as tensions between the US and China escalate. But they are resisting total divestment to a country that still dominates emerging markets benchmarks. 

The chief investment officers of three global pension schemes say they are re-evaluating or reducing their exposure to China as tensions between the world’s largest and second-largest economies escalates.

Alison Romano, CEO and CIO of the San Francisco Employees’ Retirement System, told the Fiduciary Investors Symposium at Stanford University on Tuesday that exposure to the Chinese market had been a meaningful contributor to performance over recent years.

“When I joined [SFERS in June last year] the performance was very strong, based on a number of strategic bets,” she told the symposium, hosted by Top1000funds.com.

“We leaned into growth, we leaned into innovation, we leaned into China.”

But she said increased geopolitical risk attached to the market meant she is now re-assessing that portfolio exposure, which she described as overweight.

“Let me be very clear – we’re not throwing in the towel. But we are evaluating our risk-reward basis, there is increased risk,” Romano said. “We want to be very careful who they partner with to invest there, that they have on the ground knowledge or connections.”

She said analysts, experts and industry peers held a wide range of views on China, which made it difficult to come to a position on the appropriateness of its inclusion and weight in a well diversified portfolio.

The comments come amid heightened tensions between Washington and Beijing, with reports of diplomatic communications having faltered between the two world powers and conflict over maritime disputes and alleged espionage, most notably the incident of a suspected Chinese spy balloon over US territory earlier this year.

Mark Walker, CIO of the UK’s Coal Pension Trustees, told the symposium the fund had reduced its Chinese exposure from 15 per cent to 10 per cent of its public equities portfolio, under “pressure” from trustees and concerns about geopolitical risk. He said it would likely also reduce its private equity exposure to China going forward, but added that the country was too big to ignore or divest entirely.

He said he and his team were considering how to remain a neutral position in the escalating US-China tension, while also looking to burgeoning Southeast Asian economies that have large or growing populations and can provide alternative emerging markets exposure.

“We’ve absolutely not eliminated it, but we have downplayed,” said Walker, whose fund represents UK-based mining sector workers.

James Davis, CIO of $25 billion Canadian fund OPTrust, said the China challenge was symptomatic of a broader concern around pricing geopolitical risk, especially in developing economies.

“I am not sure I am being adequately rewarded for being exposed to China,” Davis said. But he said he had resisted eliminating the fund’s exposure to China because it still accounts for at least a third of most emerging market benchmarks.

He said divesting China would be difficult for that reason, arguing the case showed some of the flaws of an index-hugging approach to emerging markets investment. “Benchmarks are constraining; I personally don’t like them,” he said. “We follow the total portfolio approach, so we try to avoid getting caught in the benchmark trap.”

Table discussions of delegates to the symposium centred on geopolitical risk, with some attendees questioning whether China should be split out from other emerging markets when making asset allocation decisions.

 

CalSTRS has recognised the unique opportunity presented by the energy transition needs a unique response and its Sustainable Investment and Stewardship Strategies (SISS) portfolio has been specifically positioned to invest in opportunities that fall between private equity and infrastructure asset class buckets.

The SISS private portfolio which has made $1.4 billion in commitments since it was set up in March 2021, aims to take advantage of material sustainability-related economic and financial shifts. It targets three risk-return allocations across opportunistic climate infrastructure; venture capital/growth equity low carbon solutions; and hybrid/innovative climate solutions.

Setting up that fund structure a few years ago has allowed the fund to make the most of opportunities as they developed, according to Scott Chan, deputy chief investment officer of the $317 billion fund.

“If we hadn’t done that three years ago years ago with this approach, we probably would have missed out on opportunities we have now committed to,” he says.

The SISS portfolio is set to grow over the next few years to about $3 billion and is the beneficiary of a recent asset allocation change where 4 per cent from global equities was reallocated to direct lending, private equity and inflation-sensitive assets.

“We are finding opportunities in the transition are falling between risk and reward in private equity and infrastructure,” Chan says. “We have intentionally made a portfolio to navigate that so we can be flexible financiers. That is key to our success in the energy transition, we have built a team focused on the opportunities and have been pursuing that for the last couple of years, and we want to further that.”

Chan says the opportunities presented by the energy transition don’t necessarily fit neatly into existing asset class buckets or risk/return profiles.

“This could be significant as the energy transition evolves so we are lining it up. We are trying to own stakes and as it matures getting in position and creating the right structures,” he says. “It’s part of the playbook of the collaborative model… We’ve seen this story before and we are lining up our opportunities to capture it if it is very large and significant.”

The evolution of the portfolio is expected to follow a similar arc to the maturation of the real estate and infrastructure portfolios which has evolved to now be accentuated by direct lending and unique partnerships.

In real estate the fund directly owns operating companies evolving from original investment via funds through joint ventures (JV) and then direct ownership.

“This is heading the same way. Now we are in funds but we are trying to take general partner stakes with the best operators in the energy transition,” Chan says. “Eventually we will be so close to the partners as the industry evolves we will JV with operators and may end up owning directly. We want to create the right portfolio partnerships for being able to capitalise if that happens.”

Within the SISS private portfolio about 50 per cent is allocated to opportunistic climate infrastructure with a primary focus on clean energy and decarbonisation. It looks at sectors with existing commercial operating models but where capital is required to scale solutions. The sustainability real assets investments have structured downside protection and stable cashflows.

A further 30 per cent is in the hybrid/innovative climate solutions bucket with unique structures which might not fit into the other asset classes. It’s a blend of company investments and real assets that intentionally decarbonise heavy emitting sectors and are made up of a mix of growth equity and structured downside protection.

The remaining 20 per cent looks at venture capital and growth equity and technology-enabled low carbon solutions. Here the focus is on solutions not contingent on binary policy outcomes or subsidies and sectors with large emission profiles where end-users seek cost-effective solutions to reduce emissions.

The SISS portfolio, managed by Kirsty Jenkinson, sits in the “innovative strategies” bucket as part of the total portfolio asset allocation.

That portfolio returned 9.3 per cent over the year to June 2023, against a custom benchmark of 0.8 per cent. The three-year return is 11.3 per cent.