Sustainable investing has been one of the fastest growing trends in global markets over the past two years. Investors need to understand how investment analysis plays a role in calling for sustainability in the markets.
Fundamental analysis makes it possible to estimate the value of a company in terms of income, production, costs and profits. Value investing sets the rules that weight the stock’s price against the estimated intrinsic value.
But what we know today about fundamental analysis ignores a long-term cost known as externalities in economics. Science has shown that industrial production that increases to meet the needs of a growing world population also generates greenhouse gases that warm the planet. This is a long term cost that someone ultimately has to pay, but is not currently reflected in the prices we pay as consumers. There is also plastic waste, pressures on food production and water supply as well as social costs such as income inequality and health risks posed by excessive production and consumption. The impact of industrial production or human activity on the biosphere is already becoming more visible with extreme weather events, droughts, disease and threats to food and water supplies.
Why Should Investors Care?
Investors will need to take these risks into account in their investments. The move is not new as many funds, especially outside the Philippines, have already started to integrate environmental, social and governance (ESG) risks into their investment processes. ESG, sustainable and socially responsible investing belongs to the spectrum of investment styles that take these non-financial and material risks into account in investment decisions.
There are two reasons. First, there is the risk of transition or the risk of a trend change to integrate sustainability. Whether we like it or not, global energy markets will begin to decarbonise their power grids. The private sector is likely to show the way. Access to finance and insurance for coal-fired energy companies and other fossil fuels is expected to be gradually affected. Green capital can avoid banks that do not adhere to a sustainable finance framework. The second reason is the risk of effects of environmental damage on physical assets. As scientists predict, the 1.5 ° Celsius trend will result in more extreme adverse weather events. While insurance can cover damage, the effects can spill over into other failures. The return of inflation as a threat to real yields is partly linked to the food supply affected by the disease. As recently as 2019, Metro Manila was hit by a water supply shortage with demand growth from urban centers exceeding existing capacity.
Where is PH in the global movement?
In our opinion, ESG and sustainable investing is still in its infancy here, but growing rapidly. ATR Asset Management (ATRAM) launched the Sustainable Development and Growth Fund (SDGF), an investment trust fund that selects companies based on their integration of the United Nations Sustainable Development Goals (SDGs) into strategies commercial using a proprietary scoring framework. The first of its kind in the country, the fund outperformed the Philippine Stock Exchange Index (PSEi) by 14.3% at the end of October. At the heart of the strategy is the analysis of non-financial sustainability data disclosed by companies with an overlay of profitability measures and quantitative methods.
The aggregate non-financial data of our SDGF companies over the past two years shows the effect of the 2020 lockdown. With a contraction in GDP (gross domestic product) of 9.6%, we have also seen a drop in emissions, of energy and water consumption and waste generation of 11%, 12%, 24% and 32% year on year, respectively. The reduction in economic activity in 2020 resulted in less impact on the biosphere and negative impact on communities and business profits. The outlook for the planet, people, and profits are intertwined.
ATRAM’s research on sustainable development has three key elements. First, there is an implicit correlation between research and development, innovation spending, and employment growth with returns. Unfortunately, most local businesses spend less than 1% of their income on innovation. Those who do tend to grow faster.
“Good” against “bad”
The second point is that the image is not necessarily synchronized with the data. Some may call it a form of greenwashing, but we see this as a tendency towards selective bias. We don’t think this is intentional but a consequence of the preference to report “what we did” instead of highlighting “what still needs to be done”. That said, investors may not see how well the cost of these externalities is built into the business. Investors should be aware of this natural bias.
The third is the alignment of values with respect to impact. There are clearly non-negotiable elements for investors, for example, the impact on health, such as lifestyles that promote cancer and disease, criminal activity and harm to others. However, some investors may label companies as “bad”, for example, carbon emitting or “good”, for example, low / zero carbon and focus on exclusion to maintain consistency with their values.
For funds that prefer to impact the carbon footprint, waste, food supply, etc., investors will need to understand the need to engage with both the “good” and the “bad”. There are tradeoffs and the desired impact of the integration may take time depending on the speed and urgency of the transition.
Sustainability is not just a one-off thing, but requires constant monitoring, intervention and adjustments. SDGF’s goal is integration, impact and returns. Going forward, ESG strategies could focus on aligning values and returns.
With the emergence of sustainable investing, the value of valuable investing is no longer just a number but also a vote of confidence, appreciation, and even gratitude from the community. INQ
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