Materiality + Performance = Impact
A New Paradigm for Green Investing
If you asked ten investors what the characteristics of a “quality” business are you would get eleven answers. Some would emphasize growth, others returns on equity and capital, and still others balance sheet strength. As they say, “that’s what makes markets.”
Similarly, there is no accepted definition or established set of criteria for what constitutes a “sustainable” investment or portfolio. In fact, an MIT study found that, “ESG ratings from different providers disagree substantially.”[1] A Harvard study went a step further noting that the disagreements among ESG data providers are not only large, but actually increase with the quantity of publicly available information.[2] Like “quality” sustainability means different things to different people.
We have observed that often what sustainability means for practitioners of ESG or sustainable investing strategies is avoiding rather than addressing environmental issues. If a company has significant greenhouse gas emissions or is resource intensive, it is put on a blacklist regardless of how it is performing on these issues. We started Sargasso in no small part because we did not share this definition of sustainability. In many instances we see the greatest opportunities to drive long term sustainability by investing in companies that have material environmental issues and, in our view, are having success in addressing them.
Materiality + Leading Performance = Impact
The Sargasso approach is simple: identify and invest in businesses that exhibit a material (i.e., significant) environmental impact and, from our vantage point, have a demonstrated record of performance in addressing those issues.
Materiality
While there are different ways of driving environmental impact, we believe that a good place to start is by identifying companies that are addressing a material environmental issue. For example, if you want to have an impact on plastic waste you need to invest with businesses that have significant exposure to plastics and plastic waste in their business and are taking concrete steps to address it (from disclosure, to recycling, to introducing plastic substitutes etc.). The same is true for water, deforestation risk, and other critical environmental issues. However, this approach is the opposite of the current ESG investment playbook which values avoidance: the lower the emissions or resource intensity in a portfolio the “greener” it is said to be.
Leading Performance
In 2020, as the Covid pandemic brought business activity to a standstill, global CO2 emissions declined by 6%.[4] “Peer Green Funds” were roughly in-line with the global average – with their portfolio emissions declining 5%.[5]
While materiality and performance are the central pillars of Sargasso’s approach, there are variations on the theme, and nuance is required. For example, we acknowledge geographic differences; an environmental leader in India does not look like an environmental leader in Finland. Further, we make a distinction between products and operations. Some companies merit inclusion in the portfolio not because of their operations but because of a product or service that is playing or will play a key role in a more sustainable economy. Therefore, some companies with modest environmental materiality in their own operations can have enormous influence beyond their four walls.
Finally, because the data is most robust and more easily standardized, we often use climate to illustrate the importance of materiality and performance. However, it is essential to find leaders across environmental areas: climate, water, forest, biodiversity, and waste and circularity. Investors who emphasize sustainability need to go beyond climate and identify leaders across these verticals because environmental issues are deeply interconnected. For example, nature-based solutions, such as avoiding deforestation and better managing ecosystems, can provide up to one-third of the climate solutions by 2030 to keep global temperatures increases under 2°C.[6]
The challenge is enormous but clear: As a world we must bend the global emissions curve rapidly and dramatically, reduce the rate of deforestation, stem the seemingly indomitable tide of waste, and find workable solutions for the growing number of areas in water stress. To us, the answer is equally clear: identify businesses that have material environmental issues and exhibit leading performance in addressing them. These businesses are offering the world a model on how we can, today, achieve true sustainability.
Again, we welcome your thoughts, comments, and questions which you can send to lbony@sargassoenvironmental.com.
References
[1] Florian Berg, Julian F. Koelbel, Roberto Rigobon (MIT Sloan, University of Zurich), “Aggregate Confusion: The Divergence of ESG Ratings,” September 28, 2020.
[2] Kotsantonis, Sakis, and George Serafeim, “Four Things No One Will Tell You About ESG Data.” Journal of Applied Corporate Finance 31, no. 2 (Spring 2019), P.50–58.
[3] To develop the Peer Green Funds dataset, we started with the over 1 million funds listed in Bloomberg’s fund database as of Aug 20, 2022. We then screened for funds that were environmentally friendly, global public equity funds. The specific filters we used are: actively managed funds that focus on public equities with >=80% of assets invested in public equities globally/internationally, domiciled in the top three global fund markets (USA, Luxembourg and Ireland) and represents the primary share class, and are characterized as environmentally friendly. We removed funds that had a narrow business focus (e.g., water business, energy efficiency). From the resulting list, we then selected the top 20 funds based on assets under management. For comparisons of environmental metrics, we use the top 40 holdings of the 20 selected environmentally-friendly funds.
[4] IEA, “Global Energy Review: CO2 Emissions in 2020,” www.iea.org/articles/global-energy-review-co2-emissions-in-2020.
[5] Current emissions are based on 2020 reported emissions either through CDP or company reports. For companies not reporting, emissions were estimated based on sales and/or comps. 2050 trajectory is based on science-based targets published by companies. For companies with no science-based target, no reduction is assumed.
[6] Griscom, Bronson et al. “Natural Climate Solutions,” Proceedings of the National Academy of Science, Vol. 114, No. 44, October 31, 2017. Research led by The Nature Conservancy and 15 other institutions. www.pnas.org/doi/full/10.1073/pnas.1710465114
General Disclaimers
This post is for informational purposes only and should not be deemed as investment advice or as a recommendation to purchase and/or sell any individual securities discussed in this report. We provide this information with the understanding that we are not engaged in rendering legal, tax, or accounting advice. Investors should consult with their own professional advisors for advice on any investment, legal, tax, or accounting issues. Further, this letter does not purport to be a complete description of the Sargasso Strategy and does not constitute an offer to sell, or a solicitation of offers to buy, any securities. While the investment team has experience managing client portfolios, the Sargasso Strategy has a limited operating history. Steinberg Asset Management, LLC (SAM) does not guarantee the achievement of long-term goals in the Sargasso Strategy. Past performance is no guarantee of future returns. All investing involves risk including the possible loss of principal.
The opinions, forecasts, assumptions, estimates, and commentary contained in this report are based on information provided to Steinberg on both a formal and informal basis which SAM believes to be reliable. However, SAM cannot represent or warrant their accuracy. The impact on SAM’s opinions, forecasts, assumptions, estimates, and commentary due to inaccurate information, incomplete information or information taken out of context may be substantial. SAM assumes no liability for errors and omissions in the information contained herein. Further, all opinions, forecasts, assumptions, estimates, and commentary in this report are made only as of the date indicated and are subject to change at any time without prior notice.
Discussions and calculations regarding potential future events and their potential impact are based solely on historic information and SAM’s estimates and/or opinions and are provided for illustrative purposes only. No guarantee can be made of the occurrence of such events or the actual impact such events would have on the performance of the companies described in this report.
Environmental Leaders: “Environmental Leaders” are determined by SAM based on proprietary analysis and include companies at the forefront of addressing material environmental issues, with targets and performance in line with established science.
Peer Analysis: References to peers are based on a proprietary analysis and identification of certain listed funds that self-identify as environmentally-friendly.