Sustainable success: Six months after launch, BNP Paribas’ green-focused EARTH hedge fund is soaring

Ulrik Fugmann and Edward Lees, BNPP AM

Since launching last summer, BNP Paribas Asset Management’s Environmental Absolute Return Thematic (EARTH) hedge fund has generated a striking double-digit return, trading long and short positions in energy, materials, agriculture and industrial companies across both developed and emerging markets.

The ESG-focused strategy – which is managed jointly by Edward Lees and Ulrik Fugmann (pictured, above left with Lees), co-heads of BNPP AM’s Environmental Strategies Group in London – invests long in companies that are actively addressing environmental challenges, such as carbon emissions, waste production, and food, water and energy concerns. It then pairs them with short positions in unsustainable firms, or those names facing pressure amid environmental transition trends. It also employs general hedges to maintain a low net exposure.

Launched with USD77 million in mid-July 2020, the EARTH strategy today manages about USD270 million in assets. During that time, the fund has gained an eye-catching 62.96 per cent in its main institutional share class, and has already started 2021 strongly, rising more than 11 per cent in January.

Foundations

“It’s picking up some momentum now,” Lees says of the fund’s initial six-month run, which has been powered by successful stock-picking in fuel cell, hydrogen and solar names, as well as an early rotation into certain Asian positions.  The electrification of transportation has also helped bolster returns, while alternative methods of farming have provided additional investment ideas as the global farming system begins to transform itself.

“The shorting has also helped,” Lees tells Hedgeweek. “We’ve stayed away from some names that have had very high short interest, and which really got squeezed particularly nastily in January that caught out a lot of other hedge funds.”

Lees and Fugmann met at Goldman Sachs in London in the early 2000s, where they initially focused on equities trading before building a principal strategies group. There, they invested across the capital structure with a strong focus on natural resources, in both the green and brown spaces, in addition to developing quantitative processes.

They later left Goldman Sachs and originally planned to launch a green-focused hedge fund strategy themselves, with support from Goldman and backing from a family office seeder, before an eleventh-hour meeting with BNP Paribas Asset Management convinced them to pair up with the French investment giant.

“We met BNPP AM really quite late in the process,” says Lees, who began his career in 1994 at Morgan Stanley in New York, initially focused on investment banking and later private equity, before joining Goldman in 2000. “Here it’s a big business, with more infrastructure, and we saw that they could help us have a more of an impact and grow larger and faster than us doing it ourselves.”

The duo first launched a long-only, energy transition-focused fund in September 2019, which overhauled an earlier oil and gas-focused strategy which they had inherited when they first arrived at BNPP AM. They broadened the strategy’s focus to target a range of green energy themes, including transport electrification, industrial energy efficiency, and smart grids.

“We modelled out a new strategy to look at companies that were providing solutions for environmental issues, specifically relating to themes leading to energy transition,” Lees explains. “That fund was started with EUR120 million, and today we are just over EUR3.5 billion.”

Having successfully rolled out a long-only offering, the pair then set to work on launching the EARTH hedge fund, which tapped into their long/short investing experience. The strategy extends the long-only fund’s energy transition and decarbonisation focus with a broader mix of themes and trades encompassing land, water, air, sustainable food, plastics, recycling, and detoxification, among other things.

Building the book

While the long-only energy transition strategy comprises some 90-100 names, the long/short EARTH fund is typically made up of around 30-40 positions.

“EARTH is not just a collection of racy small caps; in fact, we try to tilt it a little bit more towards some of the bigger names,” Lees notes of the portfolio composition.  “A lot of the names would fall typically under energy, materials and industrials, but there are more and more technology stocks that are coming in to what we do. We’re not prescriptive about what sector or companies we can be in or not be in, but it does need to have an environmental solution.”

He describes the portfolio-building process as a “multi-disciplinary” approach, which brings together top-down thematic perspectives, drawing in government policy direction globally as well as macroeconomic trends, and fundamental stock selection.

“We narrow it down from sector dynamics and themes to the stocks themselves, which is where we spend most of our time,” he continues. “Ultimately, we do have a fundamental investment process that aims to pick good stocks. But it’s important for us that our stock-picking doesn’t exist in a vacuum, and is instead aligned as best as we can with what the big trends are.”

Underlining this point, he adds: “We’ve seen time and again people who are great stock-pickers identify a valid stock signal that unfortunately is just much smaller than the larger sector and macro signals,” he says.

The fund trades a wide spectrum of names across a range of market capitalisations. These include large industrial corporates, and certain smaller names that may not be making much money, as well as value stocks, particularly during the last six months, together with core yield stocks like utilities, and technological disruptors.

“We don't just invest in one kind of stock – we’re quite intentional in trying to have a diverse range of stocks that we hold,” Lees explains.

“We also try to use this theme of diversification across geographies - we have a lot in Europe, North America and Asia, and that’s shifted around as opportunities have presented themselves.

“For example, when China passed its net-zero 2060 policy in the second half of last year, we dramatically increased our ownership in China, where we’re now well above weight compared to the MSCI. We’ve been also adding more and more to Europe starting from late summer last year.”

Examining future opportunities, Lees sees increased growth in offshore wind, particularly in the US, as well as an acceleration in electric vehicle penetration.

“As every quarter that goes by it feels like people need to accelerate their view of when EVs hit that tipping point versus internal combustion engines,” he observes. “Battery storage is also clearly massive, and non-lithium-based battery storage solution is going to be very exciting. It’s worth keeping an eye on when green hydrogen becomes economically viable - I think there's enough money being thrown into technological development here that will make it hit a tipping point sooner than people think.”

He also points to the growing role played by governments in driving green policy, citing the UK government bringing forward its proposed internal combustion ban by ten years, along with recent tax credit policies in the US which benefit solar and wind.

‘Long green, short brown’

Lees maintains that long/short investing has always had a meaningful role to play across markets, but believes it was neglected as a potential contributor to sustainable investing in the past.

“Why does long/short have a role to play in sustainability? It enables people to believe in sustainability as well as allowing them to hedge against market downturns,” he says. “Sustainability, for all its merits, doesn’t always just go up - it can still be influenced by supply and demand characteristics, and have periods of time where it de-rates. So you can protect against that by hedging.”

As more hedge funds take a sustainable investing stance in their strategies, he says long/short strategies can also lean into an added alpha signal on the brown side by targeting companies that are being disrupted by newer green industries.

“You can also hedge out some undesirable parts of businesses that are in the midst of change. Not every company is perfect – some are in the middle, they’re trying to do things better, but they're not quite there yet,” he continues.

“When you have a long/short mandate, you can actually find a company which is transforming 30, 40 or 50 per cent of its business in the positive way, and you can short or hedge out that remaining part that's not changing at all. So you can effectively, in a synthetic way, isolate the good component of that company.”

He also believes the marked shift in investor sentiment towards ESG and sustainable investing in recent years – which he describes as “like night and day” – has helped support the green revolution within this specific corner of the alternative investment industry.

“It’s really changed a lot. There were always a number of ESG long-only funds, but it was very tough in particular on the long/short side,” he says, recalling one meeting with a potential investor who suggested ESG would not become relevant for “at least another five years”.

“We were just doing what we thought made sense, but from an investor standpoint it used to be a lot harder than it is today.”

While most sustainability-focused capital still tends towards long-only investments, allocators are starting to understand the benefits of going “long green and short brown”.

“This is not just a fad,” Lees concludes. “It’s smart to be investing in areas that have a huge amount of growth for the next 20 years, and there are ways that you can mitigate some of your risk. What’s different now is that there is now an audience for the sustainability-focused hedge fund, where there just wasn't before.”