ESG-focused funds have rightly been receiving a lot of attention over the last 12 months or more, as institutional investors continue to analyse the impact their portfolios are having on the planet, and society at large.
ESG-focused funds have rightly been receiving a lot of attention over the last 12 months or more, as institutional investors continue to analyse the impact their portfolios are having on the planet, and society at large.
However, knowing what makes a good ESG fund is a tough proposition. Are managers truly seeking to generate alpha by backing the best companies from a sustainability standpoint, and shorting the laggards? And if so, what is the secret sauce when it comes to building an investment thesis, and using ESG datasets in a highly developed, proprietary fashion?
Not many managers can truly attest to having developed a sophisticated ESG screening programme but one fund that has been leading a charge on this is the 1798 TerreNeuve Strategy at Lombard Odier Investment Managers.
Arnaud Langlois, formerly of Brevan Howard Asset Management and Millennium Capital Partners, is the portfolio manager and a leading figure on sustainability trends.
As Langlois explains: “We think we add value through early identification of sustainability leaders versus laggards. We look to identify these opportunities by combining high-level thematic research on key sustainability themes with our own proprietary bottom-up ESG diligence framework that we have been using for over 10 years.”
Simplistically, Langlois and his team look to determine which companies are delivering products and solutions that address some of the major environmental and social issues of today, while viewing laggards as those who are misaligned with long-term ESG trends and have poor governance controls.
Easier said than done, one might think, but in this data-rich age we live in, it’s not simply accessing as much data as possible, it’s what you do with it. How is the data being funnelled, refined, in order to arrive at original conclusions on companies who might otherwise be overlooked by sell-side analysts?
Over the past 10 years, Langlois has been developing proprietary data sets, although the TerreNeuve team does use a select number of external data suppliers where appropriate.
Langlois explains that approximately 70 per cent of the data used in their sustainability rating framework is based on the team’s near 20 years’ experience. Key to this is knowing the right questions to ask companies.
“We find our due diligence process is quite different from a lot of our peers. They tend to maintain their legacy process around idea generation and as a box ticking or exclusion exercise, up-weight the top 20 per cent of their portfolio, reduce the bottom 20 per cent, based on the third-party data, and call themselves an ESG fund.
“For us, from idea generation to thematic research, sustainability is at the heart of what we do,” says Langlois.
Langlois is of the opinion that sustainability is no longer a ‘nice to have’ for investors but rather a key driver of alpha “and a central proposition to launching our strategy many years ago”.
Part of what differentiates the TerreNeuve team for their peers is how they use proprietary data to generate ideas in the portfolio, in addition to leveraging an extensive network of policy makers and industry experts, and conducting in excess of 700 management meetings a year.
Deep diving into sector-specific value chains is a big part of the Fund strategy, the objective being to understand the competitive nature of each value chain and identify the winners and laggards across various sub-sectors.
“On average, we have 10 different themes in the portfolio ranging from resource efficiency to evolution of circular economies, agriculture…it’s all encompassing. We look at sustainability issues across the full value chain – consumer, agriculture, environmental and chemical technologies,” says Langlois.
“For example, we are not just going long the main offshore wind farms; we are diving deep across the verticals of the value chain and seeking out what we believe to be the most cutting edge groups who stand to benefit from this next revolution in renewable energy.
“From the chemical manufacturers producing the polymers going into the wind blades, to the cable manufacturers and so on… we find there is value being overlooked beyond the headlines and scope of sell-side coverage, allowing us to identify less well-known names and build a truly differentiated portfolio.”
It is a full assessment of the value chain, from start to finish.
This singular focus on sustainability is apposite for funds like the 1798 TerreNeuve Strategy when one considers how regulation is evolving, especially in Europe with its hugely ambitious European Green Deal. The core aim is to make the EU carbon neutral by 2050.
According to Euractiv, an EU policy news site, the draft set of proposals includes EUR1 trillion of investments in building renovation, renewable energy, hydrogen, clean mobility and the circular economy.
For investment houses like LOIM, this is a huge opportunity to take advantage of some important themes that will develop over the coming years, such as building renovation (to reduce carbon emissions) and the growth of ‘smart buildings’. Within TerreNeuve’s ‘resource efficiency’ bucket, it currently has 15 per cent exposure to the EU Building Renovation theme.
Electrification of transport networks is another significant theme that is likely to play to the strengths of Langlois and his team. Currently, approximately 13 per cent of the fund is exposed to ‘clean mobility’.
The EU Taxonomy is an integral part of the European Green Deal, and is an attempt to define whether an economic activity is sustainable or not.
In a recent white paper, Langlois pointed out that based on the sectors reviewed by the Technical Group (which account for about 90 per cent of EU emissions), “our long book has close to 60 per cent exposure to Taxonomy aligned activities, compared to about 12 per cent for MSCI World”.
In his view, such positioning should lead to “a substantial tailwind for the portfolio in the coming months and years”, as investors start to do the work on the Taxonomy and capital flows according to its dictates.
“Over the last 12 months we’ve seen a lot of exciting new companies come to the market, especially in the Nordics where we have some fantastic relationships,” says Langlois, “but things have clearly accelerated in the US as well, as a result of SPAC launches. That has been a big driver of new businesses coming into the public market.
As he assesses the current market opportunities for the TerreNeuve Strategy in the midst of this SPAC activity, the focus is on maintaining investment discipline and sticking to the central value proposition i.e. not getting seduced by new companies IPO’ing at ambitiously high valuations.
“There are some really good businesses and management teams being acquired by SPAC operators. The issue is that in the first wave of launches last year, things seemed reasonable but in the latest wave, from Q4 2020 through Q1 2021, we have found more questionable business models brought to market and valuations have become extremely demanding for public market investors.
“The current market environment feels to me a bit like the early 2000s,” concludes Langlois.
And we all know how that ended.
