Correlated Confusion

Edinburgh was host to the Ethical Finance Conference last week where Nicola Sturgeon, Craig Bonthron and other famous names presented. One of the panels discussed ESG data issues and the misconceptions that the market has with ESG rating agencies. I found one point particularly interesting, around ESG rating correlations.

It’s true that we have pointed out rating agency limitations before and summed it all up in a previous blog (no consideration of product impact, market cap and regional bias, incomplete data and backwards looking). We often refer to examples of highly-rated tobacco companies making the cut in ESG funds, where investors hope their capital is promoting a better/healthier/more sustainable world.

But to buck the trend, I want to point out one criticism that I feel they don’t deserve and it revolves around the following chart…

This shows the correlation of ESG scores between two major providers – or the lack of. This has led some to ridicule ESG data when held up alongside the likes of Fitch, S&P and Moody’s highly correlated credit ratings. The argument being that ESG investing should not be trusted until the industry matures and ratings converge. Otherwise, how can we possibly follow what one issuer says versus another?

Our view? Quite simply, we shouldn’t. This would grossly oversimplify ESG metrics and what they can actually tell us.

Take GHG emissions for example, this should be an objective measure that is easily calculated allowing rating agencies to attach AAA to low emitters and CCC to high emitters. The data would have to be standardised by let’s say, tonne Co2 per $1m dollar revenue. But under this method comparatively would a tobacco company be considered a less risky investment to an EV manufacturer? Both face completely different environmental challenges.

Issuer_Name tCo2/usd million sales
Philip Morris International 21.90
TESLA, INC. 40.00

Source: MSCI data

Then there are the issues that really should not be measured against one another. Labour management is often assessed, which is essentially the culture of an organisation. But what is ‘good’ culture?  I’ll quote Investopedia’s definition; “culture is implied, not expressly defined, and develops organically over time from the cumulative traits of the people the company hires.” Ermm yes, it’s unique to each company and whilst metrics such as turnover, pay and diversity can help to understand it, a subjective assessment is still required. What might be deemed ‘good’ culture for a tech company in the US, might not be the same if applied to an industrial in Taiwan.

Ultimately, these scores should be treated like an opinion. In much the same way that three different brokers will have three separate price targets for a stock, maybe even spread across buy/sell/hold, underpinned by different methodologies and assumptions.

We should not expect highly correlated ESG scores and instead each one should be evaluated on its own merits.  Convergence of ESG ratings is unlikely and not what the industry should be aiming for.

About the author

Euan Ker is a Sustainable Investment Analyst. He is responsible for analysing and monitoring environmental, social and governance factors within the Global Sustainable Equity Strategy. Euan joined us in 2014 as an investment implementation analyst with responsibility for implementing macro investment decisions across a number of fund-of-fund mandates, totaling some £13 billion under management. Prior to moving to the ESG Research team in 2018 his responsibilities also included asset class, regional and currency hedging overlays through derivatives. Euan has a 1st Class Honours degree in Management with Economics from Robert Gordon University. He has the IMC professional qualification and has 5 years’ industry experience.* *As at 30 April 2019.

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Where on earth are all the e-buses??

That’s not a rhetorical question; of the 425,000 electric buses worldwide at the beginning of the year, 421,000 were in China.

So why do over 99% of electric buses reside with the Asian superpower? A lot is to do with government policy and generous subsidies handed out there. Take the city of Shenzhen for example, government subsidies were providing almost half of the cost of an electric bus in 2015, sparking a rapid transformation of its entire bus fleet. By the end of 2017, all 16,359 buses had been electrified.

Electric Bus Adoption in Shenzhen, China


Source: Shenzhen Urban Transport Planning & Design Institute Co, Ltd

Compare this to the US and Europe where subsidies are smaller and you see that governments are more willing to let market forces play out. This inevitably leads to slower adoption as the economics take longer to tip in favour of electrifying transport. Less than 1% of the US’ municipal bus fleet is currently electric. But this is forecast to change to 6% by 2025 and 80% by 2040. Have we finally reached the inflection point?

The economics are aligning
The initial cost of an e-bus can be up to $200,000 more than its diesel counterpart. But a number of studies have shown that even with this initial premium, e-buses are now cheaper when the total life cycle of the vehicle is taken into consideration. Lower fuel and maintenance costs significantly reduce the overall costs of running an e-bus over its full years of service:

Total Lifecycle Costs of Transit Buses


USPIRG.com

Unfortunately for many local governments, the higher initial outlay is still a stumbling block and realising the financial benefits 5+ years down the line takes a long-term mindset. But now companies like Proterra offer leasing agreements for the battery, making the initial cost the same. The price to buy the battery outright (the expensive bit) is also coming down.

Why should we care?
The effects of the EV industry on displacing oil demand is growing. It’s estimated that 256K barrels per day (equivalent use of a medium-sized country such as Portugal) were displaced by passenger EVs and e-buses in 2018. If the goal is to move to lower carbon economies, e-buses can make a sizeable difference to the transport sector. So far, the majority of this fossil fuel displacement has come from China’s fleet, replacing more than 4 times than that of passenger EVs:

Cumulative fuel demand displaced by product 


Source: BloombergNEF

Cities are coming under increasing pressure to reduce congestion and clean up the air we breathe. Many are signing up to initiatives such as the Fossil-fuel-free streets declaration that has participants pledge to; “Procuring, with our partners, only zero-emission buses from 2025; and ensuring a major area of our city is zero emission by 2030.” London, Paris, Los Angeles and Copenhagen are amongst the signatories.

Further positives include comparable ranges (it’s a bus that holds the world record for distance travelled by an electric vehicle; 1,100 miles), less noise and better driving performance.

With the economics aligning and the positive societal and environmental benefits from e-buses, it might be appropriate to finish on the old adage of ‘you wait forever for one to come and then three come at once’.

 

P.s we have an added extra this week from our Ethical fund range;

‘In response to client feedback, we are pleased to announce that the Kames ethical fund range is now fossil fuel free.

Kames recently celebrated the 30th anniversary of the Kames ethical equity fund. In the three decades of providing UK investors with ethical investment products, the Kames ethical funds have evolved in response to client feedback and changing societal concerns. The funds have previously made only selective investments in in the oil and gas sector.  Excluding the sector continues the funds evolution, ensures their continuing relevance and brings them into line with investor requirements.­­

The breadth of the client-led exclusions that the Kames ethical funds apply mean they remain some of the most stringent in the UK market. The changes we have now made will also mean they meet the demands of investors who are seeking fossil fuel free investment opportunities.’

 

About the author

Euan Ker is a Sustainable Investment Analyst. He is responsible for analysing and monitoring environmental, social and governance factors within the Global Sustainable Equity Strategy. Euan joined us in 2014 as an investment implementation analyst with responsibility for implementing macro investment decisions across a number of fund-of-fund mandates, totaling some £13 billion under management. Prior to moving to the ESG Research team in 2018 his responsibilities also included asset class, regional and currency hedging overlays through derivatives. Euan has a 1st Class Honours degree in Management with Economics from Robert Gordon University. He has the IMC professional qualification and has 5 years’ industry experience (as at 30 April 2019). 

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Is the world facing a cooling crisis?!

Okay, I know what you’re thinking- this is counterintuitive given the record-breaking temperatures recorded last week in France, or this research from NASA which practically suggests the world is on fire:


Source: https://data.giss.nasa.gov

Then you have the WHO estimating an additional 255,000 deaths per year by 2050 from extreme heat waves if we continue on our current trajectory.

So as our world warms up, we must cool down.

And what’s the solution? … Air Conditioning. (AC)

The International Energy Agency (IEA) estimates that 1.6 billion air conditioning units are in use around the world right now, a figure that has tripled since 1990. And of the 2.8 billion people inhabiting the hottest areas of the world, AC penetration is less than 10%.

So, how is this going to work with warmer temperatures, and an increasing demand for AC?

China, India and Indonesia will account for the majority of this due to growing population and income levels, coupled with lower AC costs.

AC units are energy intensive and if this extra demand isn’t met with renewables it leads to more emissions, more global warming, and again, more demand for cooling, more emissions, more global warming….the loop goes on. China for example, meet almost all of their energy demand for cooling by burning coal right now.

Bloomberg New Energy Finance (BNEF) predicts; “air-conditioning demand reaches 4,764TWh in 2050, or 12.7% of total demand. This is 2,564TWh higher than today, an increase equivalent to almost as much as the European Union’s entire electricity consumption at present.”

That’s right, almost 13% of global electricity will be used by AC units by 2050.

So, it’s crucial that the world breaks this loop and the additional demand is met with renewable energy.

Peak time energy demand will shift to mid-afternoon when the sun is at its hottest and AC units are turned up to the max. This is almost perfectly aligned with the power generation of solar panels and they might provide the best chance of breaking this destructive loop.


Source: https://www.iea.org/futureofcooling/

As Ryan mentioned last week, the tipping points (declining costs of renewables + government policy) are here and green shoots are emerging. In China, developers of solar projects are guaranteed the same price as coal plants for their energy for at least 20 years. In India, solar is now the cheapest source of new power generation throughout the daytime. BNEF predicts solar will account for 30% of their energy mix by 2050.

The tipping points are here but we have to hope they tip fast enough to keep up with new energy demands.

About the author

Euan Ker is a Sustainable Investment Analyst. He is responsible for analysing and monitoring environmental, social and governance factors within the Global Sustainable Equity Strategy. Euan joined us in 2014 as an investment implementation analyst with responsibility for implementing macro investment decisions across a number of fund-of-fund mandates, totaling some £13 billion under management. Prior to moving to the ESG Research team in 2018 his responsibilities also included asset class, regional and currency hedging overlays through derivatives. Euan has a 1st Class Honours degree in Management with Economics from Robert Gordon University. He has the IMC professional qualification and has 5 years’ industry experience (as at 30 April 2019).

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When will Green be the New Black?

Plastic bag charges, vegan diets, electric cars and re-usable cups. Environmental issues are certainly en vogue. Eco-movements have sprung up to challenge the environmental impact of certain industries and whether they want to or not, companies are now competing to show consumers exactly how sustainable their operations are.

So why then is one industry that prides itself on staying ahead of the curve, still lagging behind? Environmental awareness is not ‘the new black’ for the fashion industry just yet. Generally, consumers still want the latest fashions as quickly as possible and as cheaply as possible… regardless of the impact on the environment.  

Seasonal collections are a thing of the past and designers now work on ‘micro runs’, constantly churning out new fashion lines. What Meghan Markle wore yesterday, is a bestselling purchase today, and in the bargain bin tomorrow (or later tonight!). But the furious pace at which the industry works is not sustainable.

The manufacturing of textiles relies on an extremely water-intensive process. From the dyeing, printing and finishing stages, it accounts for roughly 20% of global wastewater (5 trillion litres / 2 million Olympic sized swimming pools / 2 Mediterranean Oceans). And the problem extends beyond the manufacturing process where water waste is often not treated to remove pollutants before it’s disposed of.

We believe that a company’s impact mainly stems from the sustainability of the products and services it provides. We also favour new technologies that provide solutions to pressing environmental or social problems. Kornit design and manufacture digital printing machines for textile industries. They also produce the ink used in the colouring process.

So what is it about Kornit that we like?

  1. Waterless – Kornit machines utilise a 100% waterless process. No pre-treatments, steaming or washing is required during the printing process.  
  2. No toxins – Their NeoPigment inks are non-hazardous, non-toxic and biodegradable. Kornit have a great understanding of the regulatory environment they work in and their inks currently fulfil the Oeko-Tex Standard 100 (approval for children’s apparel). They also have the Global Organic Textiles approval that ensures the inks are eco-friendly in their production and usage.
  3. Microruns – Kornit’s machines are excellent at dealing with smaller design runs. The traditional model takes too long and produces too much, leading to unwanted garments that are wasted. Digital printing can meet the demand in a more efficient and environmentally friendly way.

On top of all that? Their whole process has no problem with printing directly onto organic cotton, hemp, and bamboo fabrics that can create a truly environmentally friendly product.

Consumer demand looks less willing to change in this instance, which enables industries to keep the status quo. But when technologies like Kornit’s offers a more efficient process AND is better for the environment, it can really begin to shift the dial.

About the author

Euan Ker is a Sustainable Investment Analyst. He is responsible for analysing and monitoring environmental, social and governance factors within the Global Sustainable Equity Strategy. Euan joined us in 2014 as an investment implementation analyst with responsibility for implementing macro investment decisions across a number of fund-of-fund mandates, totaling some £13 billion under management. Prior to moving to the ESG Research team in 2018 his responsibilities also included asset class, regional and currency hedging overlays through derivatives. Euan has a 1st Class Honours degree in Management with Economics from Robert Gordon University. He has the IMC professional qualification and has 5 years’ industry experience.*  *As at 30 November 2018.

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The Perfect Storm

The UK began to give names to storms back in 2014. The Met Office hoped this would “aid the communication of approaching severe weather” so the public be “better placed to keep themselves, their property and businesses safe”. [1]

If raising awareness was their aim, then it’s worked in my opinion. It certainly feels like we have a Brian, Deirdre or Ali more often than before.

The insurance industry will likely agree.

2018 saw the insurance industry pay-out $79bn in relation to natural disasters worldwide, making it the fourth most expensive year on record. In 2017, where the likes of hurricane Irma and Harvey hit built up coastal areas of the US, the figure stood at $150bn. [2]

Global Catastrophic Insurance loses, 1970-2018;


Source: SwissRe.com

Disaster for insurance companies then? Well, no, not necessarily. Insurers are pricing this risk into their models and then into the premiums they charge. Such things as hurricane deductibles have even been introduced, where up to 10% of the value of your home may not be covered by storm damage.

Whilst the risk for insurance companies appears high, it pales into insignificance when you begin to count the economic costs of catastrophic weather events. Take, for example, hurricane Harvey where it’s estimated that the total economic cost was $80bn – much higher than the estimated $30bn of insurance losses. [3]

This is what’s known as the “insurance protection gap”. It’s the difference between what is insured and what needs to be insured. The US is considered to have a high insurance penetration rate but total losses that were covered by insurance stood at only 40% in 2017. The figure drops dramatically for emerging market economies. [4]

In the end, the protection gap becomes society’s burden.

US utilities firm PG&E illustrates this perfectly. The wild fires that devastated California last year left the company with potential liabilities of over $30bn after initial investigations suggested faulty power lines may have caused some of the blazes. The company was only insured for $1.4bn and subsequently filed for bankruptcy in January. [5]

Businesses with operations that are highly exposed to catastrophic weather events might need to adapt and it’s something investors will need to take into consideration for the future.

With changes in global climate conditions expected to increase the frequency of extreme weather events, and with densely populated areas thanks to increased urbanisation and a higher concentration of assets in exposed coastal areas – it looks like the perfect storm.

 

[1] www.metoffice.gov.uk

[2] www.SwissRe.com

[3] RMS “2017 North Atlantic Hurricane Season Review”

[4] AON “Reinsurance Market Outlook 2018”

[5] www.bloomberg.com

About the author

Euan Ker is a Sustainable Investment Analyst. He is responsible for analysing and monitoring environmental, social and governance factors within the Global Sustainable Equity Strategy. Euan joined us in 2014 as an investment implementation analyst with responsibility for implementing macro investment decisions across a number of fund-of-fund mandates, totaling some £13 billion under management. Prior to moving to the ESG Research team in 2018 his responsibilities also included asset class, regional and currency hedging overlays through derivatives. Euan has a 1st Class Honours degree in Management with Economics from Robert Gordon University. He has the IMC professional qualification and has 5 years’ industry experience (as at 30 November 2018).

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