Maria Lozovik, Founding Partner at Marsham Investment Management, explains why investment in ‘brown’ firms may offer a gateway to a greener economy.
Since early 2018, the West’s six biggest oil majors have disposed of US$44 billion in predominantly fossil fuel assets. Large miners are also currently under pressure from activist investors to dump their coal assets. It is becoming increasingly common to sell ‘dirtier’ companies in the hope that they are starved of capital and forced to become more sustainable.
Pressure to divest is commonly applied by ESG-conscious investors who no longer want to be associated with these companies or fund them. Allocating capital away from ‘dirty’ sectors is viewed as a good way of driving down these companies’ share prices and making it tougher for them to raise money. Investing in green companies is also an easy way for investment managers to show off their green credentials.
However, in practice, divestment is not the best strategy to enact change or to have a meaningful impact. In fact, it only makes it easier for less ESG-conscious investors to buy into these companies, meaning any capital shortfalls or spells of pressure are short-lived.
Whilst it is tempting for ESG-focused investors to ignore the assets in ‘old world’ sectors, doing so means overlooking the opportunity to make a real difference in these companies’ journey to net zero. Investing in the ‘old economy’ may seem counterintuitive from an impact perspective but, in reality, this is where the biggest long-term impact can often be achieved. Also known as ‘transitional issuers’, these corporates often have an established sustainability strategy – but require investment to achieve their goals.
Provided they implement the right transition processes and plans, many companies operating in ‘brown’ sectors can be crucial to the low carbon economy of tomorrow. Mining, for example, provides the raw materials needed to make components in green technology. This includes metals for the batteries in electric vehicles, the sales of which more than double between 2020 and 2021. Elsewhere, investment in the industrial sector is needed to find replacements for cement, the production of which generates around 2.8 billion tonnes of CO2 every year, as well as the packaging industry to develop alternatives to plastic.
Investment in the energy sector is also necessary for the production of hydrogen, a greener fuel and one that is currently the subject of exploration on how widely it can be used to cut down emissions in the transport sector. Currently, even the most advanced producers in the oil and gas sector have a small share of revenue or capex from renewables such as hydrogen. These new technologies are not yet as scalable as oil production, but in five to seven years they will be, so a longer-term view is needed in these industries.
AI-powered data analysis
With the right research and due diligence in place, investors can identify the old economy stalwarts that have different futures ahead of them. Key to evaluating the ESG transition strategies of these firms is conducting an in-depth analysis of their underlying data sources. There is a need to look beyond surface-level commentary that a company produces, which may include promising ESG jargon, and gain a deep understanding of its sustainability strategy – as well as a method of tracking and comparing one period with another, to ensure companies are moving in the right direction and not simply greenwashing.
This is often difficult when ESG data is scattered across numerous sources without unified standards. However, artificial intelligence (AI) can automate the reading, organising and breaking down of unstructured disclosures, allowing investors to grasp how responsible, sustainable, and environmentally and socially stable a company really is. Intelligent analysis is able to look beyond numbers, buzzwords or repetition and evaluate a company more qualitatively. For example, sentiment analysis algorithms can analyse the tone of presentations from an earnings call to evaluate how committed the management team truly is to ESG.
Leveraging AI can help investors go beyond the realms of what would be possible using only human analysts. In no way does it replace human analysts, but rather frees them up to add far more value, as they can spend more time thinking rather than doing repetitive and process-driven tasks.
Financial returns and green bonds
There is also a financial argument for investing in transitional issuers. Demand for ESG investments has pushed these companies’ share prices lower, creating a buying opportunity. ESG-conscious investors who are willing to put their faith in these companies could reap the rewards in the long-term if their sustainability goals are achieved and share prices recover.
The same applies to corporate debt issued by companies currently rated poorly due to ESG weaknesses. Investors that choose the less fashionable option will also avoid paying a ‘greenium’ on already green companies – an issue that is particularly apparent in the world of green bonds. Sustainability-linked bonds have proven popular, partly because they are seen as a financial tool for firms transitioning from brown to green. However, just because a company has issued green and social bonds does not necessarily mean they are moving to a more sustainable model overall. Proceeds from the debt may only be funding one area of the business, and may free up other capital that is misallocated to non-ESG-friendly initiatives.
Putting faith in transitional companies meeting their sustainability targets is not risk-free. There is no quick solution to finding these companies – unlike investing in green bonds or high ESG-ranked names – which is why fundamental analysis of data is crucial in the investment process.
However, investing in ‘old economy’ sectors gives capital providers the opportunity to both make a meaningful impact in the journey to net zero and uncover attractive yields. It is these ‘transitional issuers’ that can act as the gateway to a greener economy and ultimately lead the race to net zero.