Never has the imperative for sustainable investing been higher. The COVID-19 pandemic has unveiled significant social inequalities and pushed forward the urgency for global policy to respond in favour of a more inclusive and fairer world. On the environmental side, this decade is key for policy developments and financial flows if we are to have a chance of reaching the goals of the Paris Agreement.
In the Jupiter global sustainable equities strategy, which looks to invest in high quality companies that are leading the transition to a more sustainable world, our core philosophy is that companies that run their business for three key stakeholders are better positioned to deliver sustainable, long-term returns. Those stakeholders are: the planet, on which we all live, people with whom we all co-exist and profit which we all require from our savings.
A sustainable approach to investment requires an understanding of all of these stakeholder relationships, recognising the interdependencies between them and balancing their needs in a way that is likely to grow value for them all. But how does this sort of analysis work in practice?
Financial sustainability is fundamental
To make this multi-stakeholder assessment requires deep analysis of both what companies sell, and how they behave, and how both those aspects underpin and drive their long-term viability and success.
We see an assessment of financial sustainability as fundamental. A company might be highly socially impactful, but if it cannot do this in a way that also makes it financially sustainable then it is unlikely that its model is well-suited to the listed equities market. For this reason, the very first thing we look for are companies with fortress balance sheets, resilient cash flow profiles and durable franchises. Such characteristics should not only result in consistent profitability, but they also point towards a long-term approach to management and provide the strongest foundation from which a company can lead in social and environment sustainability.
Why does a company exist?
Going a step further, we ask some essential questions including what role does this company have, for whom does it seek to create value, and how does it do this in a way that strengthens stakeholder opportunity and enhances long-term profitability. Furthermore, what are the major legislative, regulatory, social and technological developments on a long-term basis that are likely to shape the world we live in and what are the implications for a company’s products and services as well as its behavioural aspects?
To take ‘net zero’ carbon initiatives as an example, we need to think about what the trajectory to net zero will mean both in terms of risks for carbon intensive businesses but also opportunities for those that can help them to transition to a low carbon world. This is just one of several key strategic questions that will have deep consequences for the defensibility of a company’s products and services as well as its competitive positioning and growth opportunities in the future, and by inference its financial value.
Sustainable evaluation model (SEM)
If this information is to be investment-relevant, it must focus on materiality and relevance.
The importance of materiality
In order to help us remain focused on the most important issues, when we analyse stocks we keep one thing at the forefront of our minds – materiality – asking ourselves which of these topics and relationships are most likely to be most relevant for our investment processes and theses. This naturally varies company by company, as well as by sector and geography.
We think about this in three ways: which factors are correlated with alpha generation; which factors are most likely to present risks to future cash flows; and which factors are most likely to indicate a high quality, long-term approach to management. Through that lens, we can take the variety of sustainability and ESG topics and data points and distil them down to those that are most likely to be relevant for us as long-term, sustainable investors looking for those companies that will be winners both today and in the future.
As a sense check we use external frameworks as a reference, so we spend a great deal of time understanding how companies are contributing to the UN Sustainable Development Goals, how they are aligned with delivering a low carbon future and ensuring that they do not violate the UN Global Compact as pre-requisites for investment.
Expanding upon the example of the low carbon transition in terms of materiality, as more and more companies are starting to set out ‘net zero’ targets, from an investment perspective the really important questions relate to how companies are going to align with net zero, and in particular how this is going to be done in a way that is also going to create value for investors.
Ambitious long-term targets are all very well, but prospective investors in a company we want to see that these targets are backed up by shorter-term plans aligned with the latest scientific understanding. We also need to see strategies in place that are actionable and credible, backed up with capital allocation plans that underpin the large investments required by some companies to transition effectively, and we need to see the company align its governance practices, such as executive pay and lobbying efforts, with the low carbon transition. Without evidence of those things, a company’s lofty long-term targets won’t carry any weight with us.
We do our own homework
I’m quite often asked where analysts like us get our information. We seek out any quality source of information that can feed into our stock analysis – in many cases information will come from direct engagement with management teams and reading company reports, but we also have access to specialist research and data providers, news monitoring services, NGOs, and sell-aside analysts. Importantly, Jupiter also has its own internal ESG data analysis tool called ‘ESG Hub’, which aggregates data inputs to allow for greater diversification of data considerations.
One thing you may notice absent from the above list is ESG ratings. That is because we passionately believe that it is essential that sustainability assessments are carried out by the same people who are actually making the capital allocation decisions, directly integrated throughout the investment process. We are convinced that all that complexity and nuance cannot be usefully distilled down to one simple rating. It is also important to note the low correlations between ratings providers, and that much of this disagreement comes from their methodologies on assessing outcomes, which is a central area of focus for sustainable investing.
If sustainability is to play a genuine, leading role in an active investment product then the analysis needs to be treated with the same rigour as all other analysis in the investment process, and be undertaken by the capital allocators themselves.
Case study: human capital
Jack Henry is a multi-billion dollar company that offers technology and payment processing services to banks and credit unions in the US. It has long recognised the connection between a highly proactive approach to human capital and a market leading customer experience, investing heavily in employee training, incentive schemes, and a progressive focus on inclusion. A satisfied and motivated work force supports the company’s customer service centred value proposition: Jack Henry has sector leading customer retention, and very high recurring revenues and an average customer satisfaction score is 4.75/5. The end result is an exceptionally strong franchise, good operating margins, and returns on equity over double its cost with very little debt.
Case study: financial inclusion
Across the world there are many companies providing solutions to increase financial inclusion and lift people out of poverty. Safaricom is the leader in the Kenyan telecommunication market, and runs a mobile money platform called M-PESA. In 2006, the year before M-PESA launched, only 26% of the Kenyan population had access to financial services. By 2019 that number had risen to 83%, driven significantly by the use of M-PESA, so much so that some estimates are that over 40% of Kenya’s GDP is processed over it. This has been transformative to people’s lives in allowing them to transfer and receive money more quickly, safely, securely and reliably, as well as start businesses, without requiring traditional banking infrastructure that can be preventative. Safaricom has achieved all this while making high operating margins and returns on capital with very low levels of debt, making it a highly sustainable business both societally and financially.
Case study: climate change
The Taskforce on Climate-Related Financial Disclosures (TCFD) provide a framework for companies to disclose their climate strategies and risks. A core part of this is using scenarios to test the resilience of a company’s strategy, and when conducted well this can be a very useful tool for investors.
Unilever’s scenario testing demonstrates the investment-relevant insights we can garner from TCFD. Unilever has tested its resilience against two scenarios, one where temperatures increase by 2 degrees above pre-industrial levels and one where they increase by 4 degrees. The exercise shows that the physical impacts of climate change under a four degree scenario would have major implications on its cost base and its revenues. By contrast, under the 2 degrees scenario it is climate policies that are going to have the most impact. This means we can not only get a sense of the scale of the challenge, but also where the major issues might be for the company and dive deeper to understand how well those risks are being mitigated. In Unilever’s case, we see it as a leader in sustainability of operations, and note the significant emphasis it places on long term supply chain security to help address many of the issues highlighted by the scenario testing exercise.
Unilever’s assessment of various climate change scenarios on its business
Stock examples are for illustrative purposes only and are not a recommendation to buy or sell.
The value of active minds: independent thinking
A key feature of Jupiter’s investment approach is that we eschew the adoption of a house view, instead preferring to allow our specialist fund managers to formulate their own opinions on their asset class. As a result, it should be noted that any views expressed – including on matters relating to environmental, social and governance considerations – are those of the author(s), and may differ from views held by other Jupiter investment professionals.
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