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For many people, former US Vice President Al Gore’s 2006 documentary – An Inconvenient Truth – was a wakeup call to the sheer challenge that global warming posed to humanity.
Gore won the Nobel peace prize in 2007 for his efforts around climate change. He founded Generation Investment Management together with Mark Ferguson, who is co-chief investment officer of the $31 billion firm.
Back in 2018, Gore defined sustainable investing as the “single largest investment opportunity in history”. People seem to have taken him at his word.
Investment in environmental, social and governance-conscious assets (ESG) rose by 42% to $17.1 trillion in the two years to the end of 2020, according to investment firm Raymond James.
“We’re really pleased that there’s been a mainstreaming of the whole sustainability ESG phenomenon,” Ferguson said in an interview with Insider.
ESG investors have to think, not just about a company’s green credentials, but about their fundamentals – the delicate balancing act that Ferguson has dealt with for years.
“We are forcing ourselves to think about more carbon-intensive industries, forcing ourselves to think about the ‘greening’ of industries, as opposed to just ‘in green companies’,” Ferguson said.
We asked Ferguson to break down his take on the three biggest questions ESG investors are asking right now.
Is there a “green stock bubble”?
With so much cash pouring into ESG assets, some investors are concerned about a “green bubble”, according to Morgan Stanley. Two of the largest US renewable exchange-traded funds – Invesco Solar and PowerShares WilderHill Clean Energy – have gained around 300% in the last three years alone.
Some have compared the sector’s gains with those of the dot-com bubble in the early 2000s that was built on investor exuberance over technology stocks.
There are some parallels between the two, Ferguson said, but the key difference is the “extent to which the enthusiasm is justified by real-world behavior.”
“We may be in a bubble in terms of enthusiasm for ESG stocks… but the real-world behavior is one of deeply unsustainable and quite alarming trends,” he said.
Rather than investors getting excited about the internet and the companies that stand to benefit, this trend has a context of environmental and societal circumstances that “justify this level of intensity,” he said.
“You just need to have a clear eye on where there might be a disconnect between the hype and the reality, but know that this is actually a later than needed response,” he added, saying “once we start fixing that, then we can start worrying about whether we’re spending too much money fixing it.”
Are electric vehicles the solution?
One of the ESG phenomenon’s hot-ticket stocks has been Tesla, the electric luxury carmaker run by Elon Musk, which has seen its shares gain over 350% in 12 months. It’s not the only one. Chinese competitor NIO has gained almost 1,000% in that time.
Other major car companies are also moving into electrification, by “turning off R&D and product development for internal combustion engines,” Ferguson said.
“Once that happens, it’s like a one-way door,” he said. This will fastrack the next four to five years of EV development, he said: “it’ll just be a flood.”
Even in the EV sector, which has proven so popular, not everyone is a believer. In an exclusive interview with Insider, famed short-seller Carson Block said of Tesla, which currently trades at almost 1,000 times its future earnings: “Love it or hate it, there’s no f—ing way it’s worth this much money. I mean, it’s just not.”
Regardless of the debate around valuations, some investors have said EVs are only a short-term fix to a longer-term problem of carbon emissions, and hydrogen offers a better alternative to the internal combustion engine. A number of Wall Street banks including Goldman Sachs and Morgan Stanley are optimistic on hydrogen’s prospects.
But Ferguson is unconvinced.
In practical terms, hydrogen-powered cars literally face an uphill struggle, he said, because of the sheer weight of their battery. But, more importantly, there is simply no better alternative than EVs right now, and by the time hydrogen has caught up, electric batteries will have gained the upper hand, he said.
Instead, where hydrogen has scope to bring real impact is with long-distance vehicles, trains, ships and stationary power – possibly by 2030, he said.
To exclude or not exclude?
The third big question for ESG investors is what to do about companies that fall into the “improvers” category – those that built their businesses on fossil fuel energy and are now trying to adapt to a more sustainable world, such as oil and gas companies.
Investors like Ferguson are under pressure, both internally and externally, to re-evaluate these assets, he said.
Regardless, Ferguson says there’s no place for them in his portfolio, not just because they are unsustainable.
Ferguson’s mandate is to find assets that use sustainability to improve already fundamentally good businesses.”The problem I have with all of these big energy emitters is that the sustainability of these businesses is one problem, but they’re actually quite poor businesses,” he said.
For example, tobacco, another industry with plenty of detractors, is highly consolidated, profitable and has its negative externalities factored into its balance sheets, the opposite of oil. “[It has] terrible businesses with low barriers to entry and massively capital-intensive,” Ferguson said.
Ultimately, Ferguson is having to force himself to look beyond pure exclusion and think about the more carbon intensive industries that are ‘greening’ up. But this won’t fix the problems inherent for many of these companies. We must recognise that this transformation “turns them into less unsustainable businesses, but doesn’t necessarily turn them into good businesses,” he said.
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