What's Your Prior?

Finding ESG Momentum

December 16, 2020 Damian Handzy Season 1 Episode 5
What's Your Prior?
Finding ESG Momentum
Show Notes Transcript

Figuring out which companies will profit from ESG is all the rage, and my guest, Jacob Gemmel, has a promising approach: start with a fundamental Quality assessment of stocks and disqualify any company that does not have forward motion on improving ESG from both an operational and product perspective. Join me in learning how Swedbank Robur invests for the long term and turns upward ESG momentum into long-term outperformance.

Related links mentioned in the episode:

SwedbankRobur

Jacob Gemmel

UN Sustainable Development Goals

Briant Matthews LinkedIn

Briant Matthews Book

Briant Matthews Research

Morgan Housel LinkedIn

Morgan Housel blog

Morgan Housel book

Michael Mauboussin LinkedIn

Michael Mauboussin Website

Damian Handzy:

About 10 years ago, Michael Bloomberg, who was then mayor of New York City began working with a team of Dutch, hydro engineers who were commissioned to design a flood protection system for New York City. Recognizing that global temperatures were rising, they worried about what would happen if a category one hurricane directly hit the coastal city. Now the mayor hired global experts who knew a finger to about keeping an ocean from flooding a city. In fact, before New York was renamed by the conquering British in 1664, it was actually a small Dutch colony known as New Amsterdam. Most of New York city li es just a few feet above the current sea level and having some of the world's most expensive real estate flooding could be devastatingly expensive. Now the Dutch proposed installing several retractable barriers and other engineering marvels, but it would cost somewhere between 20 and $40 billion to erect. And that was far too steep, a price tag for the city council to approve. So this project fell victim to the classic conflict between long-term benefits and short-term costs something. Every company in the world struggles with, but the damage from just one storm Superstorm, Sandy that hit in 2012, shortly after the proposal was rejected. The damage was about $20 billion. Now to this day, New York has still not built a serious storm protection system. And the clock is ticking, not just on this city, but on many coastal cities around the world.

Jacob Gemmel:

Hello and welcome to what's your prior the podcast for the adaptable investor with your hosts , Damian Handzy, welcome to this .

Damian Handzy:

What's your prior . And today we're going to delve into the concept of investing in companies that do what New York failed to do, spend money today to ensure a brighter future down the road. Now this concept, obviously isn't unique to finance, right phrases like safer or any day and no pain, no gain. Well they're meant to capture the benefits of sacrificing something today in order to benefit in the longer term . Now, building a successful business is all about aiming for longterm success while managing the short-term needs and risks of going under investors use many different strategies to identify which companies are likely to provide that long-term benefit. And we at style analytics provide factor analysis tools to help them identify the characteristics of those stocks that fit the various categories or styles. Now, some of these styles, they're pretty easy to measure and understand right? Size of stock is an example, small cap stocks. They tend to really outperform large cap stocks in the long run. It turns out it's easier to double in size. If you start out small, no surprise. It's also interesting. Everyone agrees pretty much on how to measure the size a public company. You look at the market cap, the value and growth. Those styles are each a bit more complicated, but there are still several generally accepted sub-factors to examine for value. You look at things like book value to market price, or at free cashflow yield for growth. You look at things like the rate of profit growth or the rate of sales growth, but hardest of the factors to measure in my opinion is quality. There are a lot of different sub factors that people use to measure quality like return on equity, profit margin, low leverage. That means not borrowing too much. Now one way to think of quality companies. Well, they're the ones that make the tough decisions. They're well-managed they're well-governed today. We'll be speaking with Jacob Gemmel who's been investing in quality stocks, his entire career, and more recently, Jacob has added ESG into his investments and today's episode will be all about how ESG enhances a quality portfolio. Jacob now runs all global ESG investing for Swedbank robur . And I started by asking him about his philosophy of adding ESG on top of quality investing .

Speaker 3:

We trying to act as long-term investors. And , uh , we built a thesis sort of when it comes to longterm investing that the economic profits from a business that is what drives returns in the long run. So quality. What does that mean to me? Quality is sort of observable financial history of a company that has proven some sort of competitive advantage. I extended fate of their, of life cycle . As a company,

Damian Handzy:

Jacob then described a number of the traditional ways that people measure quality, all is a backdrop, a set of prerequisite conditions for him to even consider making an investment. All of these measures look kind of in the rear view mirror, they tell him that a company's management has historically demonstrated good governance, but one of the things he didn't include is a measure of price, stock price. So I asked him, does it matter how much the stock costs for him to invest in them?

Speaker 3:

I would argue that big part of my portfolio wouldn't classify as sheep in any ways, because I do also think that companies with competitive advantage, they come at a price, but they can stay pricey as well. And that's why my thinking is that you derive your returns from partly thinking about the company, if they can keep their valuation at certain levels, plus derive return from the operations. That would be my returns as a stockholder.

Damian Handzy:

So with that set of prerequisites, Jacob told me that he thinks about a five-year investment. What is the likely future of the company looking at about five years? So I asked him , so what makes this approach, the marriage of quality investing with ESG so powerful and why does ESG seem to fit with a quality mindset more potentially than it does with other types of investment strategies ?

Speaker 3:

Yeah. Maybe I can sort of only speak to our strategy and philosophy around it, and I'm sure there's a number of people out there that could utilize ESG in their own frameworks and make something out of it. But according to us, we think going back to being long-term investor and fundamentally I we're looking for the quality in the company, basically that means that these are often tools that can help us understand a business bond better, especially from a governance point of view, but also how the operation is run and how they thinking about their future income. When it comes to what kind of products and services they want to be invested in. I would argue that the furnace out on the , on the ESG again, that is probably Europe, us is catching up and , uh , Japan and the rest of Asia is still in process of getting there.

Damian Handzy:

Jacob described for me a really interesting approach to measuring how well a company implements ESG while he went out of his way to compliment all of the ESG vendors that are out there for providing a framework and for providing historical data on many companies, practices, Jacob likes to learn about a company's ESG approach directly from the management. Now, unlike disclosing financial information, which is highly regulated, ESG data is not yet regulated that you never have a situation where a CFO or a CEO speaks to one investor about the company's financial results, because there are many rules around equal and fair disclosure. If a company provides information to one investor, it better provide information to all of its investors, but managers will speak about their ESG practices, their projects, and their intentions, because they're allowed to. Now that information gives Jacob a real edge when deciding which companies are doing the most around ESG,

Speaker 3:

We try and always to contact the company, preferably talk to the senior management before when we make an investment. And after that, we also want to have a good dialogue with the companies we invest in,

Damian Handzy:

But that's not all they do with ESG. Jacob talked to me a little bit about history. That's kind of,

Speaker 3:

I take it back to 2015 to the Paris agreement in conjunction with that. You and also came out with their 17 SDGs. The SDGs that Jacob refers

Damian Handzy:

To are the UN's sustainable development goals. These are things like no poverty, zero hunger, quality education, sustainable cities and communities , uh , reduced inequality. Anyway, we'll put a link in the show notes. So if anyone's unfamiliar, you can learn more about,

Speaker 3:

That was basically framework. This is the way four months to have a more sustainable future for, for the globe basically. And so this was a framework that they want to deliver to countries, communities, cities, corporates, and to have a discussion and trying to steer capital in that direction. So to us, this was a good framework to put together and we sort of sat down, thought about it and try to see, okay, how can we get exposure to the SDGs? What was there a structure forces in play here at the same time? We can think about sort of from a more financial point of view, where are the areas in society where we think there will be maybe better growth or, or maybe not as cyclical growth going forward? So this is a combination of sort of the good work from , from the UN when it comes to the structure of the future, if you can put it that way and our internal work, when it comes to what we think from, from a financial point of view as well. And so these are the areas we think capital , we go in this direction, intervention go in this direction and therefore, if we can identify companies this way, we have a better shot at getting decent returns.

Damian Handzy:

Okay, let's pause for a second to recap. So Jacob starts from a very sound long-term financial principle to identify high quality companies that he might invest in from a factor perspective, he then incorporates ESG considerations, but he goes beyond the regularly available ESG data to speak to the company's management teams directly so that he can understand what exactly each one of them is doing about ESG. They then look at the UN 17 sustainable development goals for a framework of what will be important into the future. Now he went on to describe for me how Swedbank robur maps those 17 SDGs from the UN onto four long-term investment themes that Swedbank Roper uses to prioritize investments. Those themes are climate demographics, health, and wellness and digitalization by interlacing the UN sustainability goals with their own forward-looking and overarching themes. Swedbank robur has created a well thought out and easy to understand framework for making long-term investment decisions, but they then go one level deeper. And they look at each company's adoption of ESG from two different dimensions, the company's operations and separately, the company's products, they plot each company's score on a very straightforward graph operation score versus product score.

Speaker 3:

And that makes it easier to have the first discussion on where they are on this map. It's easier to talk about either focus on the products and service or the operations, depending on where we plot them on this X, Y axis. So it's a helpful to and communication. And it's also will be an interesting tool over time when we can see a sort of movement of especially our portfolio companies.

Damian Handzy:

And that's where Jacob had me, they don't just plot the company's current score, but they also plot their speed. How fast the companies change to improve both their operational ESG score and their product ESG score. Now it's style analytics. We provide technology tools that analyze stocks and portfolios from both a factor perspective and an ESG perspective. And one of the most promising ESG factors, the thing that's supposed to deliver higher returns is the concept of ESG momentum firms that are improving their ESG scores. That's ESG momentum. They tend to outperform the market. So it's really good to know which firms will have higher ESG scores down the road. And Jacob's approach again, of combining the UN's SDG framework with Swedbank robbers , for long-term thesis and their use of that X, Y plot of product versus operations score and movement direction. Well, all that does exactly what you want. It allows him to pinpoint the companies that are most likely to improve their ESG approach on the very topics that are most likely to be important in the future. Now, to wrap things up, Jacob wanted to share with everyone, a couple of inspirational authors speakers that , that he has learned a lot from over the years. So without stealing his thunder here .

Speaker 3:

So whenever I talk to somebody, this is always about paying for what, or being on the shoulders of giants, et cetera, you don't invent things yourself, you get inspired and you get sort of a , your own version of it, your own temperament involved in whatever you get inspired from when it comes to that quality investment part of it, or sort of , uh , how you think about the business and its fading, et cetera. I have to give a big shout out to, as I refer to him, the Chicago brain, Brian Matthews credit Swiss hall in Chicago, his work around fade , competitive advantage lifecycle , et cetera , has been so inspiring to me, big shout out to him. I also, whenever I come across it , either podcasts or books or articles, Michael, and I think have that intellectual curiosity that should inspire lot of people. And of course I have to mention as well. So one of the, I think the best financials, right? There's out there right now that keep on producing every second week, basically. And it's Morgan Housel . I haven't met him, but he is a , I think his writings are, are fabulous,

Jacob Gemmel:

Jacob. That's great. Thank you so much. We're going to include links to all of those in the show notes so that all the listeners can easily find those references.

Speaker 3:

Thank you so much. This was fun. Yeah. Thank you for fun. I really appreciate it. Have a great day though. Okay. Bye. Now

Jacob Gemmel:

[inaudible] .