Does Cinderella care about the environment?
We believe that value and income investors can engage to effect positive change in carbon-intensive sectors.
In recent years, the glamour in equity investing has mostly been found in companies involved in ‘The New Economy’ – areas including the internet, social media and green-solutions companies.
Contrast the contrarian investors in the value world, who at first glance – like Cinderella cleaning the fireplace – are most unglamorous. In the past few years, we have spent more time in the dirty, unfashionable ‘Old Economy’ areas of the market.
However, that is not to say that ESG isn’t as important to us. Indeed, it is in the capital-intensive areas of the economy that the CO2 problems are being created – and so there that the world needs changes to be made.
LGIM’s Destination@Risk modelling makes it clear to us that utilities, steelmakers, cement companies, and oil and gas producers are where CO2 emissions must be reduced and then eliminated.
Many ESG funds take the exclusion approach here: ‘just don’t own these stocks’. Simple to do, convenient to say when marketing, but in the realpolitik this achieves very little.
With recent commodity prices being so high, these companies are generating strong cashflows and do not need our capital. Sell their shares and you lose your votes and influence over their actions. At worst they will be taken private, which can lead to even less effort to reduce their environmental impact.
Engaging versus divesting
In our value and income equity team, the mantra is ‘engagement beats divesting’.
Take ArcelorMittal*, the world’s largest steel company. We started meeting its management in earnest in December 2015. Since then, we have had 15 further meetings. These include two with the chairman and a site visit regarding its environmental plans to remediate Europe’s largest steel plant.
Through those meetings, we have pressed the company on its long-term plans and the sustainability of a company built on coal-fired blast furnaces. We speak as a long-term shareholder who, when finances were troubled, supported the company during two rights issues. Thus, one can engage and hope to encourage change.
Over the past two years, ArcelorMittal has announced plans for how to achieve a 30% reduction in CO2 emitted per tonne of steel, and how to reach carbon neutrality by 2050. Initially this was for European production, but has now been expanded to cover the company worldwide.
Our ESG efforts are global, even though achieving global results is often a tougher and longer path than in Europe. In Asia, we are shareholders in the Singapore-listed United Overseas Bank (UOB)*. It will not finance new coal activity, and when clients refinance UOB requires commitments to divest from coal.
However, sometimes we cannot influence a company to improve. For example, if our team cannot see a likely path where the company will manage the transition to net-zero carbon, we will take the final step of divestment. NTPC*, the Indian power company, is highly reliant on coal-fired power stations, for example. It has no plan for phasing this out in the timescales required, so we sold our holding from the portfolios managed by my team.
We believe these efforts also benefit our clients. A company with poor ESG credentials is likely to be viewed as having an unsustainable business, so will likely trade at a discount. A significant improvement can lead to a reappraisal by the markets and strong share-price performance.
Like Cinderella, we are raking through the ashes. We expect to find a few diamonds there.
*For illustrative purposes only. Reference to a particular security is on a historical basis and does not mean that the security is currently held or will be held within an LGIM portfolio. The above information does not constitute a recommendation to buy or sell any security.