“Hurried children,” says David Elkind, PhD, in his book with the same name, “[…] grow up too fast, pushed in their early years towards many different types of achievement and exposed to experiences that tax their adaptive capacities.” 
Despite the ubiquity of ESG and SRI investing, these two wunderkinds of finance were recently born out of a small number of dedicated shops in a niche corner of the market.
Once obscure acronyms used by a few specialists, ESG/SRI have found fans within millennial analysts like us, pension trustees, sovereign funds, and retail investors alike. At the same time, sustainable assets under management have grown from a low base not long ago to making up to 44 per cent of global AUM, with inflows showing no sign of abatement despite Covid-19.
This is long overdue given the imminent environmental challenges we face. Likewise, the alignment of consumers, corporates, investors and not least, politicians around sustainability will offer some of the best investment opportunities in a generation.
So how do we ensure that this nascent industry at a critical moment in its development grows up to fulfil its main purpose: to meet the demands of the current generation without jeopardizing the basic needs of future ones?
Sustainability at a reasonable price
To be credible and deliver positive outcomes for all stakeholders, any sustainable strategy must be realistic and anchored to valuation.
We must first acknowledge that there are few pure sustainable companies in Europe today. Based on our analysis and using data collected by Vigeo Eiris, the number of companies with a market capitalization of €1bn euros or more that derive between 90 per cent to 100 per cent of their revenues from sustainable goods and services represent fewer than 75 companies or 12 per cent of the total market capitalization of the universe.
Furthermore, 70 per cent of those ‘pure sustainability plays’ are in the healthcare sector meaning the opportunity outside healthcare is concentrated in about 20 well-known and well-owned companies.
Looking at the market in aggregate, the exposure to sustainable goods and services of MSCI Europe has been increasing slightly from 20 per cent to around 23 per cent in the last two years but many of the companies either do not have any sustainable revenues or fall in the beginner/improver camp, with sustainable revenues between 10 per cent and 30 per cent of total.
During the same two-year period, the OYSTER Sustainable Europe fund portfolio has had exposure to sustainable companies consistently above 40 per cent, focusing not only on the sustainable leaders of today but also on the beginners/improvers that are pushing their business models towards more sustainable activities.
If the companies in our portfolio execute on their business plans, we estimate the exposure to sustainable goods and services to increase to 60 per cent in five years’ time. It is a measured but more realistic approach to advancing the sustainability agenda in a healthy way.
More importantly, for sustainable investments to be successful tomorrow, they need to be anchored to valuations today. Story stocks are popular because they are easy to grasp, and sustainability adds a human emotion dimension to any equity story. But left unchecked and unattached to numbers, these narratives can turn into fairy tales leading to unreal valuations and fuelling the proverbial ‘green bubble’.
Indeed, one doesn’t have to go too far to find signs of overheating. The sustainability leaders of Europe have re-rated by a factor of 2x when compared to the improvers/challengers over the last three years. In addition, these leaders tend to have a bias towards ‘growth’ stocks. This means there are risks associated with an increase in interest rates or a prolonged period of market rotation towards ‘value’ stocks.
Even so, we must be careful not to confuse growth investing with sustainable investing. For example, the OYSTER Sustainable Europe portfolio shows a valuation that is close to the market average, despite having a sustainable exposure double that of the market. At the same time, it is a diverse portfolio of sustainable leaders and improvers at reasonable prices, balanced between cyclicals, value and growth styles.
The benefits of such a strategy are evidenced throughout periods like 2020 when the first half of the year was dominated by an unprecedented risk aversion while the second by an insatiable risk appetite. To some extent this shows that even in extreme market environments, and if done right, sustainable investing can lower risk and deliver above average performance that is de-correlated from peers.
Early ripe, not early rotten
History has plenty of examples when young industries suffered from the burden of too much growth, too soon. It took 15 years for internet stocks to heal from the wounds inflicted by the dotcom bubble of the early 2000s. Likewise, Germany’s solar power pioneers that were forced out of business around 2010 due to Chinese competition can attest that growth fuelled by fiscal incentives, albeit green, could be a double-edged sword.
If sustainable investing and ESG are to become the structural forces we all want them to be, with the ability to change the world, we must not hurry them into becoming fads that can’t live up to expectations.
Adrian Vlad is manager of the OYSTER Sustainable Europe fund. The views expressed above are his own and should not be taken as investment advice.