Investors are misunderstanding how to decarbonise the global economy and are inadvertently being hypocritical with their money, according to James Sym, manager of the River & Mercantile European fund.
He said climate change is “the most important investment theme for the rest of our careers” but that most investors and fund managers were misunderstanding how to manage the situation.
Many, he argued, have focused on a narrow subset of growth stocks, such as technology and healthcare companies, while eschewing the undervalued businesses associated with ‘value’ investing, namely banks, miners and oil producers.
“That might make people feel good, but it is not actually making a material difference to the trajectory of climate change,” he said.
“A business going from five to zero units of carbon is very commendable but the materiality of it is much lower than a company going from 2,000 to 1,000, which is a material contribution. It might still be a dirty business, but the atmosphere’s gain is much larger. That is what is closing the gap.”
Investors in this area should instead focus on companies where they can make a material difference, something he has been doing successfully in his £250m fund for the past few years.
Over the past 12 months the River & Mercantile European fund has been a top-quartile performer in the IA Europe Excluding UK sector, returning 2.2% while its average peer and the MSCI Europe ex UK index have both made losses. Since its launch in 2020, it has made 26.7%, more than double the index and benchmark, as the below chart shows.
Total return of fund vs sector and benchmark since launch
Source: FE Analytics
Sym said: “Clients think they are doing good by owning the same narrow set of growth stocks and think they are making a material contribution to decarbonising the world but they are totally misguided and hypocritical: they are producing carbon from the products they consume so why not invest in companies that can decarbonise that?”
For a fund that takes into account environmental, social and governance (ESG), his portfolio has an unusually high allocation to miners (17.4%) and industrials (18.4%), particularly in areas such as cement and other “dirty” businesses.
“What we have benefited from is we buy companies where the market has them on the ESG naughty step but we know they are making the material improvement. That is ESG arbitrage – the ESG re-rating,” he said.
He highlighted glass bottle maker Verallia, pulp and paper producer Valmet and steel furnace firm Danieli, as well as car manufacturer Volkswagen (VW), as examples of companies that have high emissions but that are working on ways to bring these down.
He argued that these businesses will still be required in the future and must invest tens of billions of dollars every year to decarbonise their activities.
“If we refuse to invest in them, we push the cost of capital up so we make it harder for them to make the investments they need to make,” he said.
“That is not to say that owning shares in companies that make wind turbines or solar panels is a bad thing. We need those new businesses to help, but we also need the incumbent businesses to make these changes and that is what we are focused on.”
However, one area that he avoids is oil, noting that there is too much uncertainty over the future of the commodity. He argued that these companies do well when the oil price is going up but in the future are going to have to try and pivot to renewables, throwing away hundreds of years of oil exploration.
“They need to replace all of that value with renewable energy and they will either not be able to do that as the scale isn’t big enough, or they will not meet the sustainability hill by continuing to do what they have done for a very long time,” he said.
In addition, there will be a lot of new entrants in the windfarm markets, while many people will choose instead to have solar panels on roofs, making the big energy companies redundant.