Green Technology is Good for Business, and for the Climate
Legg Mason Webcast Advocates for Environmental, Sustainability and Governance (ESG) Investing for Stewardship and Solid Returns
May 4, 2017
“Despite current trends in Washington, not only will green technology survive, it will grow.”
That was the key message of a roundtable webcast by Legg Mason, intended for financial advisors and other investors seeking guidance on the prospects for ESG under the rapidly changing regulatory landscape of the new Trump Administration.
“We very much think about ESG not just in terms of what's a nice, or what's a sustainable perspective separate from the investment view,” emphasized Mary Jane McQuillen, a portfolio manager with Legg Mason affiliate ClearBridge Investments. “What are the environmental, social, and governance factors that drive value, particularly from a long-term standpoint?”
“Does the focus on ESG investing mean there's any requirement to sacrifice investment performance?” asked moderator Richard Beales, Deputy Editor of Reuters Breakingviews.
“There have been literally hundreds of studies that cover performance aspects of integrating ESG factors,” responded Ms. McQuillen. “The overall conclusion we have seen is not so much that ESG factors will cause a portfolio to always outperform. Rather, at the very least, portfolio performance should be competitive to its peers – it should do as well. No guarantees it will always do better, or do worse. but it should do as well.”
“The best experience we've had is our live accounts, our own clients,” she underscored. “We have probably one of the largest suites of [ESG] performance history across various styles through the bull market, the bear market, over long time periods, small, mid- and large-cap companies. Our observation has been that they've been competitive on a risk-adjusted basis.”
“The answer is no,” agreed Alfred Griffin, President of the New York Green Bank, a $1 billion New York State-sponsored specialty finance company focused on the state's transition to clean energy. New York Green Bank is also involved in private infrastructure finance of clean energy.
“If you look across the clean energy space, the asset deployment infrastructure space, even for the largest-scale tried-and-true projects with a reasonable amount of liquidity in the debt finance markets, investors are getting premium returns versus more liquid, publicly-traded bonds.”
“We are seeing credit spreads in the 250 to 350 range, a 150-200 basis point premium to non-renewable liquid alternatives,” Mr. Griffin said. “For a set of cash flows that are not correlated to the broader fixed income markets, you are being very well paid for the lack of liquidity.”
“We are integrating the ESG analysis into building an investment case,” said David Sheasby, Head of Governance and Sustainability with Legg Mason affiliate Martin Currie, in Scotland. “We are running concentrated portfolios relative to the benchmark, companies that embrace sustainability, thinking about what might impact their ability to generate long-term sustainable returns.”
“One of the key things is the focus on materiality of the business over the longer term,” Mr. Sheasby said. “Look at how a company is managing and mitigating those risks, or embracing those opportunities. Companies focusing on material issues and not spending time focusing on the immaterial issues clearly deliver outperformance rather than sacrificing performance.”
“Is green energy viable without subsidies?” Mr. Beales posed to the panel. “A Lazard study was out a while ago suggesting that utility-scale solar and wind projects are already fully competitive on an unsubsidized basis. Does that sound about right?”
“It's a very interesting report,” Mr. Sheasby said. “It shows there is a very wide variation in the costs. You need to scale. For wind, there's obviously a big difference between onshore and offshore. What we have seen is huge falls in those costs over the last seven years, almost 70 percent for wind and 85 percent of utility-scale solar generation. The economics have changed significantly. Wind and utility-scale solar can now be competitive on an unsubsidized basis.”
“In the United Arab Emirates, we’ve seen a project which in 2014 was expected to cost around 62 dollars per megavoltage, now coming in at 24 dollars per megavoltage. Clearly competitive with many other power sources. And just in the last couple of days in Germany, we've seen the first bids for an offshore wind farm with no subsidies, which was very unexpected.”
Reflecting on New York State, where costs also have declined but regions face specific issues, Mr. Griffin concurred, “We find renewables to be a very cost-effective replacement.”
“We're more of a debt-type capital provider funding the deployment of clean energy, whether it be solar or wind or energy efficiency or storage,” he explained. “We package these projects, isolating cash flows, generating current returns and funding these long-term projects. There's a great deal of activity in New York, across the country and across the globe.”
Noting that “the elephant in the room” – for the U.S. – is the Trump Administration's policy shift away from environmental rules and measures that might prevent climate warming, Mr. Beales asked, “Does that policy uncertainty make a difference? Is it a big problem for investors?”
“The activity we're seeing in New York and elsewhere is really being driven by more state and local policy initiatives,” Mr. Griffin answered. “We have multiple clean energy goals around what we call REV Goals for 2030: a 40 percent reduction in greenhouse gases from 1990 levels; 50 percent of New York state's generation will come from renewables; a 23 percent decrease in energy consumption of buildings from 2012 levels. All goals for 2030 are driving a lot of activity.”
“What we see in New York is not a slowdown at all. We're seeing more and more activity as every quarter passes.”
Asked whether she and the ClearBridge team are “worried” about the Trump Administration, Ms. McQuillen said, “I suppose it's day-by-day. Some days we have lots to worry about, and some days … We try to think about things in the long term. We're not terribly discouraged. Many states, including California and New York, have reaffirmed their commitment to reducing carbon emissions, and have been working toward going past their targets. They're a big driver.”
“There's a group called the RE100, Renewable Energy 100. It's a group of companies that, so far, 83 or so have signed on. They're committed to providing finance or powering their operations through renewable power. Apple, Alphabet, Microsoft all signed on a joint statement recently, pledging that they're going to continue to use renewable power. Where we see corporates stepping up to the plate and making a business case as to why they want to support renewable power, it's not just for the sake of sounding green. It's very much about thinking long term.”
“There's good pricing parity, and the subsidy reliance is not as heavy,” she said. “Companies can support themselves. Google told us they were able to save about a billion dollars in energy costs. They're using artificial intelligence to try to extract even more savings. Companies are very innovative, either through products or services or their own operations. It's an exciting time.”
Mr. Sheasby added that, “There are quite a lot of companies outside the U.S. which are also involved” in the effort to enhance renewables. “Companies like Unilever and AB InBev, the biggest brewer in the world, all highlight the cost savings that come from this commitment to renewable energy. It's certainly not an altruistic motivation. They see real economic benefits.”
“Internationally we still see a lot of momentum. If we look at China, they set out a plan every five years. They recently set out their thirteenth Five Year Plan, which runs from 2015 to 2020. They very much shifted the focus towards environmental quality improvements and away from the infrastructure build. It's focused on plans to improve things like water quality, reduce air and soil pollution. And the focus on renewables within that obviously plays to those improvements.”
“Within that plan, they've got much tighter emission standards for vehicles, to drive the policy towards electric vehicles and hybrids. They're talking about increasing sales of electric vehicles from 400,000 last year to just over five million by 2020. Huge increases in electric vehicles.”
“So, there's a lot going on outside North America,” Mr. Sheasby confirmed. “Momentum is really continuing, if you're not being distracted from what's happening.”
Mr. Beales asked how ESG issues are specifically affecting global utility companies.
“They are some of the biggest investors in wind, solar and hydro power generation, so we continue to invest in those areas,” Ms. McQuillen answered. “The other area I think is interesting is LED lighting. Lighting is a huge part of power consumption around the world. LED currently is about 10 percent of penetration in the U.S., but we think that may be over 50 percent by 2025. We're really excited about LED lighting. We're excited about many renewable energy utilities.”
“We are also looking at other sectors, like consumer, industrial, food safety, agriculture and materials. Many companies are trying to actively reduce their water footprint, and the amount of emissions through their operations. Agriculture is an informed contributor to greenhouse gases. We like what we are seeing in the consumer staples for food, also with retailers. The information technology, hardware and software sectors are also working on a lot of interesting areas.”
“One of the key areas our sector analysis has identified is data security and privacy,” she said. “It does not necessarily sound very environmental, but it does come up again and again, in how their customers are utilizing their services and what it can help potentially save or offset, and in terms of their losses related to breaches or lack of security in customer privacy. That comes through in financial services or other media companies. Those are some areas we think are interesting.”
“There's an opportunity in home energy efficiency, whether it's using less energy through more efficient appliances or conserving energy through insulation and fenestration, or monitoring and optimizing energy usage,” Mr. Sheasby added. “We can see interesting companies playing into those. And as I highlighted in China, more broadly, there's a move to electric vehicles, which is also generating great opportunities for some car parts manufacturers. Companies particularly exposed to growth in connectivity and electrification, which we see in the car markets, can generate significantly more revenue, compared to their exposure to the combustion engine.”
“With the move to distributed power, solar or wind, there is clearly demand for battery storage: producers of the batteries, of the chemicals, and the raw materials. If you look at estimated demand for lithium, it's perhaps three times the current demand in just five years' time.”
“The other thing we see are interesting opportunities on the energy transition side,” he said. “In China, there is a desire to effectively change the energy mix. Some gas companies are quite interesting in that respect. And data security and IT security is a key area to focus on.”
Mr. Beales next noted that, “If you're thinking about material issues for your business, that's good governance. That will lead perhaps to the E and the S of the ESG, to some extent. But it does require companies and investors to ask the right questions and do the right things.”
Agreeing, Mr. Sheasby said, “We engage extensively with the companies we invest in, and governance is a crucial part. It gives insight into the culture of an organization. We clearly look at how they think about material risks and opportunities. Then we look at what do they disclose, and did they set targets for things? How did they measure some of their success? How is capital allocated within the business? That disclosure and focus on materiality varies quite widely.”
“Western Europe is very much a leading light for disclosures around things like management of human capital or energy use or water use. Those are front and center of what the European companies will tell us,” he said.
“One of the tools being used by investors are shareholder proposals that are put forward to companies at their annual general meetings. This year, I think we have some 40 climate related proposals put forward by shareholders. Three of those are actually asking companies about how executives are paid on climate-related metrics. So there's some interesting developments.”
Ms. McQuillen reported that the ClearBridge team seeks out reports directly from management.
“For every company, we typically have the CEO in,” she said. “This is really helpful. While you can read the self-start research or third-party research, having face-to-face discussions on these issues helps to spur or be a catalyst for management to know investors are thinking about this, particularly from a long-term standpoint. CEOs can be very responsive, but it doesn't just go there. As David said, shareholder proposals are also an interesting form of engagement. If we are concentrated managers, we have the ability to vote. Those votes carry a fair amount of weight.”
“This is a time where investors should be engaged and actively aware of what managements are thinking for the long term, to disclose measures and accountability, and where they plan to go.”
Noting that any investment product or strategy can face pressure owing to fees and other issues, particularly when markets are not surging, Mr. Beales wrapped up the roundtable on an audience question: “Is ESG-investing becoming a real factor for retail investors?”
“We very much see ESG integration and active ownership as here to stay,” Mr. Sheasby said. “It's part of the good stewardship of our clients' capital, so it's very much embedded in our process. We think it brings us benefits over the longer term.”
“We also think it's here to stay,” Ms. McQuillen said. “We have continued to invest in our approach, in how we think about the world in terms of ESG criteria, and how it can contribute to the performance of our portfolios. We have seen evidence that these approaches can perform.”
“In terms of segments of the retail market, we've seen a high responsiveness from Millennials,” she added. “They may have a lower entry point but they eventually keep adding and contributing – and they're going to live for a long time. If they're part of a pension, it's something the pension is thinking about. Women as well, whether they're young women or mothers or grandmothers, have been particularly attracted. Then men, of course, too; I don't want to single them out.”
“But overall the ones who are most vocal are women and the younger generation.”
“It’s here to stay,” Mr. Griffin also concurred. “It's a very large market, close to $300 billion invested annually across the globe. There's been substantial growth, and that growth is expected to continue. Reason being that we still have the key growth-drivers in place, which are continuing cost declines, rising consumer demand, capacity-replacement needs, supportive policies, and new technologies and new models. This very large market will continue to grow.”
Legg Mason affiliates ClearBridge and Martin Currie, along with the President of New York Green Bank to discuss how going green can benefit investors.
About Legg Mason, Inc,
Legg Mason, Inc. is a global asset management firm, with $728 billion in assets under management as of March 31, 2017. The company provides active asset management in many major investment centers throughout the world. Legg Mason is headquartered in Baltimore, Maryland, and its common stock is listed on the New York Stock Exchange (symbol: LM).
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