Why do you believe you can deliver sustainable performance while financing this green transition?
Environmental challenges are creating financial risks and opportunities: transition risks. Transition risks can include new regulatory constraints that increase costs for the most polluting factories, they may question licences to operate that may be withdrawn due to pollution or poor environmental standards. They also include technological changes – the cost of technology has changed considerably, some other start to be obsolete – and consumer preferences, as we switch from one product to another based on environmental concerns and the impact it might have.
Environmental challenges also implies physical risks; these include extreme events such as drought or fire or more chronic events: those risks are already materializing: the drought of the Rhine in Germany disrupting the supply chain, huge bushfires in Australia, etc.
Furthermore, the success of the green transition will require investments ranging from three to ten billion USD every year by 2030. This is a big challenge for public and private investment, which will drive new capital flows into this environmental and green theme, thereby enhancing the value of the companies in which we invest in and creating opportunities.
So what are the products, the services, the businesses that can contribute to the green transition?
While most of the financial community is already trying to answer this question using carbon footprint and carbon intensity readings, this is precisely what we are not doing.
If I take a very short example, for instance 4 stocks – Ferrari, Zalando, Veolia Environmental and Alstom and what the carbon footprint tells me. Basically, this tells me that Ferrari, on average, generates 7 million tonnes of CO2eq. per million euros invested. This figure stands at around 12 for Zalando, Alstom is around 130 and by far the worst of my sample would be Veolia, with more than 3,000 tons of carbon.
So, if I want to reduce the carbon footprint of this particular portfolio, I remove waste and water processing, and the manufacture of trains, and invest in sports cars and online fast fashion, thereby reducing the carbon footprint of my portfolio by over 99%. Obviously, we all understand that this is not the right thing to do – and does not help us meet our goals. This approach misses the issue of scope – in this example, we are missing 97% of emissions produced by a car over its entire life cycle. We have also issues on the denominator as we use enterprise value or market cap or sales, which move in a different direction independently from environmental impact; and we might also be overlooking other environmental issues – the environment is an eco-system which means it interacts with other environmental challenges, so we may have externalities on waste such as for nuclear power. We may also see negative externalities on biodiversity or water, for instance with plastics, or air quality with diesel – this is what we consider when we analyse a company and its green impact.
My message here is it to be careful with carbon footprint and carbon intensity, as they might be irrelevant in driving green transition or, worse, be counter-productive in addressing environmental challenges.
At Sycomore, we have been working on the NEC – Net Environmental Contribution, which is an alternative metric, more comprehensive and with a scientific grounding. It measures the contribution of any product or service to the environmental transition based on a full life cycle, which means we consider a product from its design phase, and look at its supply chain, processing, manufacturing, usage and even the end of its life – which might be recycling, or not. Importantly, this is a multi-criteria approach: we consider the climate but also water, resources and waste, biodiversity and air quality.
As an indicator it is very simple: it ranges from -100% to +100% with 0% standing as the average environmental impact for a given function. A given function might be feeding people, producing electricity, energy, clothes, providing mobility, etc. What is important here is that we are not comparing cars with cars, we are comparing a function – like a mobility service, with another mobility service, independently of the technology. A rating of 100% will stand for what we call ‘the eco solution’ which means the fulfilling of this function with the least environmental impact, knowing that hydro-power or solar or wind will have a negative impact on the environment. The opposite end of the spectrum, with a rating of -100%, will include the businesses that are particularly harmful to the environment and are clearly not compatible with the energy transition scenario: coal power generation, but also air freight, intensive meat production, etc. With this metric, which is quite granular, we have been able to cover around 1,000 – 1,300 stocks so far within the listed universe.
This metric lies at the heart of our investment process and within Sycomore Eco Solutions, we shall only invest in companies displaying a positive NEC, i.e. stocks which are positively contributing to the green transition.
Furthermore, we exclude stocks which have a SPICE rating below 3 on a scale of 1 to 5. The SPICE model is our internal ESG model – with SPICE standing for Society and Suppliers, People, Investors, Clients and Environment. This ensures the portfolio is well-balanced and prevents the inclusion of higher risk profile stocks within the healthcare and energy industries.
Finally, another key credential of our investment process is our expertise on fundamental bottom-up analysis. We use proprietary evaluation models, which involve a 360° review of a company – looking at the ESG side and its financial potential, and we will only select stocks offering a significant upside. We then build a high conviction portfolio investing in 50 to 60 stocks at the most.