Combining Sustainability & Performance ~ FA Magazine

Originally published by FA Magazine
By Paul Ellisjungle

Ellis: Garvin, tell FA magazine’s subscribers about Green Alpha Advisors’ Next Economy Investment thesis.

Jabusch: Sure, Paul, what we mean by what we call Next Economics is a contrast to modern portfolio theory, which emphasizes having sector allocations comparable to whatever benchmark you are correlating your portfolio to.

We don’t try to mimic a benchmark or exhibit low tracking error for a very simple reason. Our objective is to model what we think an economy five to 20 years hence will look like as the world gets more economically efficient and we continue solving for our largest systemic risks, including climate change, resource scarcity and the degradation of arable farm land.

We envision a future economy where we’ve de-risked a lot of these uncertainties and addressed underlying problems. We then go about modeling what that economy will look like and build portfolios to reflect it—as opposed to reflecting  the present day economy, which is the cause of many systemic risks.

In simplest terms, Next Economics is the practice of investing in the solutions to systemic risks and never investing in the causes.

Ellis: In your model you talk about going from the legacy economy to the Next Economy. How we make that transition raises systemic risk questions in the minds of many investors and advisors. Please share your perspective on these concerns.

Jabusch: You’re raising the question of what is the practical application of Next Economics, or how advisors should think about the transition and how clients can invest in it and benefit from it.

First, we think there is a Next Economy analog for every sector and company in the legacy economy. These analogs can help mitigate systemic risk during the transition. An obvious example is generating electricity using solar energy versus burning coal. This example meets both Next Economy requirements. First, it does not cause systemic risk and has the potential to mitigate it. Second, it is a viable, scalable solution. So it’s more economically efficient and generates wealth.

We believe in having a portfolio full of these solutions, not just in energy but every sector of the economy. This gives us the potential for  good long term returns, because these analog solutions are going to continue taking market share from their legacy counterparts. One day, solutions-oriented business practices will be the entire economy, and at that point we expect to have demonstrated good growth in our portfolio.

Ellis: I think most advisors would agree that’s what we’re always trying to do in the investment world. A couple questions I get from many advisors are, what parts of ESG analytics are material to a given company or economic sector, and once you’ve determined that, how do you measure the materiality through a consistent process?

Jabusch: Those are valid issues. There is no generally agreed upon methodology for measuring the materiality of ESG issues, but there are a number of competing methods for thinking it through. The real question for us is, “What are we trying to accomplish with our portfolio?” It’s about investing in and benefiting from the growth of solutions to systemic risk.

We think less about ESG ratings and more about what a company does to generate its revenue. Are they doing more to mitigate and help investors adapt to systemic risk than they are to causing it? Do they, in fact, represent the Next Economy? If so, then we can do the bottom-up quantitative analysis to determine if it’s an appropriate investment.

In a world where there is not yet a FASB or GAAP equivalent for sustainable investing that has regulatory authority, we believe that’s the best way to do it. It’s like putting yourself in the shoes of an economist 10 years in the future and looking back to see which companies are still in business that helped to create the de-risked economy, and which ended up on the discard pile of history.

Viewed through that lens the sorting criteria become quite clear to the extent that you can get under the hood and figure out where the bulk of a company’s revenues are coming from.

Ellis: What about investors and advisors who argue in favor of indexing when returns are competitive and expenses in an indexed portfolio are lower?

Jabusch: In general, lower expenses are good for investors, but I’m nervous about ESG rankings applied to every GICS category. That encourages the idea that one can select the top companies in any given sector and have a sustainable, blended portfolio without thinking about what a company does.

Some “sustainable indexes” include the top coal, oil and tar-sands producing companies. From this perspective the relative rankings of some sustainable portfolios worries me.

Our thesis argues that if you’re investing in companies that are causing systemic risk they will lose market share over time. For example, we don’t invest in coal or oil because we don’t see these companies fitting into the Next Economy. We don’t see oil companies doubling or quadrupling in value again, but we do think properly selected renewable energy firms and zero emissions transportation firms will experience that kind of growth.

The risks we need to think about are the ones with the power to undermine the global economy systemically, like the risks that we’re going to have a hard time farming or finding fresh water, or the risk that the tuna we eat will be contaminated with mercury. These are the types of long term risks we focus on in investment selection.

Ellis: Garvin, you’ve mentioned two economic issues that are on many investor’s minds these days, regenerative agriculture and access to fresh water. Tell us about a company you expect to grow because of its focus on these issues in the Next Economy.

Jabusch: I love that you bring up regenerative agriculture. And nothing could be more elemental to a healthy economy than water. Both of these resources have to be managed so they can thrive indefinitely.

Let’s talk first about large-scale industrial agriculture in the legacy economy. Most agriculture today is practiced in ways that are resulting in significant long term damage to soil and pollution of the rivers and oceans into which runoff drains due to the ever-increasing use of pesticides and herbicides. These practices reduce soil productivity and the soil’s ability to sequester carbon over time.

So, what’s the Next Economy analog? The assumptions that natural and organic farming practices cannot compete with industrial scale agriculture are out of date. There are opportunities in the agricultural markets to own companies that are very productive, have high yields and generate outstanding margins on their products.

Consider White Wave Foods (WWAV), a natural and organic plant-based food and beverage company. Danone recently acquired White Wave to generate more growth in their business model. White Wave became an irresistible takeover target by growing its business nine times faster than the underlying milk industry.

This is a great example of a company whose business practices solve for  systemic risks that investors want to avoid in this economic sector, more pesticide and herbicide use, which leads to depleted soil and the contamination of fresh water. White Wave makes a competitive product that consumers want to use as opposed to its legacy economy alternative, and their farming practices contribute to the long-term health of soil and water resources.

It’s not at all out of the question for investors to achieve competitive returns while focusing on sustainability. The idea that these two objectives cannot be combined is an old mythology that needs dispelling. At Green Alpha Advisors, we have seven years of demonstrated success combining sustainability and performance.


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