There has been a change in investor mindset around sustainability, it’s happening faster than previously anticipated, and will lead to an economic transformation by as early as 2030. These are the bold statements made by the global head of equity, head of sustainability research and head of UK wholesale at Lombard Odier Investment Management (LOIM) who are preparing portfolios and the business for a “fundamentally different economy” within less than a decade.
“We’re on the cusp of an understanding what we’re really seeing is an industrial revolution, a fundamental transformation of our economy as profound as past digital revolutions,” says Thomas Hohne-Sparborth, head of sustainability research at LOIM, joining our group call from the World Economic Forum in Davos.
The team has placed this at the heart of investment convictions pointing to evidence of this rapid change all around them as we understand more about how our economy and environment intertwine.
“What is quite exciting to see here [at Davos] is that there’s very little discussion left on the science behind this,” Hohne-Sparborth adds. “It’s now very widely understood by all the attendees here that this is a fundamental challenge we’re facing, where action is needed. The focus of discussions here is very much more on the action, and how to bridge the gap between past ambition and the current action that’s needed.”
He points out that as the global economy is hitting some very real physical boundaries for the earth’s system, there are physical implications such as limits on the way we use land, shortages of water, degradation of agricultural productivity, for example.
“It’s our growing understanding that our current economic model simply cannot physically be scaled up as markets continue, still today, are assuming it will be,” he adds.
“We’ll see a very rapid acceleration in this realisation, and investors are adjusting to how quickly all this is unfolding. That’s really been one of my personal takeaways over the past six months, a lot of the changes we’ve been talking about are unfolding much faster than anybody in the market anticipated.”
That seems a lot to take in, but this is not a lonely view in the investment industry – Aviva Investors’ CEO and chief responsibility officer both told ESG Clarity last year we need a “complete rethink of the international financial architecture” to avoid the end of civilisation by the end of the century.
The level of resources dedicated to researching this at LOIM shows how seriously the impending rapid transformation is being taken. The group launched a research unit four years ago, developed a research partnership with Oxford University and with Swiss universities (the latter focused on the circular economy), and also acquired a stake in SYSTEMIQ in 2021 to work on sustainable investment methodologies and roadmaps.
“The traditional approach to sustainability/ESG is to only use quantitative metrics, scoring to rank companies for things such as the quality of their disclosure, whether they’ve got the right policies and practices in place. That is a necessary thing to do, but it’s not sufficient. Our approach has evolved towards undertaking much more fundamental research as to where the direction of the economy will be,” explains Hohne-Sparborth.
Global head of equity Didier Rabattu adds: “We are very privileged to be able to dedicate resources to this together with our partners, that hopefully provides us with some distinctive edge in this market.”
This research, they say, helps build roadmaps for the economy as a whole and for individual industries to inform their investment decisions.
“This is the head of research and the global head of equity working hand in hand – something you do not usually see – to create these industrial roadmaps together and translate them into money-making ideas,” Geneva-based Rabattu says.
The roadmaps help the team to understand where companies’ profit pools will be, how industries will evolve, the corporates that will be benefit or be negatively impacted, and also where first changes of policy attention will be focused. “That’s actually nothing to do with ESG,” Rabattu says, but means they can directly integrate their insights on sustainability into their investments.
“What we are trying to do at LOIM is marry sustainability and making money. One cannot go without the other one,” he says.
“We’re not just approaching this because of new regulatory requirements or new disclosure requirements,” Hohne-Sparborth notes. “We’re approaching this with this degree of seriousness, because of the sense of our convictions that this transformation is happening.”
“The science is telling us that this current economic model simply cannot be scaled up and therefore it inevitably has to change – that is at the root of the strength of some of our convictions.”
They say it is working. It’s sometimes the case that asset managers trying to assert their ESG credentials can shy away from talking about outperformance or “making money”, but this isn’t true for LOIM. Rabattu points out that amid challenging performance its Climate Transition, winner of ESG Clarity EU Awards Climate Focused Fund category, and Natural Capital funds, fared well last year.
Data from FE shows the Natural Capital Fund, launched in 2020, returned 4.7% over the past six months to 23 January, outperforming the peer group average – the IA Global sector returned 1.5%. Over a year, the fund returned a loss of 1.5%, while the sector average lost 1.8%.
“When we talk about performance, we are not shy whatsoever. Our model is not to invest in companies that are not making any money, but in companies that are already right now producing returns and create a portfolio that investors can buy without too many biases. It’s very important,” Rabattu says.
The trio all mention the hunt for “green alpha” as a key part of creating portfolios at LOIM.
Head of UK wholesale Selina Tyler explains: “As an industry, we need to understand the importance, the complexities and the opportunities that come with the transition to a net zero and nature-positive economy and allow our clients to capture the green alpha that comes with that.”
“We amalgamate high-conviction portfolios at LOIM, through the creation of green alpha that we can isolate, and that has worked pretty well,” Rabattu adds.
There will, they add, be more opportunities to unlock green alpha amid the renewable energy transition, and they say the energy crisis has actually accelerated this.
Hohne-Sparborth explains the higher costs to consumers has led to faster uptake of energy-efficient technologies in Europe including electric cars and heat pumps to electrify buildings. They also highlight falling costs of hydrogen and in solar and batteries, while industries considered harder to abate, such as steel, cement and chemicals, are also seeing faster uptake.
“This has been the silver lining of the energy crisis,” he says.
Rabattu adds: “The amount of physical capacity that is coming onto the market through renewable energy that gets transformed into electricity is just enormous.”
For this reason, electrification is a key theme for the business alongside natural capital and food.
Direction of travel
Taking a step back and looking at the wider industry, Hohne-Sparborth says collaborative engagement is a key trend to watch. “Engagement is always one of the key levers we as investors can use to drive for positive change. There’s limited impact you can achieve if you as a small individual manager engage with the company – you can achieve much greater influence by trying to agree on a common framework with other investors and engaging key companies in unison. That is very much been the direction of travel in this industry, which is very positive.”
Collaborative engagement is very much part of their future alongside their aim to unlock further ‘green alpha’ amid the transformation to a new economic approach.
Continued dedicated research is part and parcel of that, Tyler says, which will benefit all clients not just those seeking their sustainability-focused portfolios.
“Our investment conviction is so strong that we will continue to strategically expand and leverage a distinctive research capability, leveraging our own resources and academic partnerships. The results will allow us to understand the trajectory of the new economic systems which are unfolding, and to seize the investment opportunities that come with that.
“UK clients already understand the opportunity from investing in the transition is of strategic importance, but the investors who understand this affects all of their client portfolios, not just the sustainable portfolios, are set to capture this opportunity and green alpha on a much larger scale.”
And for those really in the dark, this rapid transformation will catch them off guard, Hohne-Sparborth warns. “[We recognise] that this is no longer something that will be 10, 15 or 20 years away, it’s actually going to reshape financial markets much sooner – it’s something we will start to see happen very quickly in 2023.”