Sustainability has a favourite son

After surveying 300 large investors across the globe, collectively responsible for $23.7 trillion in AUM, Robeco’s 2022 Global Climate Survey found thematic investing to be the strategy of choice for those seeking exposure to the megatrend of sustainability – particularly where the real world impacts of climate change are less quantifiable and translatable into a financial risk.

70% of respondents are currently implementing thematic exposure within their sustainable investment frameworks, with half of them labelling it a high priority strategy. 22% are considering it in the next two to three year timeframe.

In this article, we explore thematic investing in the context of sustainability, why it’s so compelling and whether the strategy is best pursued via active or passive management.

Only the beginning

The connection between irresponsible industry and sentient suffering has exploded into the global consciousness. It’s an awakening that will force us to do things differently, a reality echoed in a recent comment by Marc Coetzee, a climate specialist at the Public Investment Corporation (PIC):

“We are incorporating the broader social impacts, predominantly employment, energy security and economic growth that result from the shift to sustainability, as well as the vulnerability of assets given future climate projections.”

Certain sectors or ‘themes’ are poised to benefit from the changes that Coetzee is referring to, including but not limited to:

• Renewable energy
• Energy efficiency
• Water & waste management
• Sustainable agriculture & forestry
• Inclusive finance and healthcare
• Pollution control

When you consider the scale and complexity of the environmental and social threats we face, it’s plain that these sustainable themes, likely to be influential for decades to come, are still in their infancy.

Fortunate fundamentals

A long runway for growth is the starting point for every life-changing investment. Sustainable themes tick that box. But there are three more enticing dynamics at play:

1. Mispricing tendencies

It’s difficult to imagine a future in which coal has no value, all your water is recycled and everyone has access to first world medical diagnostics. We also tend to underestimate how quickly these new realities are approaching, a bias exacerbated by the warp-speed innovation made possible by today’s technology.

As a result, the market – being us – struggles to correctly price assets for long-term trends. Businesses aligning themselves to sustainable themes are, therefore, prone to being mispriced, giving astute investors an opportunity to buy low.

2. Favourable regulation

 Regulation is famously reactionary. You can be sure that first world policymakers are only taking climate change seriously because the floods and fires have reached their doorsteps.

Temperatures will, however, get worse before they get better, as will the consequences of that warming. Pressure to implement stringent ESG-related regulations will follow the same trajectory.

Sure, the real-world costs of turning sustainable will create some pause. But the businesses championing the transition will, on balance, find fewer regulatory hurdles standing in the way of their growth ambitions.  

3. Secular growth

 Companies operating within secular growth trends – those that will continue to make ground for the foreseeable future irrespective of prevailing economic conditions – tend to make higher highs during bull markets, as well as higher lows during bear markets.

Such a return profile makes sustainable thematic investing a good bedfellow for cyclical assets. Exposure across several themes could serve as a core long-term holding in the investor portfolios of tomorrow.  

Pick your battles

“Invest in the businesses you love” is a wise old axiom – if you’re wowed by the products and services a company delivers, others probably will be too.

But the emotional connection is useful for another reason; it promotes the long-term investment behaviours that facilitate powerful compound growth.

Thematic investing has similar benefits. It allows investors to support businesses making a difference in areas they care about. If you live in a region that’s feeling the worst effects of climate change, the renewable energy theme is a natural fit; if you work in agriculture, sustainable farming might resonate.

Investors that ‘connect’ to the theme/s they invest in are more likely to weather the short-term volatility trying to buck them off the megatrend of sustainability.

Active vs passive thematics

In the age of technology, nascent industries – like renewable energy – are characterised by experimentation and rapidly evolving business models. Some will prevail, many will fail.

That sounds like a landscape better suited to the due diligence capabilities of active fund managers. Passive strategies also tend to be weighted by market cap, potentially excluding or diluting exposure to smaller, exciting businesses.

That said, the thematic ETF market continues to grow rapidly, particularly in Europe where sustainability is front of mind.

When considering the viability of a specific theme targeted by a fund manager, be their approach active or passive, here are a few questions to ask:

1. Is the theme broad enough to give the manager flexibility to navigate changing market conditions?
2. Is it narrow enough to give investors the exposure they desire?
3. Does the fund manager have the technical expertise needed to stay at the forefront of the theme?
4. Are there any negative externalities associated with the theme (deforestation caused by biofuel production)?
5. How long does the manager expect the theme to be relevant and why?

Thematic investing is by no means bullet proof; many themes have come to naught. Before railways were laid, canals were touted as the future of trade.

But the megatrend of sustainability is unlikely to fade – our collective livelihood and well-being depend on its continuity. It’s no wonder that investing in the sub-themes of that trend is gaining momentum.

Click here to read the full Global Climate Survey.

Please note: Robeco’s Global Climate Survey does not take South African-specific trends or data into account.