Sponsored article WHY INVEST IN EARTH?
As BNP Paribas Asset Management launches Environ- mental Absolute Return Thematic (EARTH), we asked co-managers Ulrik Fugmann and Edward Lees what in- vestors can expect from the equity fund.
With so many environmental-themed funds available, what makes EARTH different? Most sustainability-themed funds are long-only, but EARTH also takes short positions. We use shorts to isolate idiosyncrat- ic risk for alpha creation by hedging factors including sector, market and style, greatly reducing fund volatility. We also short companies that are not embracing sustainable practices, and we feel will underperform over time, to create double alpha. We are an environmental-themed fund, not an ESG fund, per se. ESG is integrated into our investment process, but it does not lead the investment, it is not how we construct our portfo- lio. We do not go long high ESG-rated names or short low-rat- ed ones. Our investment process is top down and then bottom up, whereas many investors start bottom up. The strength in investing thematically is that by considering macro and indus- try regulation, a top down approach puts the wind on your back. Our job is to find the best companies to go long and then put on our hedges.
What themes are you interested in? We invest in climate change and wider environmental issues. Energy, materials, agriculture and industrials are where many problems lie and solutions need to be found. A strong theme is hydrogen fuels cells, where we have been early and active in- vestors through our long-only fund. Investors are bullish but struggle to find assets that offer appropriate exposure. We can do that in the US rather than Europe where it is harder to find pure play hydrogen assets. In the US we also like rooftop solar, an area of tremendous growth and low penetration levels. Elec- trification will continue to be strong in Asia and the US, espe- cially in the passenger and delivery vehicle market. Technology that minimises carbon footprints in agriculture is also exciting. Another theme is the built environment, one of the fastest ways to reduce our overall carbon footprint. Much construction work is planned, and there is regulation to support carbon reduction.
Is economic uncertainty a blessing or a curse when building a portfolio? This is why long-short is a such a great strategy. Limited tools are available to navigate economic uncertainty within long-on- ly mandates because of the inability to hedge some of the mac-
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ro risks. In a long-short fund you can incorporate that into your strategy, to smooth the volatility out, subject to accurately iden- tifying the macro risks. We have identified risks in the second half, such as a weaker dollar and the US election, which could be a major catalyst for further outperformance in environmen- tally exposed companies if Biden wins. We are also looking at the extraordinary amount of stimulus, which we believe will continue. The timing of that stimulus ending will be impor- tant, so we are trying to assess the probability of a fiscal cliff. There is an argument that long-short funds underperform the market, which is an apples to oranges comparison because market neutral long-short funds are supposed to deliver an ab- solute return profile with limited drawdown risk that is differ- ent to a long only vehicle, which inherently has higher market risk and correlation to market cycles.
What would you do if a stock in your portfolio underperformed on its environmental credentials?
Our long positions are exposed to a market opportunity worth around $6trn (£4.6trn) annually across energy, materials, agri- culture and industrials. There is a similar argument for com- panies that are not grabbing that opportunity, where trillions of dollars of value could be lost. This is why launching a long- short fund is exciting. EARTH is a returns first strategy. We do not invest in companies simply because they look green - nor short those that look brown - but because we are positive on their fundamental outlook. Such companies can make money on the long side and we hedge them appropriately. We general- ly short those that we believe are structurally in a bad place, meaning their margins will suffer, their share price will fall and their cost of equity will rise. We look for solution providers who are doing things that matter and we expect the investment to make money. If we wake up one day and things have changed, what would we do? Typically, things do not change strategically for companies on the long side, whereas some considered brown are changing their behaviour and reviewing their portfolio mix, so this is more an issue on the short side. These situations are interesting because they can offer oppor- tunities for significant alpha on the long side, as the broad in- vestor base sees the change in strategy and commercial oppor- tunity in providing environmental solutions. This is something we see happening within oil services where companies engage in large renewable engineering projects, lending their experi- ence from offshore oil and gas projects. We like to engage with management and - in the case of our short investments - chal- lenge them on how they see the opportunity for environmental solutions in their business models.
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