Sustainability has always been centre-stage for Dutch asset manager NN Investment Partners (NNIP). The philosophy behind it is simple: “As a responsible investor, we aim to improve our clients’ returns and the world we live in. Because it matters, and it works.” A lot has happened in the twenty years since the launch of NNIP’s sustainable equity strategy, yet the basic approach has not changed dramatically. The focus is still on finding tomorrow’s winners: high-quality companies with sustainable businesses and a strong competitive position that are aware of their role and responsibility to society and act accordingly.
With such a mindset, it must be difficult to single out just one sustainable investment in the portfolio to showcase what a successful ESG integration looks like at NNIP. After careful deliberation, however, Paul Schofield, Head of Sustainable & Impact Equities and Oskar Tijs, Senior Portfolio Manager, make up their mind. The case they want to talk about is SolarEdge1, a smart technology company that is best known for pioneering an innovative way to collect and manage energy in solar systems.
“We see renewable energy, and specifically solar, as an area of continued strong growth in the energy transition value chain,” explains Tijs. “We are looking for winners within the chain, companies that can grow with sustainable solutions while having an economic ‘moat’, resulting in an attractive return on invested capital. SolarEdge ticked all these boxes when we entered in 2016, growing rapidly and gaining market share while increasing its margins with distinctive products protected by patents,” he adds.
In 2009, SolarEdge launched an intelligent inverter solution for photovoltaic systems, maximising power generation while lowering the cost of energy produced. This cost-efficient solution has allowed the company to gain a sizeable residential market share in the US, Europe, and Australia. The model is also scalable, which opens opportunities in the commercial and large-scale utility markets. “It is a rare solar play that combines strong growth with consistent high return on capital,” says Tijs.
SolarEdge IPO-ed on NASDAQ in 2015 and has since shown significant growth in revenue and gross margin. By now, NNIP is hardly alone to have discovered this company, so perfectly positioned to aid the global sustainable energy transition with its innovative technological solutions. In hindsight, SolarEdge seems like an obvious sustainability play, yet it was probably not when NNIP stepped in to become one of SolarEdge’s biggest shareholders back in 2016. So, what is it about NNIP’s idea generation process that enables it to zoom in on future winners like SolarEdge early on?
Looking at the chain
Finding high-quality, sustainable businesses that can stand the test of time is not a quick or straightforward process. It means being selective: narrowing down the investable universe step by step until you reach a well-rounded portfolio. And NNIP has developed a consistent and repeatable approach to do that. An initial raw screening excludes from the very start companies that don’t align with NNIP’s norms-based restriction criteria as well as those that aren’t transparent or score poorly on ESG metrics. In the next step of the process, a detailed financial analysis of the remaining companies, conducted with the help of the HOLT® database as a screening tool, reveals the most interesting opportunities to look at. “We refer to these high-quality businesses as ‘sustainable compounders’, given the long-term compounding effect of their positive economic and societal characteristics,” explains Schofield.
The unique feature of NNIP’s approach, however, is perhaps the way analysts and managers both focus on value chains rather than on traditional industries and sectors. “When I think about energy, I don’t just consider energy companies. There is so much more to it,” says Schofield. Apart from traditional oil and gas energy companies and renewable ones like solar and wind-panel producers, the energy value chain also includes companies that make the components for these industries. Most of the non-traditional energy companies are typically in the industrials, materials, and IT sectors. As a result, the coverage for the energy value chain is much broader than simply traditional energy companies and their service providers.
Looking beyond sector constraints makes it easier to discover which part of a value chain creates the most profit and which companies are in the sweet spot. Moreover, analysts who are not constrained by traditional sector definitions are better equipped to locate potential growth opportunities. From the vantage point of overlooking the entire value chain, they can also identify and assess new trends and find new data sources.
Beyond ESG scores
Back to SolarEdge, it is easy to see how the stock made it through the sophisticated screening process and caught the attention of an analyst back in 2016. Financially screened as a ‘sustainable compounder’, it is also a perfect fit for one of the value chains that NNIP has a particular focus on, ‘Energy Transition’.
Yet had they chosen to solely trust external ESG ratings at the onset, SolarEdge might not have made it into NNIP’s portfolios. “A few years ago, the company scored quite poorly,” recalls Tijs. “Mostly because their ESG reporting was not good enough for the rating agencies.”
According to NNIP, although external ESG scores are helpful as an initial filter, they are insufficient for identifying truly sustainable companies. They are usually backward-looking, and there is not always a logical or material link between the scores and a company’s behaviour and business model. There is also a significant bias towards larger companies with the resources to produce high-quality annual sustainability reports. Proprietary research is, therefore, crucial to locate truly sustainable companies with potential for additional alpha.
Dealing with companies means dealing with people, so engagement is also vital in assessing non-quantitative idiosyncratic risks related to corporate behaviour. “We talk to the CFO of SolarEdge every quarter at least,” says Schofield. This regular and frequent follow up is partly a matter of gathering material information, but it also means engaging to improve disclosure on ESG issues. In SolarEdge’s case, the company has relatively recently started producing ESG reports, nudged by investors like NNIP. Consequently, their external ESG rating has improved a lot, too.
SolarEdge has been a stellar performer in NNIP’s portfolios for years now. So, could it be that it has already played out its role, and it is time for the managers to move on to other, more attractive opportunities? “The SolarEdge business case is still intact,” explains Tijs. “Yes, we’ve had to reduce our holdings slightly, for risk-management reasons, but as long as we believe in the company, it remains a good fit within our portfolio,” he adds.
Schofield says that he is continuously impressed by how SolarEdge’s R&D department is driving innovation, resulting in 348 awarded patents and 266 patent applications filed until the end of 2019 alone. Even more impressive, however, is the company’s sustainable impact. “Based on the installations until the end of 2019, SolarEdge estimates an annual avoidance of 12.6m tons of CO2,” he points out. Driven by the additional installations in the past 6 quarters, the volume should have increased to an avoidance of some 20m tons of CO2 annually until June 2021, according to him.
“We apply a high-conviction approach that seeks out companies with high and resilient long-term returns and a meaningful sustainable impact. It results in portfolios with a rather low turn-around,” says Schofield. “We invest for the long term,” he concludes.
 Disclaimer: For illustration purposes only. Company name, explanation and arguments are given as an example and do not represent any recommendation to buy, hold or sell the stock, or in any way invest in these companies. The security may be/have been removed from portfolio at any time without any pre-notice.
Image: Markus Spiske on Unsplash