Stockholm (NordSIP) – In a turbulent world, reeling from financial crises, pandemics, geopolitical risks, and high inflation, investors are increasingly pressed to find innovative approaches to sustainable finance. JO Hambro, a UK-based long-only equity manager managing US$30 billion and founded in 2001, proposes to address this issue, in partnership with Regnan, an ESG advisory business in Australia which was acquired by Pendal (JO Hambro’s parent company) in 2019.
“When we were looking at how to enter the global market in sustainability, ESG, impact and thematics, we believed that launching an investment franchise with credibility and purity was crucial. We felt Regnan was an ideal partner given its long-term track record of helping asset managers and corporates address their ESG and sustainability issues and targets,” says Patrick Aylwin, Head of Global Financial Institutions – UK, Europe & Asia at JO Hambro Capital Management Limited.
According to Bertrand Lecourt, Head of Thematic Investment Strategies at JO Hambro, financial markets are facing a paradigm shift in the manner in which they approach their investments. Lecourt argues that a thematic approach based on companies that address concerns involving water and waste management offers the right mix of stability, returns and sustainable impact.
A Thematic Approach
According to the traditional approach to asset allocation, investors follow a structured approach where their potential investment universe can be divided along geographical, industrial sectors and investment styles. “Although that segmentation has worked well before we can see that that model overlooks some gaps. Thematics, when done well, are able to fill those gaps,” argues Lecourt.
The problem is that even long-term macro analyses cannot account for all possible developments. “At the start of the last quarter of the year, investors review their asset allocations. They consider what markets might do in the coming twelve months and try to predict what the world might look like in the future. Predictions are often wrong because some unforeseen event unfolds, such as a financial crisis, a pandemic or a regional war,” Lecourt explains.
According to Lecourt, overcoming the unpredictable currents of financial markets requires taking a long-term historical approach that focuses on the constants rather than on the variables. “Instead of focusing on what traditional macroeconomic analysis can’t show us, we should focus on that which we are certain will still be important for mankind in 50, 100 or 250 years. One evident theme seems to emerge from these considerations: Humanity’s need for water and waste management services,” says Lecourt, who is also the co-manager of the Regnan Sustainable Water and Waste Fund.
Water & Waste – Driving Factors
For Lecourt, the stability of Water & Waste as an investment theme is supported by reliable and supportive dynamics across five dimensions: Urbanisation, Consumption, Infrastructure pressures, Regulations and Health issues and Resources and Scarcity concerns.
Urbanisation is one of the most important drivers of the Water & Waste theme, according to Lecourt. It ensures the efficient allocation of resources by gathering people together, and creating a nexus for economic transactions. “Since 2011 more people have been living in cities than in the country side. This trend is expected to continue. By 2050, estimates suggest that 70% of the world population will live in cities,” Lecourt explains.
According to Lecourt, this is not just a shift in the existing population stock. The fund manager emphasises that increased urbanisation occurs in tandem with population growth, which is itself strongly correlated with water consumption and waste generation. “Typically, people consume four to five times more when they move from the country-side and into cities. We’ve seen this in emerging markets,” he argues.
“Everything we consume is water. It’s not only drinking, washing and cleaning. Agricultural and industrial processes consume water too. The production of a microchip, a cup of coffee and 1Kg of beef requires the use of 30 litres, 130 liters and 15,400 litres of water, respectively. But it’s also important to remember that eventually, everything we consume also becomes waste that needs to be disposed of. One piece of cardboard takes 2 months to decompose. A milk carton will take five years to decompose. The sort of foam plastic cups we often drink hot beverages in can take as long as 50 years. Batteries take 100 years to decompose,” Lecourt adds.
This increase in consumption puts pressures on infrastructure. “Increased waste production creates a need for more and better waste water management, collection, recycling and disposal. This creates opportunities for investment in the maintenance, repair and upgrade of old waste management infrastructure as well as in new infrastructure projects,” Lecourt continues.
The increase in consumption and investments also creates a need for increased regulation, according to Lecourt. “Regulation guides companies towards the goals that society seeks to achieve, by providing the necessary standards that the company needs to follow to ensure they are producing food or managing waste sustainably.”
“Regulation can also open new markets, as in the case of The Ballast Water Management Convention which requires the ballast water onboarded at the source by ships for stability. Ballast water contains thousands of aquatic or marine microbes, plants and animals, and needs to be treated before it is discarded as waste at the ship’s destination. Disposal of untreated ballast water can cause extreme ecological and economic damage to marine ecosystems and cause serious health issues to humans. We estimate the total addressable market (TAM) created by the Convention to be worth US$360 billion by 2027,” Lecourt says.
The last driver of the constant appeal of the Water & Waste theme is resource and scarcity. “On the one hand, fresh water is becoming scarce, so the efficient use and recycling of resources is crucial. The need to treat waste as well as technological improvements are allowing us to move from having to dispose of waste to being able to treat waste as a resource. The mere need of addressing waste management means that related services appear for which waste is a crucial component,” Lecourt says.
“In developing countries, waste management creates demand for waste collection and removal services provided which can stimulate the economy by leading to the creation of local operators. More developed countries are characterized by demands for a more complete service, including biological treatment, material recovery such as sorting and recycling, biological recovery and energy recovery. To avoid waste, you need to reuse and for that you need water,” Lecourt explains.
Financial and Sustainability Appeals
Supported by these reliable drivers, Lecourt argues that there is a strong financial case for investing in Water & Waste. According to him, companies operating within the scope of this theme are large, global, growing faster than the rest of the world and not well covered by big banks. “85% of water and waste companies not covered by big banks’ research departments, which allows us to find opportunities others are missing.”
Addressing concerns that such a thematic fund might not be large enough, Lecourt uses the experience of his own fund as an example of the scale and liquidity that can be found. “Some people may be wary that this approach might not be ambitious enough, but US$3 billion to US$10 billion is not small,” he says.
The Water & Waste theme also provides stable returns and diversification. “Water & Waste has a similar risk-return profile as a tech fund, while at the same time being uncorrelated to tech, financials, energy and healthcare stock,” Lecourt explains.
Finally, investing in Water and Waste allows investors to diversify their sustainability exposure. “Of the relevant three polluting outputs (i.e.: gas, liquid and matter) climate change has caused most investors to focus on only one: CO2 emissions (gas). A strategy that focuses on Water & Waste allows investors to gain exposure to a different type of sustainability concerns,” Lecourt argues.
Lecourt uses the example of his own fund. “Because we want the fund to qualify under Article 9 of the EU’s Sustainable Finance Disclosure Regulation (SFDR) we ensure that we can identify ten solutions in water and ten solutions in waste that can be aligned with the UN Sustainable Development Goals (SDGs).”
What it Looks Like in Practice
There are four important aspects of the practical implementation of a Water & Waste investment strategy, according to Lecourt. “Asset managers need to design an investment universe, understand the long term drivers, have a stable and replicable investment process and the ability to quantify insights, which is necessary for reporting and mapping.”
“The first consideration is ‘purity’. The vast majority of such a fund’s revenue (90% in our case) has to come from activities relevant to the Water and Waste theme. Second, a Water & Waste strategy must be supported by a commitment to ESG integration. We conduct our own ESG assessment and ensure that two-thirds of our companies are BBB (MSCI) rated or above in our fund, for example. We use our own ESG rating system, which is backed up by MSCI ESG rating,” he explains.
“ESG ratings can also serve as a tool that can help investors engage with companies,” Lecourt adds using waste disposal as an example of an important topic of engagement. “There are a number of targeted issues in waste management that cause us to engage with companies to help them tackle these challenges,” he explains.
According to Lecourt, landfilling presents a very relevant example. “If it is not done well landfilling may lead to leakages that can contaminate water sources and damage ecosystems. Recycling or the use of waste for energy generation can help avoid the risks of landfills. However, there is a danger that recycling could lead unwanted unprocessed waste to be exported to poorer countries, which would not be sustainable.” Converting waste to energy is another good alternative to landfills, Lecourt argues. “When countries convert waste to energy they are able to offset pollution twice. They can mitigate the risks associated with landfills and dispose of the waste by burning it, while at the same time finding a source of energy that is less polluting than coal,” he says.
Lastly, a Water & Waste fund should seek to do the least harm possible. “It is important that our investments on this theme are not carried out at the detriment of other important sustainable considerations such as the mitigation of CO2 emissions. We want to focus on water, while internalising the costs of our investee companies’ operations to other sustainability issues. If companies fail on the sustainability objectives a Water & Waste fund should be able to divest,“ Lecourt concludes.