Sustainalytics: 10 Investment Themes for 2017

Sustainalytics, a provider of ESG and corporate governance research, ratings, and analytics, released a thematic research report, 10 for 2017: Investment Themes in a Changing World, earlier this year. The report looks at the key drivers of 10 ESG investment themes that are expected to create new risks and opportunities for investors.  In addition, 10 companies are profiled, spanning seven countries and eight industries, that are poised to take advantage of these trends. The unifying threads for the investment themes include:

• Rising concerns over data security/privacy and related market opportunities associated with blockchain, autonomous vehicles, and cybersecurity.
• Growing sustainability and market trends highlights the declining cost of solar power and the consumer shift toward plant-based proteins and trends such as value-based drug pricing, energy storage and workforce diversity are also explored.
• Improving corporate transparency covers an assessment of the increasing focus of European regulators on tax avoidance, more transparent corporate tax reporting, and the potential impact of U.S. regulations around executive pay disclosure.     

At this halfway point through the year, I spoke with Doug Morrow, Associate Director of Thematic Research at Sustainalytics [pictured], to discuss 10 for 2017, its highlighted themes, the methodology behind the picks, and performance to date—Jason Howell

JH: How long have you been publishing ESG Investment Themes?

DM: Investment Themes is the flagship report for Sustainalytics’ thematic research team. We publish at the beginning of the year and this is the fourth installment of the series. There is one major difference in the 2017 edition from previous years. Prior to 2017, the report was centered on specific issues such as climate change/renewable energy. In 2016 we actually focused on one issue only: the Paris Agreement. In this year’s edition, Sustainalytics decided to take a thematic approach, essentially taking an ESG angle on major investment themes and highlighting companies we think are well-positioned to take advantage and outperform by being aligned with the theme. Going forward, Sustainalytics intends to publish in this manner—similar to this year—as we are seeing substantial increases in thematic investing from investors.

We consider Investment Themes a mini-playbook for ESG investors with the added advantage of company-specific recommendations.

JH: Is this report applicable only to ESG investors?

DM: The report primarily appeals to ESG investors but is gaining traction with non-ESG investors looking for ways to outperform, based on management’s strategy and alignment with current trends.

JH: How do you choose your investment themes?

DM: We look at the three pillars of ESG management within a company, big trends in the economy, and how investors can apply these considerations to specific companies.  We also strive for diversity across the ESG pillars and don’t focus on one particular segment. The themes are chosen at the beginning of the year and remain in place throughout the year—we don’t update until the following year.

JH: Are the individual stock selections chosen from companies that your research department currently covers?

DM: Yes, Sustainalytics currently provides coverage for over 6,500 public companies, and all of the companies we discuss in the report are part of our coverage universe. Our analysts assign ESG scores to these companies based on how they perform against their same-sector peers on material ESG indicators.

JH: Are there any themes you consider more important than others?

DM: All of the themes are compelling and treated equally in the report.

JH: How often do you update ESG indicator scores/coverage ratings?

DM: A company’s overall ESG score is determined in part by the strength of relevant management programmes.  Companies typically disclose information about these programmes annually. However, a company’s ESG score can also be impacted by real time events. A major controversy, such as an environmental accident or product recall, for instance, can negatively impact a company’s score.

However, our Investment Themes report is looking at a company’s exposure to a particular theme, not overall ESG scores per se. Barclays is a good example.  They are an average performer from the perspective of overall ESG scores.  But they are well ahead of the industry curve with blockchain, so we profiled them in our discussion of blockchain in the financial services sector.

JH: We are undergoing many political and economic changes globally- Trump, Brexit, U.S. rate increases.  Do you see these events having a significant impact on ESG themes and stock picks?

DM: It’s too early to tell. The market is trying to digest what Trump will accomplish and the impact of Brexit. Same with U.S. rate hikes. Some themes such as the overall movement from fossil fuels to sustainable energy—solar, wind—are largely immune to major macroeconomic changes. Political changes can clearly have an impact, but many of themes we’re looking at are being driven by market fundamentals, not policy, such as energy storage, distributed generation, and smart transport.

JH: Do you monitor your stock pick’s performance throughout the year and give updates?

DM: Sustainalytics definitely monitors performance and ESG scores can change throughout the year. However, we only publish the results in the following year’s Investment Themes report.  For instance in the 10 for 2017 report, we highlighted that our picks from the 2016 report, 10 for 2016, would have outperformed the MSCI ACWI by 5.6% on a total return basis. The 2016 picks were based on global companies well-positioned to take advantage of climate change-related risks/opportunities and this helped deliver market outperformance. Additionally, we saw a negligible change in the ESG scores for all 10 companies over the year.

JH:  Any emerging trends you are seeing that aren’t covered in the report? 

DM:  There is no shortage of investable ESG themes in the current environment. Climate change, energy economics, and decreasing global gas demand due to electric vehicles are just a few of the examples that are out there. In many ways, the most important changes taking place in the market have a clear ESG connection.