By Louis Larere and Luc Pez, co-portfolio managers of the OYSTER Sustainable Europe Fund.
Peter Lynch popularised “Growth at a reasonable Price” (GARP), investing in his quest to get one up on Wall Street. Lynch posted record averages of 29.2% in annual returns while running the Magellan Fund between 1977 and 1990, to place him in the pantheon of legendary investors.
He did this by applying GARP’s hybrid style of investing, which combines both growth investing and value styles. His thesis was based on stock selection rather than merely blending the two factors.
Lynch plotted his course in the ‘Goldilocks zone’ of the stock universe – those companies displaying above-average growth rates while still trading at reasonable valuations; neither too expensive, nor too cheap.
A lot has changed in the world since Lynch brought GARP into the investing zeitgeist, but perhaps one of the greatest shifts in capital allocation trends has been the growth of ESG and sustainable investing. While ESG is enthralling, the race for ESG stocks is, in large part, an emotional response by investors trying to tap into an exciting new theme.
Chasing a hot trend only for it to run cold is certainly nothing new in investing – just look at the dotcom boom, where investors ended up holding the bag by falling for a compelling narrative.
The birth of SARP investing
As investing goes green, asset managers are increasingly allocating to growth leaders displaying high ESG scores. Only a handful of rating agencies are in this business – and it is far from a perfect science.
For example, ESG rating providers differ greatly in their assessments of the same company.
The ratings are only correlated to an average of 61%. In the banking sector, on the other hand, the assessments of the creditworthiness of different providers for a company are 99% correlated. Investors should focus on the use of ESG as a fundamental part of the investment process, not a simplistic filter or shortcut to select the best companies. Furthermore, mere ESG integration should not be equated with sustainable investing.
There are many interesting sustainable investments outside the ‘growth’ sectors of the market. In fact, many good cyclical or value companies are often overlooked.
Our motto ‘Sustainability at a Reasonable Price’ (SARP) reflects a new investing world, where exuberance over unrealised potential in green stocks is manipulating valuations. The sustainability leaders of the future are now in transition – as these companies do not have a green halo bequeathed by ratings agencies, they are trading at very appealing multiples.
Since third-party scores and binary questionnaires can be manipulated by data providers or corporate investor relations departments, investors should instead focus on valuations and the price paid for sustainability exposure.
Ultimately the goal is ‘sustainability at a reasonable price’, unlike many sustainable funds that seek ‘sustainability at any price’. This approach is simple, transparent, and backed by public data usually found in corporate annual reports.
Tomorrow’s companies today
Indeed, ‘under-the-radar’ improving companies offer the most attractive opportunities both in terms of impact on society and returns for investors.
A good example is Stora Enso, the Finnish provider of renewable solutions in paper and packaging. Just 15 years ago, it used to make more than 70% of its earnings from paper manufacturing, a business far from sustainable.
Today, half of the company’s value lies in its forests that absorb around 3m tons of CO2 per year, a number that is growing with the forests.
Stora Enso also makes fibre-based packaging which is much less CO2-intensive and easier to recycle than its plastic and glass alternatives, as well as wood products that are replacing concrete and steel in construction.
The group has recently completed the construction of a pilot facility producing Lignode®, a bio-based carbon materials from lignin that could be used as a low-carbon alternative to synthetic and natural graphite in battery anodes and offer leverage to EV/energy storage applications.
We estimate old-fashioned paper production will be as little as 10% of earnings from 2021, as Stora Enso closes mills or uses them for other purposes.
Our philosophy doesn’t mean ESG analysis is not crucial to the stock picking process. On the contrary, ESG is an integral consideration, and we would be unlikely to include a company with controversial practices and no sign of improving in any of our portfolios.
But as the whole market is now turning to ESG and SRI for profitable investment ideas, there is a tendency for investors to concentrate solely on a handful of today’s leaders. Instead, it could pay to look two or three years ahead for companies making radical improvements. By doing so, investors can differentiate portfolios from competitors and avoid the perils of a ‘green bubble’. Our world, according to SARP.