The transition to a sustainable globe will be gradual over the coming decades, involving bursts of disruption - be that from stranded assets, disruptive technology or significant policy responses. We could argue that these dynamics already exist in the market with early movers challenging established companies with disruptive and future-proof products and solutions. These dynamics can be described through the parable of the tortoise and the hare.
All companies these days are competing in a race, in some way or another, towards the necessary transition and endpoint required for the betterment, wellbeing, and even existence of our civilization. Approaching this race from an investor perspective, we like to categorise companies into two baskets depending on their sustainability profile and rationale – the "hares" and the "tortoises". These profiles also contain interesting observations about the value investing philosophy, which is central to SKAGEN's funds.
The relevance for sustainability in investment processes
The respective features of hare and tortoise-like companies are intuitive. Hares, through a combination of tangible and intangible assets, bring the required products and solutions of the future to the present-day financial markets. Tortoises, on the other hand, are often perceived to be slow and even unwilling to address future absolute requirements. However, it is also the case that tortoises, for a multitude of reasons, require time to incrementally reach the future requirements of their raison d'être.
Data from the Transition Pathway Initiative (TPI) on electric utilities provides a good illustration of the dynamic between hares and tortoises. In the framework, TPI looks at i) management quality – i.e. the level of awareness and strategic importance of climate change risks and opportunities within a company, and, connected to that ii) the carbon performance (measured in accordance with industry-relevant carbon intensity measures)[1].
As is shown in figure 1, the carbon intensity of respective companies can be measured against two energy intensity pathways; those set by the company itself, and how those ambitions align against different climate scenarios[2].
As an illustration of the tortoise and hare dynamic, the hares are clearly Orsted and Iberdrola. Orsted comes out as a strong company both on management quality and carbon performance and can document a carbon performance, alongside Iberdrola, that is compatible with a below 2 degrees scenario. As we move further up the curve, we spot the tortoises. Companies like Engie, Dominion, and Enel that are currently operating in the range between the Paris Pledges and 2 degrees scenario.
The tortoise and the hare: why does it matter for investors?
Clearly, analysing and integrating sustainability factors into investment practices should be understood in the broadest sense possible and not focus solely on the hares of today. The hares do of course matter for a number of reasons: they challenge, disrupt and force tortoises to raise the bar and level of ambition – thus leveraging scope, size and network effects through their own product offering. Hares also require crucial financing to further scale and deploy their solutions to harness climate action as swiftly as possible.
Hares are not, however, unequivocally good investments for all investors. For one, they might demand a price today for future earnings that does not represent value (net present value of future earnings does not cover cost of capital), which makes it hard to accept the investment rationale from a fundamental analysis point of view. There might also be questions regarding governance structures. The recent allegations of deception and misleading of investors by the Arizona-based Nikola Corporation on their zero-emissions concept vehicles, might turn out to be a cautionary tale[3]. There may also be issues pertaining to other material sustainability factors beyond those that hares specifically seek to address – for example within labour relations, supply chain due diligence and human rights.
We believe that working with the tortoises, which we believe to be somewhat overlooked on their sustainability credentials, is also an important part of our ongoing sustainable transition efforts. Whilst the optics might not look favourable at present – at least when comparing with the hares within related industries – fundamental analysis and active value investing can help uncover companies with a sustainability proposition that has not yet materialised and is not appreciated.
SKAGEN seeks to provide its clients with the best possible risk-adjusted returns and follows disciplined value guiderails in its search for the best investments. In that search we might well find both hares and tortoises. What they both have in common is that they pass our fundamental expectations of corporate activity and behaviour as well as a clear value investing proposition.
Slow and steady wins the race?
Sustainability, in its simplest form, can be summed up by the well-known definition in the Brundtland report:
"Sustainable development is development that meets the needs of the present without compromising the ability of future generations to meet their own needs."
To achieve this goal, there are a multitude of different initiatives being carried out by states, NGOs, companies and financial market participants, often coalescing around how an activity contributes to one of the sustainable development goals. Low-carbon societies will be pivotal to reach our end-goal – but so too will good social mobility, high quality jobs and education, to name but a few.
The transition to a sustainable globe will be gradual over the coming decades, involving bursts of disruption as well as elements of incremental scaling and deployment. Whilst the focus in the market today might rest on the hares as those that will guide us towards 2050, we believe that tortoises too – at least the right ones – have a key role to play and will undergo a transformational change. In that spirit, we are convinced that there will be mispriced hares and overlooked tortoises that are of interest to value investors (and others) going forward. We will have to wait and see whether the outcome of the parable turns out to hold empirical merit in this case.
[1] https://www.transitionpathwayinitiative.org/
[2] https://www.transitionpathwayinitiative.org/sectors/electricity-utilities
[3] https://hindenburgresearch.com/nikola/