How can a sustainable approach also ensure you don’t compromise performance?

The transformation in societies, economies and technologies over the last 18 months has heralded an important turning point for companies and investors alike.

This has put a spotlight on sustainability. The rise of the “conscious consumer”, for example, is increasingly holding corporations and governments to account through buying behaviour, election choices and shareholder activism. At the same time, regulators are implementing new directives across borders to address environmental, social and governance (ESG) issues.

In turn, these trends have created a new wave of high-quality opportunities as investors strive to make an impact with their capital.

To tap into these amid the disruption and long-term transitions reshaping various sectors, investors need to look beyond traditional industry boundaries to identify future winners in today’s value chains. Yet, this doesn’t require portfolios to compromise investment performance for the sake of good citizenship.

In short, contrary to what some investors might think, companies that capitalise on change and make sustainability central to their business models can also offer compelling investment opportunities and attractive risk-adjusted returns.

Three features of tomorrow’s winners

The common denominators are three-fold: they have a durable competitive position in their markets; their goods or services do little, if any, harm to the environment or society; and they can adapt quickly and effectively to change.

Looking for companies that…

Durable Competitive Position:  Having a good business model doesn’t justify a durable competitive position, since another company might be able to replicate the product or service – possibly better or at a lower price. In fact, two key indicators of durability are cash flow return on investment (CFROI) and asset growth. Companies with high CFROI and structural asset growth are highly profitable and able to compound those profits by reinvesting internally generated cash flows into their core business and attractive opportunities.

Do Little to No Harm: Further, many companies overlook their social or environmental responsibilities, fail to build on the potential for positive impact, or simply don’t respect investors’ preferences. This mindset will often manifest itself in the form of lost customers, reputational scandals, or civil or regulatory penalties. By contrast, good ESG practices can be aligned with a company’s broader financial performance when they are materially relevant to the specific business and its future strategy.

Adapt to Change: Adaptability is also not automatic within companies. Those firms at the forefront of their sectors must also be able to pivot with shifts in regulations, social attitudes and consumer preferences. In an age of disruption, offering solutions to emerging themes suggests a company can lead change in these value chains.

Value chain lens looks beyond traditional sector

With these features of durability, sustainability and adaptability in mind, certain value chains offer a more realistic view of what’s going on in today’s economy – and, therefore, create greater potential for alpha.

These are represented by five themes: the demand for renewable energy; access to healthcare through lower-cost solutions for unmet or high-cost medical needs; conscious consumption in line with the ever-sharper focus on ethics; fintech solutions to facilitate the shift to digital payments and online access to finance; and digital enterprise amid advances in computing power, 5G and artificial intelligence accelerating productivity and business innovation.

From traditional industries to a broader value-chain lens

Identifying transition winners demands more than a top-down allocation based on a sector or style-based approach. This is a less important driver of excess return than in the past. Instead, the key to unlocking alpha are fundamental insights gleaned from analysis of the value chain via bottom-up research and company engagement.

ESG integration drives alpha

A lot of ESG investing remains top-down and quantitative. These screens are useful for weeding out the very riskiest businesses, but, in our view, they are much less useful for differentiating between businesses that pose similar levels of risk or identifying attractive opportunities. There are two reasons for that: top-down screens do not differentiate the true materiality of certain factors to specific companies; and they are backward-looking.

Furthermore, the historical data that feeds into quantitative ESG scores does not fit well with our focus, as active investors, on businesses that are making marginal ESG improvements that are yet to be priced into securities. They offer no insight into a company’s sustainability action plans. Most of all, they say nothing about opportunities to help companies improve their ESG performance through active shareholder engagement.

For us, low current ESG risk is a plus, but we see the most attractive alpha opportunities in active efforts both to manage and to change ESG exposures.

In summary, when ESG-related factors are materially relevant to a specific business, and we ask forward-looking questions rather than looking only at historical data, we believe that good performance and planning around those factors can have a direct relationship with a company’s broader financial performance.

At a Glance – Neuberger Berman Global Sustainable Equity Fund

• Seeks to invest in quality companies where sustainability reinforces competitive advantage
• Global, best ideas portfolio of typically 40 – 60 quality holdings
  • Diversified across non-correlated high-quality business models and value chains
  • Long-term bottom-up research outlook (typical two to four years holding period)
  • Active share >75%
• Sustainability, value chain lens and engagement key to approach
• The fund classified as an E.U. Article 9 SFDR fund
• The fund returned 24.8% (net) since inception on 24 February 2021, outperforming its benchmark MSCI World Index (Total Return, Net of Tax, USD) by 1031 basis points (Source: Neuberger Berman, as of end October 2021. Fund performance is representative of the Neuberger Berman Global Sustainable Equity Fund USD I Accumulating Class.)

To learn more about Neuberger Berman Global Sustainable Equity Strategy:

For Hong Kong audience, please click here.

For Singapore audience, please click here.

Why Neuberger Berman?

• Dedicated team of seven experienced, industry-leading professionals; lead-PM has 30+ years of investment experience, over half of which has been on this strategy. Strategy ranked seventh percentile among peers over five years¹
• Supported by 45-person global equity research department, including 38 senior research analysts averaging 18 years of experience, and a dedicated nine-person ESG investing team
• ESG leadership – Neuberger Berman is awarded A+ scores by UN-supported PRI and a member of PRI 2020 Leaders’ Group, a designation awarded to fewer than 1% of PRI investment manager signatories

¹ Source: eVestment as of September 30, 2020. The portfolio managers were the lead decision makers of this strategy at their previous firm, NN Investment Partners, until September 27, 2020.  Peer statistics are reflective of performance against the respective vehicle peer group (Global Large Cap Core).

This material is intended as a broad overview of the portfolio managers’ current style, philosophy and process and is subject to change without notice. Portfolio managers’ views may differ from those of other portfolio managers as well as the views of Neuberger Berman. Investing entails risks, including possible loss of principal. Past performance is not indicative of future results. As with any investment, there is the possibility of profit as well as the risk of loss.

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