Risk, return and responsibility

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Risk, return and responsibility



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By Hubert Keller, Managing Partner
Lombard Odier Group

 

Article published in Le Temps, April 16, 2018

Sustainability is the first principle of long-term investment. It is crucial not just to our ability to deliver risk-adjusted returns over time, but also to the wider economic outcome. The two are inextricably linked.

Our economy is currently operating in an unsustainable model. Over the coming decades, issues such as technological advancement, climate change, demographic shifts, scarcity of natural resources and inequality, will have a transformative effect on our economies.

Consumers, governments and the physical environment are all working to force companies, which are the engine of our economies and our portfolio returns, to transition to a more sustainable model.

Consumers’ behaviours and buying patterns increasingly reflect a growing social and environmental consciousness. The recent scandal with Facebook around misuse of personal data demonstrates how dangerous it can be today for companies whose business practices fall on the wrong side of this increasingly formidable, and increasingly informed, social consciousness. In that case, it is the company’s behaviour and not disappointing financial results, which translated into a significant market correction.

Governments are also responding. We are facing an acceleration in legislation aimed at delivering more sustainable development. Importantly, this legislation is also increasingly focussed on the role of the investment community to finance this transition, and hold the laggards to account. The European Commission’s Action Plan on Financing Sustainable Development is a case in point.

Our physical environment is also changing, which will force whole industries to rethink how they operate. The agricultural sector is going to have to go through an efficiency revolution if it is going to be able to feed another three billion mouths in 30 years. Climate change is reducing the amount of arable land and fresh water available, which will push up costs, impede growth and affect profitability across the sector.

The transition to a more sustainable economic model will also open up new opportunities for companies who can adapt and innovate. These will be the winners of tomorrow, that will survive, prosper and gain market share. Companies that are slow to respond are likely to find it increasingly difficult to control costs, maintain profitability and grow their businesses in a sustainable fashion.

As long-term investors, our job is to analyse which sectors will win and which will lose, which companies are adapting and innovating, and which are run in a sustainable fashion. We then have to take that information and integrate it in how we build our whole portfolio. After all, economics does not just affect one product, or one small part of a portfolio.

There are several different approaches to gear a portfolio for greater sustainability.

The first is about how we behave as owners. Stewardship is an important tool to help companies transition and, as owners, we can enter into dialogue with companies, engage with them and use our votes to influence them towards more sustainable business practices.

The second is to assess the sustainability of the businesses we invest in. In this context, environmental, social and governance (ESG) criteria provide a helpful set of standards to distinguish between companies based on the quality of their business practices. ESG is not concerned with what a company actually produces, but rather how they produce it. Essentially, the question we are trying to answer is how well a company operates within the balance of its ecosystem of stakeholders. Companies with better business practices are more likely to be sensitive to sustainability challenges and are therefore also likely to be better positioned to transition to a long-term sustainable business model. And by focusing on business practices in this way, we are able to integrate sustainability across a large proportion of any portfolio.

At Lombard Odier Investment Managers, we analyse around 14,000 companies globally on ESG criteria, which makes it a useful tool for integrating a best-in-class approach to equity or fixed income.

In a transitioning world, there are going to be winners and losers. By identifying for each sector the key sustainability factors of economical success, it becomes possible to identify the potential winners of the transition and gear a portfolio to take advantage of the return drivers of tomorrow. This sustainable investing approach tends to be captured by active or high-conviction managers. It is Lombard Odier Investment Managers ambition to integrate this sustainability dimension into all investment decisions.

Finally, there is direct impact investing, which involves financing businesses that provide solutions to some of the most pressing challenges. While this is an area of growing interest, it is predominantly restricted to less liquid markets, with the exception of green bonds, and thus will only relate to a small portion of any large portfolio.

If, as we believe, this sustainability dimension results in an economic shift comparable with the internet revolution, the integration of such approaches is no longer just about risk mitigation. It will give investors the chance to outperform the markets. It therefore becomes the fiduciary duty of each investor to integrate it into their portfolio.

Important information

This document is issued by Bank Lombard Odier & Co Ltd or an entity of the Group (hereinafter “Lombard Odier”). It is not intended for distribution, publication, or use in any jurisdiction where such distribution, publication, or use would be unlawful, nor is it aimed at any person or entity to whom it would be unlawful to address such a document. This document was not prepared by the Financial Research Department of Lombard Odier.

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