The single biggest economic transformation is underway. An interview with our Senior Managing Partner, Hubert Keller

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The single biggest economic transformation is underway. An interview with our Senior Managing Partner, Hubert Keller

Interview with Hubert Keller published on 23 September 2021 in Handelszeitung

 

Our current economic model is "uneconomic, inefficient, unequal and not clean enough." Where do you read this scathing criticism? In Greenpeace's magazine or at the WWF?

In ours. We call it WILD, wasteful, idle, lopsided, and dirty.

 

Quite pointed.

In our view, our economic framework has become unsustainable because it relies heavily on the environment at large and yet is destroying it at the same time. Basic economics shows that our environment has a value but we have failed to put a price on using it. I think this is about to change and we are going to witness the most important economic transformation of all time. And, as an investor, I find this fascinating.

In our view, our economic framework has become unsustainable because it relies heavily on the environment at large and yet is destroying it at the same time. Basic economics shows that our environment has a value but we have failed to put a price on using it

A transformation - bigger than the industrial revolution, digitalisation?

Much bigger. I'm not fundamentally criticising our economic model, as others might do. But I am saying that our economic framework is no longer fit to organise economic activity around 8 billion people. We extract about 90 billion tons of raw materials from the environment every year to produce goods that remain idle most of the time. The production of those goods and disposal of them generates approximately 70 billion tons of waste every year which is destroying our environment1.

Your conclusion?

If we continue like this, we will destroy the most productive economic asset that we have: nature and the environment.

If we continue like this, we will destroy the most productive economic asset that we have: nature and the environment

When did you realise that?

As a firm, we've always focused on sustainability and have developed, over the years, a sustainable investment offering for our clients. However, I think we have now reached a major tipping point and sustainable investing has to become mainstream.

 

Which ones?

Take the transition to a net-zero economy. If we are going live up to the commitment that 193 countries have made through the Paris Agreement, we need to reduce CO2 emissions by 50% by 2030. This is in 9 years…

 

You took up the focus on sustainability years ago. Are you further along than your colleagues in the Swiss financial centre?

It is difficult for me to assess the work of others. At Lombard Odier, we are on a very clear journey which prioritises the alignment of our clients’ portfolios to this profound economic transformation – which means investing in companies that are on the right transition pathway. We think this is the only way to generate quality, long-term returns for our clients.

 

That will have enormous implications for Schweiz AG2.

Probably yes. But for Global Inc. too…. We think that this economic transformation will indeed have a substantial impact on the corporate world - some companies are well positioned for the transition, others may greatly suffer or even disappear.

 

Which ones?

Those companies that are recognising the forces driving this transition and that are trying to fundamentally change their business model and adapt to the environmental reality. But there are also companies where management is still burying its head in the sand.

 

How big is the number of ignoramuses? 70 percent?

Hard to say.

 

On the other hand, how many companies are fit to seriously tackle the challenges of climate change? Through resource-conserving production, through sustainable products?

If I look at companies that are in the major stock markets indices, I would say probably half of them are well on their way to developing a convincing transition strategy.

 

They would have to support the demands of the youth who are demonstrating for measures against climate change. Hubert Keller a secret sympathiser of Friday for Future?

We should not underestimate the complexity of this economic transformation and I believe that many companies are trying to tackle it. Having said that, I also have some sympathy for these “rebellion” movements because they insist on the need for urgency.

 

Are you optimistic that we can get our act together before the world suffers permanent damage and the water level rises by meters?

I am cautiously optimistic because I believe that market forces are starting to play a prominent role in the environmental transition. Cleaner and more sustainable solutions are increasingly becoming cheaper and / or creating better value. That will drive change faster than anything else.

I am cautiously optimistic because I believe that market forces are starting to play a prominent role in the environmental transition

Example?

The automotive industry is an interesting example where market forces are taking over from policy forces. Prices of electrical vehicles (EV) have collapsed in recent years, so much so that in the next 2 to 3 years it will be cheaper to own an EV rather than an internal combustion engine (ICE car). Tesla’s valuation in the stock market was probably a reflection that investors felt the future of the industry was in EVs, eventually leading major manufacturers to implement massive shift to EVs. This is market forces at play.

 

Surprised at how fast it went?

Absolutely. But market forces are often underestimated, and I do believe that, with the right incentives, capitalism can be very powerful. As the price of green solutions continues to fall, business models will adapt very quickly creating interesting opportunities.

As the price of green solutions continues to fall, business models will adapt very quickly creating interesting opportunities

There were also stricter regulations from the authorities, such as the EU, which put pressure on. Compliance with emissions regulations is becoming more and more expensive.

True and undoubtedly, the diesel-gate that VW faced was also a wake-up call. But the mass roll-out of EVs represents a phenomenal new growth engine for those automotive companies that embrace the transition. And some of them are seizing this opportunity.

 

Is that your hope?

I believe that the forces driving the environmental transition have simply become unstoppable. We do need more pressure from policy makers, but consumers are also changing their behaviours fast and economics for cleaner or more sustainable solutions are improving very rapidly.

I believe that the forces driving the environmental transition have simply become unstoppable. We do need more pressure from policy makers, but consumers are also changing their behaviours fast and economics for cleaner or more sustainable solutions are improving very rapidly

The responsibility of the financial industry is great; it distributes capital. In the past, people often looked the other way: CO2 emissions, environmental pollution - so what? The main thing was the return on investment.

True. But we must also realise that an issue for the finance industry is the difficulty of deploying capital at scale when so many companies in the real economy are still not fully aligned to addressing environmental challenges. We need to make this point clearer.

 

The only question is: are investors ready for this, or is performance not the goal?

Wealth and asset managers will continue to focus on performance. This is the mandate we have received from our clients. Personally, I have not yet met a mainstream institutional client willing to compromise on returns for a more sustainable portfolio. However, what has changed recently is that a portfolio aligned with the environmental transition is very likely to generate much better performance.

 

The understanding is growing?

This is my impression. At Lombard Odier, we tell our clients that climate and the environment can have a significant impact on the future performance of their portfolios, both positive and negative. It therefore makes sense to put them at the heart of the capital allocation and the portfolio construction process. This argument is increasingly understood by many clients.

At Lombard Odier, we tell our clients that climate and the environment can have a significant impact on the future performance of their portfolios, both positive and negative. It therefore makes sense to put them at the heart of the capital allocation and the portfolio construction process

Other banks also have offerings in sustainability.

Absolutely. For us our sustainability offering is articulated around 3 pillars. The first one is about aligning clients’ portfolios to the challenges and opportunities created by the environmental transition. The second one is more specifically about offering strategies which will capture the potential upside from the transition. And the third pillar is about funding green investments, such as early technologies and solutions or matured ones that need scaling up. These investments can be riskier because often we lack visibility on which of the green solutions will eventually be adopted. With approximately USD120trn of capital deployed, I think our industry needs to prioritise portfolio alignment to defend returns and promote the environmental transition. This can have a major impact on the corporate world and accelerate the transition.

 

And how are you going to teach this to people? The CO2 law in Switzerland has been a resounding failure.

The processes that take place in the environment are extremely complex. You can see that with global warming. We need politicians to take greater ownership of problems and possible solutions and spend much more time explaining them to the public. With regard to the CO2 law, I think the bill was too complex and Swiss people could not quite understand the consequences of it on their daily lives.

 

One argument is: why should we bother, the big polluters are the USA, China, Russia and India.

Because we have all collectively signed the Paris Agreement committing ourselves to reduce global GHG emissions. So Switzerland, like many countries need to contribute to the overall emissions reduction while ensuring to preserve economic prosperity. And the two are possible.

So Switzerland, like many countries need to contribute to the overall emissions reduction while ensuring to preserve economic prosperity

There will be losers. Anyone who works in the oil industry or in an energy-intensive industry risks losing their job.

That is true. And that has been the way in all major economic transformations. Someone working on an oilrig in the Gulf of Mexico today may not be able to do that job in 20 or 30 years.

 

Exactly, that person will resist the transformation.

True. And it must be the priority of governments and policy makers to steer this revolution in a socially responsible way. But, more importantly, the transformation to a sustainable economy will also offer many new job opportunities. And to be clear, continuing as before is simply no longer an option as our current WILD economic model is destroying the environment, or the very resources on which it relies to generate economic growth and jobs. 

 

Don't you want to go into politics and proclaim your message from the stage?

Sadly, I don't speak German well enough.

 

ESG offers are shooting out of the ground. The investment community has long since lost track of them all.

While it is important to include Environmental, Social and Governance aspects in any investment process, I remain sceptical about the usefulness of the various ESG databases. The transition to a net-zero economy is incredibly complex and is certainly not captured by ESG data. Thinking that this will help us align portfolios to the challenges of the net-zero transition might be too simplistic. 

 

What is wrong with ESG criteria?

They are backward looking and provide a snapshot in time. They fail to capture the transition aspect, which is essential for evolving towards a more sustainable economic framework. We need to focus on forward-looking information. This is the only way to assess if a company that is “brown” today is moving in the right direction and at the right pace to “green” its business model. 

 

And how ready is the clientele?

There is a broad understanding of sustainability issues in Europe and Asia. I have also been surprised by how much more interest there has been recently on the topic in the US.

 

Specifically: what do you do with those companies that underperform in terms of sustainability and may be among the model boys tomorrow? Take Holcim: The cement manufacturer consumes a lot of energy and is responsible for a lot of CO2 emissions. But the company is innovative and a model company in the industry.

Our portfolio alignment approach will aim to separate the “good” polluters – which we call Ice Cubes, from the “bad polluters” – which we call Burning logs. 

 

Burning Logs, Ice Cubes?

Ice Cubes are highly polluting companies that are pursuing a decarbonisation trajectory in line with the Paris Agreement. It is right to invest in these companies because they stand to benefit from the transition to a net-zero economy. Given the amount of GHG emissions that they are taking out each year, they are cooling down our environment, which is why we are calling them Ice Cubes. On the contrary, Burning Logs are highly polluting companies that are not reducing their GHG emissions and risk ending up with a business model that is no longer fit for the net-zero economy. They are preventing us from reaching our overall emissions reduction targets and thus are heating up the environment.

 

Holcim is an ice cube?

I should not go into specific companies. But there are some clear Ice Cubes in the Cement Industry which are implementing a bold strategy and making large investments to abate their emissions. They are likely to benefit financially from this transformation. Then, of course, there are also some Burning Logs, which continue to heat up the environment and are likely to be the losers of the net-zero transition if they don’t change rapidly.

 

You are talking about oil companies that do not adapt their business model?

Let’s face it, it is hard for an oil company to align itself to the net-zero transition unless it stops producing oil and either goes into run-off mode or into new green lines of business. Some of them may be trying but others – particularly in the US – are not.

 

Mobile Exxon?

No names. But the core of our research is concentrated on assessing the valuation impact that companies are likely to face in the face of the transition to a net-zero economy. A high emitting company that has no credible plan to cut emissions over the next 10 years could see the structure of its cash flows negatively altered over time. Conversely, a high emitting company with the right decarbonisation trajectory could see its financial performance improve over time through market share gains, pricing power, etc… We aim to assess these valuation impacts. For us, the guiding principle for net-zero investing needs to climate-related financial exposure.

 

And what do you do with airlines whose planes run on kerosene?

Today, with the existing technologies, the emissions reduction pathway of the airlines industry is through short haul electrification, the development of more efficient aircrafts and the increasing use of bio-fuels and synthetic fuels.

 

Synthetic fuel today costs 10 francs a litre. That would make flying massively more expensive.

Correct. This is the issue of Green Premium and the question is how quickly we can crush these premiums. But aviation is a hard-to-abate industry has more time to decarbonise.

 

How do you keep track of all the industries and companies?

Our research is very much focused on understanding the granularity of each industry’s transition pathway. So, for example, what is the roadmap of a particular industry to decarbonise itself, or to fully eliminate any deforestation from its value chain, etc. We are looking at 170 industries across 5 regions globally. For this, we have built teams of scientists, physicists and data scientists and we have also developed a strategic partnership with Oxford University.

 

How sustainable is Lombard Odier itself? Video calls instead of flying?

Lombard Odier is proud to be the first global wealth and asset manager to achieve B Corp certification for corporate sustainability. This is the gold standard. Our new headquarters in Geneva is also being built to extremely high sustainability criteria. Our independent partnership model has allowed us to make the right sustainability choices, away from any external pressures.

 

Do you want to make Lombard Odier a sustainability powerhouse in the financial world?

Powerhouse? At Lombard Odier, we like to remain humble. We are simply convinced that sustainability will be a major driver of performance in the years to come and we aim to help our clients benefit from it.

 

And you are the driving force?

I would not say this. My Partners and I are completely united on this vision and trying to implement it together across our organisation. I would also remind you that Patrick Odier has just become President of Swiss Sustainable Finance.

 

You will definitely replace Patrick Odier as Senior Managing Partner in 2023. The transition from Patrick Odier to Hubert Keller will take more than a year at Lombard Odier.

Long-term planning has been a tradition at Lombard Odier for over 200 years. We have a clear plan and Patrick Odier has handed over various tasks to me in recent months, and the transition will continue until the end of next year. Then at the end of 2022, as already communicated, he will step down and I will fill the role of sole Senior Managing Partner at Lombard Odier.

 

Circle Economy (2020) ‘The Circularity Gap Report 2020’.
Schweiz AG (chg-meridian.ch)

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