If renewable energy had been an Olympic contender, it would not have made the podium in Paris. Over the last two years renewable energy has underperformed traditional energy investments, particularly in the equity space. This has forced sustainable investors to look for new opportunities. In the absence of other ideas, investors are heavily overweight in tech.
Tech companies comprise 25% of the traditional S&P 500 index. Contrast this with the S&P 500 ESG index, where the top four holdings are tech-focused companies comprising 35% of the total weight in the index.
While overweighting tech has been a short-term solution to the underperformance of clean energy, it is unlikely to directly impact those sectors that are far harder to transition, such as energy, real estate, materials and heavy industry.
Of course, tech companies can aid in the innovation space, and financial companies can help in crowding in capital for clean tech investments. Nevertheless, over the long term it is critical that we dive deeper into data to find investable solutions in the most challenging sectors. Using both thematic screening and quantitative analysis can help to isolate a cross-section of solutions that achieve strong returns while making a significant impact on the climate transition.
Thematic investing selects those sectors and activities that are most likely to have a positive impact on our ecosystems and the surrounding communities, such as investment in electric vehicles, renewable energy, biodiversity restoration, batteries or social wellbeing. Analysis of these business activities with fundamental data helps to reveal those companies that are set to achieve the best returns.
However, the inherent complexity within industries requires the addition of quantitative analysis. Investing in onshore wind development, to use one example, includes investing in business activities such as manufacturing blades, turbines and masts, development of wind farms, utilities that will operate the wind farm and potentially upstream materials. All these business activities need to be analysed to understand the opportunities and downside risks in financial performance as well as environmental performance and societal impact.
Quantitative investing strategies, with their massive datasets, help to alleviate biases and find macro trends in the market, both areas where sustainable investing tends to falter. In the first instance, we identify macro factors pointing towards an expansionary or contracting economic phase. A sector-by-sector approach then identifies those areas that are best positioned to outperform given those economic conditions.
With this refined universe, it is critical to employ a detailed mapping of the material environmental and social pressures for each sector, alongside the underlying business activity data of each company, combined with the cash flow data. With these inputs quantitative analysis helps us to target the best assets for both long and short strategies.
Ultimately, data-driven analysis is the best tool to find the most promising sustainable investment opportunities. Combining both models, thematic screening and quantitative analysis, we can break from the current trend to crowd investor allocations into emerging themes. This approach will help to select the best options for maximising impact and performance.
With the inexorable structural shift towards sustainable economies well underway, investors should break from the middle of the pack and take a holistic data-driven approach to finding the next sustainable investments trends, while the entry points are still attractive.
Trevor Allen is Head of Sustainability Research at BNP Paribas.
This article featured in the Sustainable Policy Institute Journal, Q3 2024 edition.
