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The Veteran's taking over today, looking at the extremely profitable trends emerging in ESG ๐Ÿ‘‡๐Ÿ‘‡๐Ÿ‘‡

Dress me up for battle, when all I want is peace - Those of us who pay the price, come home with the least - Nation after nation, turning into beast, When will there be a harvest for the world?
- The Isley Brothers (1976)

World leaders gathered at the United Nations in New York last week for the 76th session of the organisation's general assembly.

The general assembly came just 40 days ahead of a key climate summit, COP 26, which will be held in the UK and hosted by Prime Minister Boris Johnson, who told world leaders at the UN that the summit must be a turning point for humanity.

Johnson likened the world's current attitudes to climate change to those of an adolescent... just old enough to get themselves into serious trouble as they could drive and knew where the keys to the drinks cabinet were hidden.

However, he warned that it was time for humanity to stop partying and grow up as these kinds of behaviours were not only potentially embarrassing but also potentially terminal.

And therefore as a species we need to change our ways.

The debate about climate change and the best way to deal with it rumbles on...

However, as traders and investors, we need to detach ourselves from the argument and look at the effect that the debate, and changing attitudes among money managers, are having on the market.

Some of these effects are tangible. For example, here is the chart of US coal company Peabody Energy (ticker BTU).

Coal is public enemy number one as far as the climate lobby is concerned and as we can see Peabody Energy's share price fell dramatically from February 2019.

However as economies emerged from Covid lockdowns, energy prices, and in particular natural gas, rose to a point where coal was in demand once more, and the share price of BTU also rose sharply as a result.

In fact over the last 6-months, the stock is up by +371% despite a -12% correction over the last week.

We can clearly see the correlation between Natural Gas prices and those of Peabody Energyโ€™s stock, drawn in red, in this chart.

This is a simplistic take on the relationship between coal and gas, not that thereโ€™s necessarily anything wrong with that.

Credit Suisse highlighted some of the nuances in this relationship in a research note this week, published as part of its carbon cycle series.

The Swiss bank noted that:

The benefits of coal-to-gas switching seem clear on the face of it - gas is 2-3x less CO2 intensive than coal in combustion; 50% lower on a life-cycle basis in electricity; and can reach 60-65% power efficiency vs 48% in coal power.
However, a closer look reveals large extremes in outcome depending on the route from well-to-gate.
The benefit is tied to the tyranny of distance and can be eroded through transmission for both international pipeline (80% of emissions) and overseas LNG (70%) vs domestic gas.

Those comments reinforce an important point, which is that the path to removing carbon emissions from our economies will necessarily be a complex one and wonโ€™t be achieved overnight, in a straight line, or without some very hard choices.

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The FT ran a comment piece as the weekend which intimated that the reason that so many CEOs are happy to sign up to net-zero carbon and other environmental initiatives is that achieving the targets they're committing to wonโ€™t be their problem.

Instead, it will fall to subsequent generations of their successors to sort out.

A cynical view but probably not too far from the truth.

However, as Mark Twain (supposedly) said never let the truth get in the way of a good story and the market is already being affected by the greater awareness of climate-related issues... which means there are price changes that traders can exploit.

One obvious opportunity for traders is created by the flow of funds into ESG investments.

According to data from Lipper Analytics the amount of money invested in sustainable funds reached $1.7 Trillion by the end of March 2021, double the value of the figure from two years before.

As much as 90% of the $1.36 billion of new money invested into UK equities during July went into ESG funds.

To date, the vast majority of money that's moved into the sector has come from Europe and not the US or Asia.

That could present a big headache for US fund and money managers. After all, the US is home to almost half of the world's managed money and assets whilst Europe looks after just under 33% of global funds and assets.

However Europe accounts for more than 81% of global ESG investing according to research from consultants PWC, whilst the US total stands at just 14%.

That statistic should concern US money managers because the amount of money committed to ESG investing is expected to grow to $4.50 trillion by 2025 according to the PWC report.

Funds can easily flow across borders and the ultimate beneficial owners of the assets and their allocators owe no geographic allegiance to US money managers.

And European managers are quite happy to grow their businesses at the expense of their Trans-Atlantic rivals.

Sustainable Investingโ„ข just hasnโ€™t been on the US to-do list..

However, investor attitudes are changing.

A survey of Institutional investors conducted earlier this year by MSCI found that 78% of respondents planned to increase their exposure to ESG ๐Ÿ‘‡


That change in attitudes among money managers is likely to influence behaviour in corporate America too.

For example, in Europe, 40% of listed companies score highly on ESG criteria, whilst in the US that figure is far lower at just 16%.

Europe is starting to eat the USAโ€™s lunch in the ETF market thanks to ESG memes and 96 ESG focused ETFs were launched in Europe during the first eight months of 2021.

Flows into those funds totalled some $65.6 billion, just over half of the total flows into all European ETFs during the first 8 months of the year.

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To my mind, American investors havenโ€™t bought into ESG themes because they just havenโ€™t been sold to them in terms that they can understand.

Ideas about altruism and doing the right thing for the planet just donโ€™t strike a chord on the other side of the pond in the way they do here in Europe.

One of the prerequisites of any sale is the need to highlight to the customer whatโ€™s in it for them.

If you can get that point across to a decision-maker, then as a salesperson, your job is almost done, because if the client buys into the concept then they are basically doing your job for you.

If I were pitching ESG to a US asset allocator or the financial advisers of high net worth individuals, my pitch might go something like this:

If we look at the charts above we can see the returns of the S&P 500 ESG Index drawn in black and compare those to the standard version of the S&P 500 index, shown in red,

In doing so we find that the ESG index has outperformed its Non-ESG rival by almost +10%, in the period since April 2020.

I'd reinforce the point with a closing comment:

Is that the kind of performance you can afford to ignore?

The Veteran pitching ESG 

As the US buys into this meme there will be a harvest, not just for the world in terms of a lower-carbon future but also for investors who are aware of these trends and who position themselves to take advantage of them.

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