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The ‘unbubble’ in sustainability valuations

Via LinkedIn : In the simplest terms, investment bubbles are caused when too many investors start to believe an investment case beyond the point at which it is justified by rational analysis of the information available (…and momentum takes hold).

The valuation of the sustainability performance and exposure of companies suffers from the opposite: an ‘unbubble’.

An ‘unbubble’ occurs when investors refuse to believe an investment case in direct contravention to the evidence provided. It is harder to spot than a bubble (because it is defined by money NOT moving rather than by money moving). But the effect (in this case, on society and environment) can be just as damaging.

‘Unbubbles’ can be found throughout the sustainable business and sustainable investment value chain. For example, in spite of repeated evidence to the contrary, there is widespread prejudice that SRI investment systematically underperforms.

However, because of the prejudice that organic apples are spotty and that recycled paper jams the photocopier the perception is sustained.

To illustrate…

My first job was at an asset management firm – one of the first to run specialist SRI funds. Over the time of my employment, the funds’ performance was very respectable. (I was not the portfolio manager so I cannot take credit for this.) I did, however, do a bit of marketing – so I received exposure to the way the funds were perceived by the market. As I say, the funds’ performance was usually comfortably above average. However, a couple of quarters stick in the memory – when the past performance was exceptionally good.

During this time my powerpoint presentation to financial advisers introduced the fund, built gradually through a description of the SRI strategies (blend of thematic, negative screening and best-in-class), towards an explanation of how the sustainability and financial factors were merged. The ‘ta-daaaa!’ slide at the end showed that the fund had delivered top quartile performance over 1, 2, 3, 4, 5, 6, 8, 9 & 10 years. (It was 2nd quartile over 7 years).

And yet, a depressing number of financial advisers watched my presentation in silence before commenting (as if wisely): “Yes, but the trouble with SRI funds is that they underperform.” … even with the slide deck still open and the “top quartile over 1,2,3,4…” page in front of them.

There’s not really an answer to this. If someone chooses to form an opinion that is in direct opposition to all information available to them, a punch on the nose is really the only option left.

But bubbles burst…

The nature of bubbles, of course, is that they don’t last. Reality has a way of catching up and delivering a punch on the nose. The timing of this punch is usually unpredictable … as is the source of the punch … but the consequences usually follow a fairly predictable unravelling.

The rational, analysed information builds and builds and builds until a significant trade occurs to deliver the punch. Importantly, I think it is a ‘trade’ rather than a new piece of information. Bubbles burst when the money starts to reverse direction – not just when evidence emerges that the money should reverse direction.

What will burst the ‘unbubble’ in sustainability valuation?

Most of us in the SRI research business spend our time building the volume of information that, to switch metaphors will flood out once the dam is breached and other investors start to incorporate sustainability into their valuations.

But it is also worth spending a little time considering where the punch will come from … (or what will cause the ‘tipping point’)

In respect of finance’s response to climate change, candidates are starting to line up. Will the punch be delivered:

  • By the increasing volume of money invested in Green Bonds?
  • From development and widespread application of the Stranded Assets thesis?
  • From COP21 in Paris?
  • From a single large pension fund or a collective of pension funds? From the university endowments?
  • From a major corporate collapse?
  • From a technological breakthrough?

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