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Are Stock Market Rotations Affecting ESG Strategies? | The Big Conversation | Refinitiv - YouTube
Channel: Real Vision Finance
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A few weeks back, we shared the new聽
concept of FAANG 2.0 that had been聽聽
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making the rounds on Wall Street. Fuels,聽
Agriculture, Aerospace, Nuclear and Gold聽聽
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-the seemingly new ingredients for the 2022聽
portfolio which still looks to be holding true.
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In that episode, we discuss the handover in聽
leadership from the 'Old FAANG' stocks such as聽聽
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Facebook (now Meta), Apple, Amazon, Netflix and聽
Google, and what it means for your portfolios.
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But there's another aspect beyond just聽
the major Technology stocks. This recent聽聽
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and potentially meaningful rotation聽
has had a particularly dramatic effect聽聽
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on the performance of ESG strategies, that's聽
Environmental, Social and Governance strategies,聽聽
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which tend to be coincidentally weighted聽
towards Quality and Growth factors.
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The recent commodity surge and the聽
ensuing Growth-to-Value rotation聽聽
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has sparked a debate about whether this is just聽
a short-term cyclical blip... or something more聽聽
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structural that could be with us for years聽
ahead? And that's today's Big Conversation.
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At the heart of this discussion is the current聽
state or shape of the United States' yield聽聽
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curve as measured by the 10yr yield versus聽
the 2yr yield. Having recently inverted,聽聽
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where the 2yr yield is higher than the 10yr yield,聽聽
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is the curve sending a warning sign of an聽
impending recession? If so, perhaps all聽聽
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those arguing that the 'value' trade is just a聽
short-term cyclical blip will be proven correct.
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But what if the recent commodity strength is just聽聽
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the beginning of a structural聽
bull market in commodities?
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Well, oddly enough, and this is the聽
difficult copper pill to swallow,聽聽
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the structural argument in favour of commodities聽
and value over 'growth' is indeed the world's聽聽
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transition towards more sustainable investing.聽
Lithium, cobalt, nickel, and many other raw and聽聽
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rare earth minerals are projected to experience聽
a surge in demand to fulfil the very needs聽聽
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of renewable energy efforts like electric聽
vehicles and better electrical grid systems.
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Take, for example, the fact that聽
metallurgical-grade silicon which is used in聽聽
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solar panels, requires coal, oil coke聽
and wood chips, amongst other materials.
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This raises the question... Is the recent rotation聽
towards 'value', which includes many names in the聽聽
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oil and gas and metals and mining sectors, purely聽
a stock market rotation? Or is this a space that聽聽
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can see large scale institutional activity in聽
the future? And let's be clear, this would not聽聽
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be institutions voting for less clean energy; it聽
would be the necessary portfolio rotation required聽聽
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by them so as not to miss the surge in demand and聽
therefore performance. Now, if this is a blip,聽聽
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then major rotation is less likely. But it's聽
important to recognise that the longer commodity聽聽
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prices stay elevated, the more institutions need聽
to chase price and so the virtuous circle begins.
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Now let's pause for one second there and look聽
at this from another angle. Historically,聽聽
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high commodity prices have brought about a聽
flurry of M&A activity and increased capital聽聽
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expenditures for the new mines all the way from聽
copper through to gold. Today, we're seeing a much聽聽
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slower reaction function, as depicted by the聽
slow and reluctant rise in new oil and gas rigs.
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The same can be said for聽
the broader mining industry,聽聽
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which has its own complicated history of聽
environmental impacts and human rights issues.
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Well, stocks like Peabody聽
Energy, which is up nearly 24x聽聽
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since the November 2020 bottom,聽
see increased institutional demand,聽聽
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should there be a persistent need for coal聽
as a primary source of electricity? Will,聽聽
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capital markets - particularly in credit -聽
be willing to provide billions of dollars in聽聽
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financing for new mine projects? And let's not聽
forget that reopening mines is no small task.
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Or will investors require even higher聽
commodity prices to entice increased supply?
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These are all questions we should be聽聽
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and need to be asking ourselves as聽
we look out into 2022 and beyond.
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And as I mentioned before, if the yield curve is聽
correct in predicting a recession somewhere around聽聽
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the first half of 2023, perhaps the recent聽
'value' rotation will quickly lose steam.
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And if 'value' does begin to lose steam, perhaps聽
the recent rotations were just a cyclical blip聽聽
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within a longer-term structural trend towards聽
'growth'. And if so, and that's what you believe,聽聽
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then the recent correction in ESG strategies,聽
along with a re-rating of many higher-multiple聽聽
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Quality and Growth stocks, seemingly聽
does present an attractive opportunity.
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More importantly, this washout could prove聽
to be a great time for long-term investors聽聽
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to increase their exposure聽
towards sustainable investing聽聽
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via high-quality companies with stronger聽
corporate governance and ESG compliance.
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To gain more insights on this topic.聽
I sat down with Cornelia Andersson,聽聽
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Head of Sustainable Finance聽
and Investing for LSEG...
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Hey, Cornelia, thanks for joining聽
us. Welcome to the Big Conversation.
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My pleasure, Jamie
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So we've been talking in recent weeks about聽
this shift away from growth and towards value.聽聽
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And one of the approaches I want to address this聽
issue from is M&A. And I know that's something you聽聽
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know a little bit about. I think M&A is a really聽
important way of looking at markets because it's聽聽
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one of the truest forms of price discovery. And I聽
know M&A was such a had such a bumpy year in 2021.聽聽
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So I want you, if you don't mind, just to go into聽
a little bit of a background about what you're聽聽
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seeing in capital markets and M&A and a and a聽
better perspective of what it was like last year.
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Yeah, absolutely. Happy to, right? So look,聽
I've been active in the dealmaking community for聽聽
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for many, many years now, both in the private聽
equity side, but also for Refinitiv LSEG,聽聽
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being a very keen observer of market trends and聽
engaging actively with our key participants. So聽聽
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if we take a look at what's happening in M&A,聽
which is really the heartland of corporate聽聽
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finance and a big driver of market activity across聽
the board, we can see a really interesting story,聽聽
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and we've seen some significant change over the聽
last 18 months or so, right? So including in Q1,聽聽
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a very large drop in the year on year volumes,聽
which will surprise some observers. So but let's聽聽
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let's take it back to basics, right? So Q1 of 2022聽
was yet another trillion dollar quarter. In fact,聽聽
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it was the 7th in a row, which does indicate a聽
relatively healthy dealmaking market, but it was聽聽
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also a 20% drop compared to the previous years.聽
At the end of 2021, after nearly 2yrs of ongoing聽聽
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pandemic crisis mode, but also booming capital and聽
M&A markets dealmakers were in an optimistic mood,聽聽
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focussing maybe on economic fundamentals on聽
business and investor needs and local factors,聽聽
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and any concerns of external factors and adverse聽
influences. It hit really historic lows and this聽聽
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is very unusual, and it was proven out in January聽
and February as dealmaking in the first 2 months聽聽
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of 22 hit record breaking levels. And in fact, the聽
first 2 months of 22 saw the largest opening year聽聽
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for global M&A in modern times, exceeded only by聽
the final stretch of the dot com bubble in 2000.聽聽
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So more than 740 billion M&A transactions were聽
announced in January/ February, but volumes of聽聽
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then fallen to to a slowdown in February and聽
suddenly through March. So the question then聽聽
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is what what do we expect to see going forward聽
here in terms of what investors are seeing?
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So this lull in M&A activity we've seen in the聽
first quarter isn't so much that M&A volume is聽聽
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low. It's really just relative to such a bumpy聽
year in 2021. So that begs the question for me,聽聽
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what are the reasons why we're seeing this聽
lull, is the credit market tightening up聽聽
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and you know particularly for the some聽
of these commodity related stocks,聽聽
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are they finding it harder聽
to access capital markets?
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Yes, it's a very good question and there's a聽
number of drivers for that. There's an element聽聽
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of dealmakers and corporates become comfortable聽
with operating in the new normal after a pandemic.聽聽
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So when the pandemic hit in 2020, that really聽
pushed M&A volumes to almost grind to a halt.聽聽
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What then happened was a process of聽
retrenching, of really reviewing corporations,聽聽
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shoring up balance balance sheets and focussing聽
on growth strategy. So that then naturally led to聽聽
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an increase in both divestment聽
activity as well as acquisitions聽聽
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as companies continued to pursue聽
their strategic growth and options.聽聽
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Combine that with some really fundamental healthy聽
conditions for M&A making, such as, such as聽聽
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thrive and capital markets, particularly on the聽
fixed income side, combined with low interest聽聽
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rates. And they really are the perfect conditions聽
for fairly extensive M&A markets and dealmaking.聽聽
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And we also see right is a willingness at the聽
C-suite level of really engaging with large聽聽
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scale M&A transactions. So interestingly, what聽
we've seen is a growth in what we call megadeals,聽聽
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so the very large transactions have increased聽
significantly over the last 2yrs as well.
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Ah Cornelia, thank you because that's a perfect聽
segue way into the topic of ESG investing. So聽聽
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there has been a bit of a lull聽
in ESG investing generally,聽聽
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and I want to know what you're seeing in聽
terms of the funding of ESG strategies?
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Sure, absolutely. Well, the first thing I would聽
like to comment on there right is that when you聽聽
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look at the returns, there's always a big debate聽
right, around is this an ESG bubble? And are some聽聽
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of those returns that we're seeing? Not really,聽
you know, not really exceeding what you would get聽聽
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investing in non ESG stocks or assets. And I think聽
the key point to it right is that, generally,聽聽
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longer term success here is based not on the聽
short term investment horizon, where often on聽聽
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ESG stocks can perform better. But if you look at聽
a slightly longer time horizon, so say 3 to 5yrs,聽聽
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we generally see that funds tend to outperform.聽
ESG funds tend to outperform non ESG funds.聽聽
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And really, what we're seeing here,聽
there's a number of different things,聽聽
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but investors generally, so whether we're talking聽
about institutional investors or corporates or聽聽
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even private equity are waking up to the idea that聽
sustainability is not a short term trend, but it's聽聽
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a significant change in the real economy. And that聽
therefore there are real sustainability risks,聽聽
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as well as opportunities that may be material. So聽
sustainable investing now is very much becoming,聽聽
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not about necessarily a quick term when, but聽
it's about securing those longer term financial聽聽
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returns. It's about mitigating risk as well as, of聽
course, aligning with investor demand. And I think聽聽
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it's safe to say that many of our investors, from聽
from retail investors to the largest institutional聽聽
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investors, they're now very clear on their聽
desire to see the capital invested in a way聽聽
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that aligns with with core values, and that is聽
very much reflected in fund flows, for example.聽聽
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So Refinitiv Lipner provides in-depth research聽
on fund flow data and analytics, and they've聽聽
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looked at flows into ESG funds to certainly been聽
in three strong year, with inflows to green funds聽聽
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going going up steadily and very interestingly聽
as well, if we take a look at February's mutual聽聽
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funds/ flow numbers and ETFs, there's been a loss聽
right, so lost about 10 billion collectively,聽聽
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but with the exception of ESG funds,聽
right which have seen positive inflows. So聽聽
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there's certainly a continued investor trend聽
of wanting to invest into ESG. So, you know,聽聽
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you can discuss whether it's a short term聽
bubble or not. My view is that it's it is not.聽聽
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We're dealing with. We're dealing with a change聽
share, which is sort of both by a a push factor聽聽
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and a pull factor. So the push factor very much聽
comes from the regulatory side of things, right?聽聽
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So regulators across the world are introducing new聽
measures around corporate reporting in particular,聽聽
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which are focussed on ESG and sustainability.聽
The pull factor comes from both investor and聽聽
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client demand, which is very much focussed on聽
seeing products and services aligned to ESG core聽聽
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values. And we see this reflected not only on the聽
fund float side, but also both on M&A and in the聽聽
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capital markets. So green bonds, for example,聽
has really dominated the green finance space聽聽
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and has increased very dramatically over the last聽
decade. So we're we're now at a point where we聽聽
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saw a trillion dollars issued in in green finance聽
last year, which is a fairly significant amount.聽聽
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And increasingly, there's interest in investors聽
in terms of how to allocate capital meaningfully聽聽
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to projects and businesses that are going to聽
continue to drive that transition to net zero.
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Cornelia, thank you so much for聽
your time. We talked some about聽聽
[806]
some really important issues there.聽
Once again, thank you very much.
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Thank you, James.
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