For nearly three decades, Capital International has sought to make money work better and to generate strong investment returns for our clients that are sustainable over time. These objectives are manifest in our investment philosophy and process that we call Sustainable alpha.
This investment philosophy and process has evolved over the years based on our experience of what actually works, both in the good times and through economic downturns and financial crises. This is a process and approach that has demonstrably delivered strong investment returns consistently over time.
From our investment research and forecasting, we observe that the companies that tend to deliver superior long-term returns for our clients exhibit two consistent characteristics.
Firstly, they create tremendous customer value, often using innovation and technology to transform the markets they operate in. This is what we describe as the thrust forces driving the business forward. We of course also look at external factors: Are its products or services sufficiently in demand? Does it have a competitive advantage? Is the market it operates in growing? Fundamentally we seek strong, growing businesses, but that alone is not enough.
Secondly, in order to maintain a world class performance over time, a great company, just like a great athlete, must keep in shape. To achieve this, a company must seek to consistently minimise the resources it consumes such as energy, raw materials and operating costs. We see these as the drag forces that can pull a company downward.
In our view, it is only by consistently reducing these drag forces whilst increasing the thrust forces, that a company can propel itself to success and generate returns not just for today, but sustainable returns for the future.
History is littered with yesterday’s growth stocks that ignored drag forces. Led by overpaid executives that believed their own press, recklessly spent other people’s money and took for granted their temporary dominance in a particular market. All too quickly they became bloated, spendthrift, behind the curve or just plain lazy.
The best executives, and indeed the best investors, live by the ancient Persian adage; ‘this, too, shall pass’. Knowing that the things that drive your success today are temporary and that markets are constantly changing, generates awareness of trends, a focus on productivity growth and financial prudence, as well as encouraging innovation to embrace the opportunities that change offers.
It should be no surprise that good management, strong governance, healthy motivated staff, a strong value proposition and increasing productive efficiency are fundamental characteristics of the high performing businesses that deliver strong investment returns.
These characteristics are also, of course, the very definition of sustainability and strong environmental, social and governance practices. Profitability and sustainability are not mutually exclusive concepts and the companies that will perform best over the long term are those that are committed to operating sustainably, constantly striving to improve efficiency and driving positive change.
We also need to be honest. We cannot simply flick a switch and divest from all sectors that fail to immediately meet arbitrary sustainability criteria. Right now, without fossil fuels, we cannot heat the millions of homes through harsh winters. Without industrial farming, we cannot feed the world’s 8 billion people.
It is a false choice to think we can or should disinvest from crucial industries on which our prosperity depends. This will actually create poverty, exploitation and suffering. Or, worse, lead to nationalism and even conflict. The exact opposite of the outcome we seek.
Instead, we need to encourage and champion iterative change, a process that’s incredibly powerful and overwhelmingly positive. Embracing innovations and technologies that create the sustainable solutions of tomorrow while constantly improving efficiency, reducing resource intensity and driving up productivity.
Hard working people and successful businesses are not the enemy of prosperity, they are the source of them. The reverse is also true. Businesses that fulfil these human needs, respond to change and innovate to create renewed value and increased productivity are the drivers of human prosperity. These are the successful businesses of tomorrow and these are the businesses that will deliver the best returns to investors.
Interestingly, when targeting sustainable investment returns, it’s the direction of travel for a business that is critical, not necessarily the starting point. Some of the best opportunities can be found in historically ‘dirty’ companies that have strong natural demand and are committed to the journey of developing better innovative, sustainable solutions and increasing efficiency.
So whilst our aim is to invest in assets that deliver sustainable profitability, it is not about virtue investing or green washing. We do not take an exclusionary approach to asset selection. To the contrary, we believe that all sectors are required for prosperity; a company doesn’t have to be perfect in terms of sustainability today but what we are looking for is clear evidence of and a commitment to progress.
This investment approach targets returns that are sustainable, not only for our clients, but also for society and the environment too.
It’s the ultimate win-win scenario.
In essence, Sustainable alpha is about identifying companies that can consistently increase the value they create, whilst reducing the resources they consume.
Quite simply companies capable of creating more from less – a perfect recipe for profitability.
Disclaimer: The views, thoughts and opinions expressed within this article are those of the authors and not those of any company within the Capital International Group (CIG) and as such are neither given nor endorsed by CIG. Information in this article does not constitute investment advice or an offer or an invitation by or on behalf of any company within the Capital International Group of companies to buy or sell any product or security or to make a bank deposit.
Regulated investment activities are carried out on behalf of Capital International Group by its licensed member companies. Capital International Limited and Capital Financial Markets Limited are licensed by the Isle of Man Financial Services Authority. Capital International Limited is a member of the London Stock Exchange. CILSA Investments (PTY) Ltd (FSP No. 44894) and CILSA Solutions (PTY) Ltd (FSP No. 6650), t/a Capital International SA are licensed by the Financial Sector Conduct Authority in South Africa. All subsidiary companies across both jurisdictions are represented under the Capital International Group brand.