Aligning the Stock Market with the Planet (#24)

Aligning the Stock Market with the Planet,
w/ Luciano DIANA

Your host Ben Robinson, is speaking with , Senior Investment Manager at —one of the leading independent wealth and asset managers — where he is running the Pictet Global Environmental Opportunities Fund. In this episode we cover: should government stimulus packages be conditional on companies investing in energy efficiency? Why plant-based products are a space that you need to be paying attention to? Why we should be bullish about the ability for market forces to solve climate change? And more!

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Luciano recommends:

  1. One book: 
  2. One influencer: 
  3. Best recent article: , NY Times, April 28th
  4. Favourite brand: Vacheron Constantin®
  5. Productivity hack: Never let your inbox rule you. Action, delete or file

Full podcast transcript:

 

What happened with COVID-19 was a stark example of what we don’t want, right? We don’t want to solve environmental problems by shutting down societies because the pain is too big. So, the only real practical way forward is to invest in technology. And this is what we’re doing. — Luciano Diana

Full transcript:

[00:01:29.02] Ben: So, Luciano, thanks very much for coming on the podcast! Maybe we could start by you telling us how you got into environmental investing?

Luciano: Sure! Hi, Ben. I got into cleantech renewables research when I was at Morgan Stanley, back in 2005, and that was because I was very interested in the wind sector, the solar sector, I was part of a mid-cap team. Nobody was really covering those talks, so I carved out a small list of companies to research. And then, a few years later, when I joined Pictet, I started managing the Clean Energy Fund for a few years.

[00:02:11.16] Ben: When did you say that you started to look at it at Morgan Stanley?

Luciano: In 2005.

Ben: Even as recently as 2005, there wasn’t really much kind of invested interest or coverage of cleantech?

Luciano: There were just a few mid-cap names — definitely no large caps that were involved in renewables. And yes, it was a bit of a cottage industry. At the time, I also covered things like biofuels in a lot of companies that actually don’t exist anymore; I did a big piece on the carbon trading market that started around that time — the European Emission Trading Scheme, the carbon offsets, all that stuff. And so, it was very interesting work. I spent most of my time as an analyst to educate investors on industries — in fact, as much as on individual stocks. So it was quite a lot of fun!

the definition of what is environmental has broadened a lot since my days in 2005. So, back then, the view was quite narrow: solar energy, wind energy — and those are part of the solution, but they’re just one of many types of technologies that you can adopt to make an impact — Luciano Diana

[00:03:06.29] Ben: Just looking at the investment perspectives, which I downloaded from the Pictet website, one of the things it says is, “With our Global Environmental Opportunity Strategy, investors can help safeguard the planet while retaining the prospects of long-term outperformance.” How much of a paradox is it, to think that you can get a sustained rate of return from economic growth at the same time as you can protect the environment?

Luciano: That is the key reason why this fund is having success. And generally, investments into ESG funds with an environmental tilt are growing because we are able to get both objectives of the financial return and also the environmental impact. And the key to that is that also, the definition of what is environmental has broadened a lot since my days in 2005. So, back then, the view was quite narrow: solar energy, wind energy — and those are part of the solution, but they’re just one of many types of technologies that you can adopt to make an impact. Today, the way that we define an environmental investment is anything that can improve the natural resource efficiency, or address pollution. And that, then, ranges from energy efficiency to water technologies, to waste management, to software companies that are addressing the digitalization of manufacturing. So, it’s a very broad investment theme. And so, this diversification is very important for performance. So that’s the magic formula for our investors because we have an objective to outperform global equities by 3–4% per year or over an economic cycle. So, we’re not aiming to get 10, 20% plus volatility for the fund that is roughly in line with that of global markets. And then, we also have a positive impact.

[00:05:14.10] Ben: You sort of alluded to it there, when you listed the kinds of investments that you could make, but how broad is our environmental products and services? Like, for example, could you invest in Tesla? Could you invest in Zoom? What are the boundaries, exactly, of environmental products and services?

anytime that you digitize a process, you have some kind of raw material efficiency there — Luciano Diana

Luciano: Yes. So, the definition is relatively broad. And there is one framework that we use for our investment universe. It’s a scientific framework that was developed in 2009 — in fact, it was published in Nature Magazine back then — by a group of scientists coordinated by the Stockholm Resilience Center. And that tells us that there’s nine environmental domains that really matter. Climate change is one of them, but also, biodiversity is there, the water cycle is there, chemical pollution is there, and others. And each one of these domains has a boundary. The scientists are telling us more or less where the boundary is, and the economy needs to stay within the boundaries to avoid a nonlinear and unpredictable change.

Luciano: So, we, first of all, look for businesses that stay within the boundaries, to begin with. That means they have a low environmental footprint, and that means that they’re not predicated on overconsumption of natural resources to exist. That’s the first step. The second step is we look for the solution providers among them. So, it’s not enough just to have a low environmental footprint — like, for example, maybe a healthcare company could have a low environmental footprint — but we also look for solution providers for the environment. So, any solution, again, that addresses resource efficiency or pollution control. And if we find a company, a business that satisfies both of these conditions, and that has a sufficiently high proportion of its revenues in this domain, then we consider that eligible for our universe. And we ended up with 400 companies, which doesn’t seem much, but 400 companies that have at least 20% of their sales in some kind of environmental solution, globally — and these are listed equities, by the way, so this is a clearly listed equities fund.

Luciano: And then, within that, you find many technologies. You mentioned Tesla — for sure, electric cars are there. Volkswagen is not, also BMW is not, because they don’t do, at least today, enough electric cars; they still have a big legacy in combustion engines. You mentioned Zoom; Zoom is part of the theoretical universe, like Citrix, for example — any solution for remote working because remote working has a positive impact, avoiding commuting and all that. And then, for example, I mentioned before: software. Software is important for us when it’s linked to an engineering application. We’ve invested in virtualization software for a number of years. We invested in building information management software, in companies like Ansys and Autodesk. They really bring digitalization into the manufacturing, into the construction sector. And anytime that you digitize a process, you have some kind of raw material efficiency there.

the challenges that we have in terms of the damage we’ve done to the environment, those are huge challenges, so we can never go fast enough — Luciano Diana

[00:08:46.21] Ben: Have you seen a change in the kinds of investors that invest in your fund? Back, when you started it, I can imagine investors largely consisted of either funds or individuals that were interested in ESG. Would you say it’s gone way more mainstream now?

Luciano: Absolutely! It is becoming more mainstream. So, the fund was repositioned in 2014 — that is the key date, September 2014. Today, we have roughly $3.5 billion under management; mostly it’s retail and wholesale clients. We have large distributors within Private Wealth Management organizations, fund selectors, and some institutional clients as well, such as family offices and pension funds. So, definitely, more mainstream and not necessarily clients that want to use this as a satellite approach to their equity allocation but more and more as just an approach to global equities.

[00:09:53.00] Ben: I can imagine that doing what you do marries your professional interests with your personal interests, in the sense that we’re all affected by climate change and I think you’re somebody who’s very interested in it, in a personal capacity as well. Would you say, generally, you think things are moving fast enough?

Luciano: They are not moving fast enough because the challenges that we have in terms of the damage we’ve done to the environment — things like the concentration of CO2, the amount of plastic that we throw into the oceans — those are huge challenges, so we can never go fast enough. But what has changed and is encouraging and it’s very important for our theme is that the awareness on these issues has stepped up dramatically over the years. So, when we started, we thought that this would happen, we thought that young people would start to also get angry and complain about the state of affairs and how the older generation is treating things — and Greta Thunberg happened, so for us, it’s not really a coincidence. It was bound to happen, at some point. That’s very encouraging. We’re seeing how consumer preferences are changing. We’re seeing how the private sector is investing. And all of this has to do with more information, more awareness, so that’s the keyword for us.

[00:11:13.25] Ben: We haven’t yet reached the inflection point where all these nascent trends growing consumer activism, growing corporate responsibility, start to compound. Would you argue we haven’t reached that point, yet?

we cannot expect to leave the planet alone by shutting down our current society — Luciano Diana

Luciano: They are converging. I’m not sure about the compounding, but they’re definitely converging. So, they’re getting aligned. In most regions of the world, we see a very good alignment. I would caveat that the United States is a special case because of the current president and his policy toward environmental protection. That’s the only situation where policy is going backward instead of forward. But even there, if we take a long-term view, we think that eventually, the direction will turn 180 degrees. And so, the alignment will be pretty consistent across the regions. That’s powerful! I think there’s a sense of urgency. I think you might have questions later about COVID and the pandemic. We have almost put the entire economies to hold for an emergency which had the probability of being very severe in the short term. The hope is that we can mobilize, also, to address climate change and to build more resilience in the system.

[00:12:36.08] Ben: One of the challenges with climate change is that it’s always there, is a threat, but it’s not present in the same way as, let’s say, the pandemic is, where it’s constantly in the headlines. It’s like, one day we hear about a fire, another day we hear about a drought, but it’s not kind of this all-consuming, headline-grabbing issue that stays permanently on our consciousness. So, do you think that’s one of the issues which is, on the one hand, you’ve got kind of fatigue because we hear about it so much, but conversely — or paradoxically — it doesn’t stay sufficiently in our consciousness that we’re always reminded of it and we’re always acting on it?

Luciano: It’s not there every day but I would argue that in the last year or two, we’ve seen enough shocking events around the world to remind us about how dire the situation could become if we don’t act: the Amazon fires, the bushfires in Australia, and the hurricanes, and so forth. What I would also add is that it’s becoming more clear that climate health, the state of the planet, and our health are interrelated. So, more and more studies are linking air pollution with deaths in different cities. Even with this pandemic, there is an element of linkage there, seeing that people that are weaker in their lungs tend to be affected more gravely by the pandemic. There’s also the argument about climate change potentially favoring the spread of diseases. So, all these linkages are emerging one by one and I think the picture is getting clearer in people’s minds.

I think there will be some structural changes. Not huge. So, I wouldn’t go as far as saying that office work is dead, that we’re all going to work from home. There’ll be more flexibility. — Luciano Diana

[00:14:20.24] Ben: You mentioned earlier, but in the sense that the pandemic has accelerated digitization, I guess it’s been helpful in accelerating the energy efficiency.

Luciano: Yeah. So, there’s a couple of dimensions there. One is the pandemic and the other one is the current oil price. Maybe I can address both of them separately. So, on the effect of COVID, indeed, we are accelerating some technology trends that we were already seeing and we were investing in, and we think that’s going to be good because, ultimately, the environmental footprint of society might improve if we go in that direction. That’s one thing. When it comes to energy efficiency, we think that is going to continue but then, we have to also factor in the price of oil, the price of electricity — and whether that’s going to slow down investments in certain parts of the world for capacity, in general, we know that renewables have taken share, for example, versus fossil fuels. But, we also know that due to the lower economic activity and the pandemic, the overall level of investments in the energy sector has gone down by 20%, I think — there was a study from the EIA that was just released a day or two ago. So, that has to do with a slower economy, and the oil price is just a symptom of a slower economy. So, in the short term, it might not be the case that we’re going to see an acceleration, but that, in our opinion, is just a temporary effect. Again, when we do thematic investing like we do within our fund, we tend to look at the long term. So, a one or two-year-time horizon is too short term; we look at three years and plus. And if we look at three years and plus, then for sure, energy efficiency will continue to remain very important.

the worst is over and the markets tend to really have a huge amount of relief when they know that the worst is behind. — Luciano Diana

[00:16:21.00] Ben: What you touched on there is one of the biggest paradoxes about the environmental movement, which is almost like we have to continue to consume in order to create the incentives to be efficient.

Luciano: Yes, that is a very deep and philosophical question about where is society naturally going toward. Human beings need to reach a better state, they strive for better economic conditions, and therefore, society moves in a certain way: more mobility, different types of consumption. What happened with COVID was a stark example of what we don’t want, right? We don’t want to solve environmental problems by shutting down societies because the pain is too big. So, the only real practical way forward is to invest in technology. And this is what we’re doing, is really to try and get technology to save the day, and realistically, not trying to look for moonshots that don’t have any economic chance of success. Potentially changing our habits a bit, but not to the point of, sometimes I say, going back to the caves, the genies out of the bottle. And so, we cannot expect to leave the planet alone by shutting down our current society.

Ben: It’s almost like we need to create the demand, to create the profit incentives for entrepreneurs to come in and develop the technology that will save us?

Luciano: Yes.

[00:18:05.03] Ben: While demand has been temporarily reduced because of COVID, is this the moment where you think the government should step in? Like, for example, should stimulus packages be conditional on companies investing in energy efficiency, for example?

Luciano: Yes! There’s definitely a great opportunity within any crisis, and also, in particular, when there’s huge amounts of money being thrown at the economy. Not to put any conditionality would be, really, a shame. We are encouraged by what we’re seeing in Europe for the moment — the $750 billion package where a quarter of that seems to have some ties attached to it. We will see what happens in the United States. There’s also the potential for a huge Green Deal at some point in the future. And, in China, definitely, we’re seeing the subsidies going in the right direction. What I would say, though, is that, as investors, we don’t want to overplay the role of governments, and we don’t want to over-rely on those. Going back to the beginning of this conversation when I was mentioning renewables back in 2005, they were not yet ready as a technology, they needed a significant amount of subsidies, and therefore, there was huge volatility, also, in their businesses, when the subsidies were changed by governments. So, that lesson, as investors, has to be always there in the background — and that’s why, when we talk about technologies such as software for resource efficiency, digitization, these technologies make economic sense, and ultimately, they are adopted because of cost-saving reasons. So, whether the economy is in a good state or in a bad state, the companies always need to save money.

[00:19:56.17] Ben: I know you didn’t want to talk about moonshots, but are there any technologies that are not broadly on people’s radars, that you think could be game-changing? Things like carbon capture and technologies like that. What’s emerging that we should kind of be excited about?

Luciano: So, the carbon capture is indeed the holy grail of solving climate change, but it’s still too far away for us to look at, as investors, in public equities. So, we’re looking at the different initiatives, but the cost per tonne would require a price of carbon that the governments are not ready to accept. What I find very interesting — and that could have an equally important contribution not just to climate change, but to biodiversity and many other dimensions — is the plant-based products. So, it’s an industry that pretty much didn’t exist five years ago or even four years ago, and now it’s out with some valid products for consumers. So, very small, but with a huge potential impact. So, at the moment, there’s only one company that attracts a lot of attention in the stock market, which is Beyond Meat, but there’s others that are going to come into the market. So, I think as investors, while it’s early stages, while it’s not really clear who’s going to emerge as a winner, this is a space that I would definitely pay a lot of attention to.

[00:21:36.03] Ben: And is there a geographical bias, in terms of where the best companies and the best technologies are emerging from? And if there is, is there any way to rationalize that? Is it because of government policies and because of either just these places have startup hubs? What does the geographical picture look like for these technologies and companies?

Luciano: It’s quite skewed towards North America. So, if we look at our portfolio, for example, it’s been maybe 60%, roughly, exposed to that region, on average, over the last five years, and then, potentially 30% Europe and the rest of the emerging markets. So, the reason for that is innovation. At the end of the day, American companies tend to invest more in R&D. They have products that are leading-edge, and they tend to be also fairly well-managed businesses. In Europe, we have technology, but not as much, so clearly, on a relative basis, less than North America. And, in a way, the personal disappointment at the moment is that we are not able to find enough opportunities in emerging markets. So, we know that there’s a disconnect between the environmental issues that are present there, and the solution providers that domestically are developing solutions. That’s a function of, again, on average, not having enough companies that innovate. In China, there’s some great internet businesses, but we haven’t seen great environmental businesses that are really doing technology. It’s mostly companies that are applying technology that comes from elsewhere in the West and then deploying it, for example, for water management or renewable energy. So, we’re still lacking a bit some champions there.

[00:23:40.08] Ben: Should we put a price on the sea?

Luciano: We should definitely think a lot more about the oceans than we did in the past. David Attenborough’s documentary has done wonders for the awareness on plastic, and we should look after our marine life much better. When it comes to awareness, ocean acidification is a big problem. I don’t think that most people in the audience would know about it. It’s also linked to the intensive agricultural practices that we adopted all over the world. Basically, there’s a link between how much we fertilize our fields and when we overfertilize them, the nitrogen that is contained in the fertilizer is not absorbed by the soil so it ends up in the rivers that end up in the oceans, and that creates what’s called dead zones — so, zones where algae bloom, algae grow, they decompose and they absorb oxygen in the process. So, the ocean, as we get more and more of these dead zones around the world, along the coasts, actually is losing oxygen — and that has consequences on the types of marine life and fish that can thrive. So, we get a lot of jellyfish in the Mediterranean, for example; that’s a very resistant type of fish, but maybe tuna is a species that needs more oxygen than others. So, when we talk about the ocean, absolutely, we need to make sure that we limit the amount of plastic that we throw in there, we need to limit the amount of nitrates that we throw in there with intensive agriculture, and also be a bit more responsible in the way we fish.

[00:25:40.25] Ben: I suppose what I was getting at was like, in the same way as we’re starting to put a price on carbon, which should then get absorbed into the cost of production and should somehow internalize externalities, is the answer to the problem of polluting in the ocean to put a price on the ocean? Or is that you kind of think these things are too simplistic?

Luciano: Realistically, it would be too hard to put in practice. It’s the ultimate common good for countries. So, I think it’d be nice to think about a solution there. What we need to figure out is a way to get a carbon price, first. I would be very happy if we did that. And we know that we had several challenges in Europe, and we haven’t even started to think about a North American solution.

[00:26:33.20] Ben: Do you think that the pandemic can have a lasting change in terms of business life? So, business travel, commuting. And then, I think you told me earlier, that you’ve been attending a virtual conference. How does a virtual conference work in the investor world? Do you still have one-on-one meetings with the corporates, for example?

Luciano: I think there will be some structural changes. Not huge. So, I wouldn’t go as far as saying that office work is dead, that we’re all going to work from home. There’ll be more flexibility. As you say, if I just look at my job, some type of travel might be avoided. This format of virtual conferences is absolutely a novelty in the investment management ward, but it’s working very well. I think the feedback from both companies and investors is very positive. Basically, yes, you can meet management on a one-on-one basis, on a small group basis on Zoom — these days, that’s what the default platform is, really — and get pretty much everything out of it as you would with a physical meeting. That could take away maybe a quarter of our yearly travel because then, we would still need to go and see clients, we would still need to go and see companies on-site because there’s lab visits or facilities visits, so obviously, you cannot do them online, but this type of corporate axis could change.

[00:28:07.00] Ben: So, do you think virtual conferences might be something that becomes a new habit or a new function of investing?

Luciano: I think so. Maybe not all of them. I don’t think every single conference out there will turn into a virtual event. But I wouldn’t be surprised if one out of three, for example, becomes just virtual. That’s going to be positive.

[00:28:33.17] Ben: I wanted to ask you about the stock market, in general. So, between the 19th of February and the 23rd of March, the S&P lost a third of its value, and since then, with no underlying improvement in the economy whatsoever, it’s recovered. What do you put that down to? Is that a bull trap? Is that just the market looking through the recession? How do you explain where the S&P is at right now?

Luciano: We had the perfect vision in the market — not in the economy, but in the market. And ex-post we’re all geniuses and we all sound very smart. When you’re in the thick of it, it is a different story. So, when the market started to correct, there were a huge number of question marks about the virus. And we don’t do that anymore, but we were talking about parallels for the Spanish flu, and so forth. So, the panic on the way down, in my opinion, was justified by simply a complete lack of information and the unprecedented nature of the lockdowns. March 23rd was exposed to the point of peak panic. Why has the market rebounded since then? Clearly, the response from Central Banks has been unprecedented. So, there was a technical factor there — there was literally money being pumped into the markets to buy assets, equities, bonds, pretty much across the board. So, I kind of could follow the psychology of the market until just maybe a couple of weeks ago and in the recent couple of weeks I’ve also been a little bit puzzled by how far we’ve gone because when we look at the state of the different economies, we’re definitely seeing an improvement. But, I would say that in the US, we still have a few question marks about where all the unemployed people are going to end up if they’re going to be all reabsorbed quickly or not. It’s been pretty brutal over there and the money hasn’t necessarily reached unemployed people’s pockets. Maybe it’s available on paper but not in their bank accounts. So, the effect on the consumer economy in the United States is still a bit of a question mark.

The rise of passive investing is going to continue and it’s a challenge for the industry. But, when it comes to thematic investing, what we see is, really, the active approach is still successful. So, thematic investing is about looking for secular growth themes, is looking for different types of innovation, so it requires a very dynamic approach to identifying opportunities and that’s what passive investing doesn’t have as much. So, an ETF tends to be more rigid, of course, you have a certain universe; maybe once a year, whoever manages that product does a refresh of that universe and then keeps those stocks and maybe rebalances them every quarter. As an active investor, there’s a lot more dynamism. — Luciano Diana

Luciano: So, you could say that maybe the market overreacted a little bit on the way down and now it’s overreacting a little bit on the way up. The fact is that now we know the virus is not the Spanish flu, that it has affected a certain part of the population. So, in its current form, it’s unlikely to affect children and adults in the same way as it affects elderly people. And I would argue that, also, if we have a second wave — which is not yet a base case scenario — it’s a risk, but it is not considered as a base case scenario — our toolbox and our preparedness for that will be much higher than we had at the beginning. So, even if we have a second wave — and this is what I’m getting my head around, as well, these days or I’m trying to get my head around — are we going to have a second lockdown phase? I doubt it’s going to be the case. The measures to address that will be much more targeted. We will have testing, we will have tracing, we will have, hopefully, some pharmaceutical solutions there. So, the worst is over and the markets tend to really have a huge amount of relief when they know that the worst is behind.

[00:32:25.02] Ben: And you don’t think that, as poor earnings are announced, that somehow we’ll have a couple of legs down in the market?

Luciano: At this point, no. I think that the second-quarter earnings are going to be awful, but the market will absolutely look through them. And again, I’m trying to second-guess what the average investor is thinking, but we’re looking at 2021. If anything, I’m not so worried about what the companies are going to report. I’m maybe a little bit worried about things that were not present in the list of risks two-three months ago that they are now. And one is the geopolitical tension between China and the US, which has gone in the wrong direction. So, if we had issues with the trade war in the past, and the stock market reacted to that, then we’ve reached a deal. If we were to go back on that agenda, if the deal fell off, that’s a risk that would worry me because that would be a left-field sort of situation. And then, the other thing that I find interesting, and, to a certain extent, a bit sad is that we’re seeing the markets back at all-time highs, but actually, this is a time when the virus is hitting the population at large, the worst. Actually, in the last week or 10 days, we’ve seen the highest number of new cases since the beginning. And the reason why the market doesn’t necessarily care so much about that is because it’s not really touching the developed markets — it’s not touching the US, is not touching Europe or China or Japan, and now it’s about Latin America, it’s about Africa — and the companies that are represented in the stock market don’t have huge exposure to that part. But, from a human perspective, this is peak suffering. So, to have the stock market in a euphoric state, when hundreds of thousands of people are getting hit for the first time by the virus is, in a way, a bit sad, but that’s what it is in the financial markets.

in order to tap into innovation — and environmental technology, for example, in our case — we don’t feel that we need to necessarily look at very small companies. We have some holdings in companies that are already very well established to maybe $20–30–40 billion on market capitalization, so pretty large. And they’re the ones who are actually driving the most innovation in their respective space. So, finding opportunities in small caps is definitely there, but it is not an absolute necessity if you want to capture innovation. You can also get that from slightly larger companies. — Luciano Diana

[00:34:56.15] Ben: And I suppose another factor is — I don’t know if this is the right terminology, but they call it decapitalization — this idea that companies have been buying back more and more of their stock, fewer and fewer companies actually tend to list — you know, that divorce between Main Street and Wall Street, and that divorce between the developed world markets and the developing world has never been bigger because the stock market is less and less representative of the average business?

Luciano: Absolutely! And I think that was part of the knee-jerk reaction of several investors at the beginning of the drawdown in the markets. When you read the news about restaurants and cruise lines and airlines are really feeling the brunt of the hit, that’s only 6–7% of the market capitalization. In terms of employment, it’s a much bigger sector, so it may be 20% or so if you put everything together — the travel industry and tourism. But in terms of stock market capitalization, it is much less represented.

[00:36:05.02] Ben: We’re starting to see data come out about how stock pickers did during that kind of wobble or correction. And, basically, stock pickers did no better than passive funds. And so, I suppose the question as a fund manager I wanted to ask you was, how much are you concerned about the rise and rise of the passive investing in ETFs and index funds? Does that worry you or do you think there will always be a role for the stock picker?

Luciano: The rise of passive investing is going to continue and it’s a challenge for the industry. From a personal level, looking at what I do and looking at what we do with thematic investing at Pictet, I’m not concerned because we don’t see ETFs have been really taking the majority of the floors in our space. So, when it comes to thematic investing, what we see is, really, the active approach is still successful. I don’t have the exact numbers, but I think ETFs don’t represent more than 15% of our space. So, thematic investing is about looking for secular growth themes, is looking for different types of innovation, so it requires a very dynamic approach to identifying opportunities and that’s what passive investing doesn’t have as much. So, an ETF tends to be more rigid, of course, you have a certain universe; maybe once a year, whoever manages that product does a refresh of that universe and then keeps those stocks and maybe rebalances them every quarter. As an active investor, there’s a lot more dynamism. And in times like the drawdown, the key is to be able to take advantage of these locations that these situations create. So, an active manager can say, in wanting to buy that stock for a long time, “Valuation was not attractive enough — I have the opportunity, and then I go for it too.” So, obviously, it’s always easier said than done, but that’s the attractiveness of the active approach: that you can take advantage of these situations.

it pays to focus on the innovators and the companies that typically don’t have huge capital requirements to grow. That’s also another thing: even if capital is very cheap these days, the strongest performers that we had, have had that characteristic — high returns on capital, but with not a huge amount of capital employed. — Luciano Diana

[00:38:29.20] Ben: Do you think the other big opportunity is in your old hunting ground of smaller mid-cap stocks? Because, if MiFID is increasing the cost of covering smaller mid-cap stocks, don’t you think, almost by definition, there’s more arbitrage, there’s fewer people looking in detail at those stocks and therefore, that’s the place where you can uncover real value as an active investor?

Luciano: Absolutely! So, that is definitely true. MiFID, too, has caused a big change in the industry. We are seeing the need for more internal research, so, we ourselves are beefing up our teams internally, and, of course, we rely less on the sell-side. So that’s true. What I would have to say, though, and if I look at also my fund, in particular, is that in order to tap into innovation — and environmental technology, for example, in our case — we don’t feel that we need to necessarily look at very small companies. In other words, we have some holdings in companies that are already very well established to maybe $20–30–40 billion on market capitalization, so pretty large. And they’re the ones who are actually driving the most innovation in their respective space. So, finding opportunities in small caps is definitely there. What I’m saying is that it is not an absolute necessity if you want to capture innovation. You can also get that from slightly larger companies.

[00:40:08.21] Ben: Last question: what you’re saying is sometimes big is better, right? And that’s particularly the case where you have Demand and Supply Side Economies of Scale. But, in general, do you think the market is good at pricing Demand Side Economies of Scale, or is this idea that a product can get better and better the more people use it? And is that a possible area for value arbitrage?

Luciano: It’s a possibility. We don’t have, in our universe, the big platforms, like you would have — so Google and Facebook are not part of our universe — so we don’t really have examples of that economic power. But, what we do see is definitely that the economic modes of certain companies that have technology, they tend to get stronger and stronger every year as these companies mop up smaller competitors, and they acquire them. Because then, you have the flywheel of good free cash flow generation, which allows M&A to happen — and so, we have quite a lot of those stories where yeah, indeed, large is better because you consolidate the industry around you. So, yes, I think the answer to your question is, in our opinion, it pays to focus on the innovators and the companies that typically don’t have huge capital requirements to grow. That’s also another thing: even if capital is very cheap these days, the strongest performers that we had, have had that characteristic — high returns on capital, but with not a huge amount of capital employed.

[00:41:50.09] Ben: Fantastic! Can you leave us with one reason why we should be bullish about the environment and bullish about the ability for market forces to solve climate change?

Luciano: We should be bullish about the environment because we all want a better planet and our children, they will demand us to do that for them, and their awareness is going to be at a different level to what we’ve experienced in our lives. That’s number one. Number two is that we have the technologies so we don’t need to look for moonshots. We have technologies that can improve things and that can lead to performance. So, as investors, we can expect to have portfolios that outperform the markets, have a positive impact, and don’t require us to take more volatility or can use as a core component of our long-term investments.

Ben: Perfect! Thank you so much for coming on the podcast!

Luciano: Thank you for having me, Ben!

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