MARCH 2021 1

ESG in Equities: Identifying Winners in the Energy Transition

Clean energy and anti-pollution initiatives

will continue to impact the equity investment

landscape—but not all companies will be

winners, and careful analysis will be needed to

identify those that stand to benefit and those

that may see a threat to their business model.

BARINGS INSIGHTS

EQUITIES

Marios Halloumis, CFAESG Investment Analyst, Equities

Piers Aldred, CFAInvestment Manager, Global Resources

Paul Morgan, ASIP, CFAInvestment Manager, Global Equities

BARINGS INSIG HT S MARCH 2021 2

The global response to climate change has escalated in recent years, evidenced in part by the

policy steps being taken by governments around the world. Within hours of being sworn in as

the 46th U.S. president, for instance, Joe Biden signed an executive order to reaccept the Paris

Agreement—thereby committing the U.S. to outlining climate actions, known as nationally

determined contributions, and to pursue domestic mitigation measures aimed at achieving the

objectives of such contributions. The European Commission announced the European Green Deal

in December 2019, which aims to transform the region into a low-carbon economy by achieving

carbon neutrality by 2050 and decoupling economic growth from resource use. And in China,

Xi Jinping announced a pledge to make the world’s biggest GHG emitter carbon neutral by 2060.

These commitments have already affected, and will likely continue to influence, the investment

landscape, whether directly or indirectly. Indeed, Article 2 of the Paris Agreement calls for

synchronizing investment flows with efforts to bring about low GHG emissions and climate-

resilient developments. Companies that are directly or indirectly exposed to these trends will

almost certainly be impacted as a result—but not all companies will be winners, and careful

analysis will be needed to identify those that stand to benefit and those that may see a threat to

their business model.

In this first piece of a new series on environmental, social and governance (ESG) in equities, we

explore the potential opportunity created from increased investment in two key policy areas under

the European Green Deal—clean energy and the elimination of pollution.

Clean Energy

Clean, renewable energy has been part of human civilization since ancient times. From Egyptians

using wind power to sail their ships, to Persians using the first-known windmills and wind-powered

water pumps around 500AD, the harvesting of renewable energy has been achieved in a variety

of ways. Encouragingly, creativity in this space has not ceased. For instance, there are startup

technologies, such as bladeless wind “turbines”, that are a fraction of the cost of a traditional wind

turbine and require far less space to install—providing a potential solution for densely populated

areas, such as those in emerging markets. That said, decarbonizing the energy supply is no small

task, especially considering that 84% of today’s total energy supply comes from fossil fuels (FIGURE 1).

SOURCE: BP. As of December 2019.

Nuclear Energy

Renewable Energy

Hydroelectric

Natural Gas

Coal

Oil

4%

5%

6%

24%

27%

33%

FIGURE 1: Global Energy Supply by Source

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As we look across the landscape today, there are a wide array of companies

involved in the transition to clean energy—from equipment manufacturers like

Danish wind turbine manufacturer Vestas, to industrial gas manufacturers like

Linde, which aims to supply clean hydrogen. Even some traditional energy

suppliers are enabling the move to cleaner energy. For instance, Royal Dutch Shell

is using hydrocarbon cash flows to invest in low carbon and energy transition

businesses.

Companies that can materially contribute to the decarbonization of the

environment may experience a tailwind going forward amid the growing push

for a carbon neutral economy. Finnish company Neste, for example, produces a

renewable diesel product that has helped its customers cut GHG emissions by up to

90% over the fuel’s life cycle when compared with fossil diesel.1 More recently, the

company has developed a renewable aviation fuel with significant potential to help

decarbonize aviation. At the same time, Neste is taking material steps to contribute

to the circular economy, in this case through the production of renewable plastics

and use of waste material as renewable feedstock.

Eliminating Pollution

In addition to underscoring the importance of clean energy initiatives, the EU

Green Deal emphasizes the need to better monitor, prevent and rectify pollution

from the air, water and soil. Complementary to this, the Stockholm Resilience

Centre defines “biosphere integrity” as one of four components that are critical

to the functioning of our planet and now to be deemed “high-risk” (FIGURE 2). The

Paris Agreement also stresses the importance of protecting and maintaining these

systems, including oceans.

SOURCE: Steffen et al. As of 2015.

Below Boundary (Safe) In Zone of Uncertainty (Increasing Risk) Beyond Zone of Uncertainty (High Risk)

Climate Change

Novel Entities(Not Yet Quantified)

StratosphericOzone Depletion

Atmospheric Aerosol Loading

(Not Yet Quantified)

Ocean Acidification

BiogeochemicalFlows

FreshwaterUse

Land-SystemChange

BiosphereIntegrity

Nitrogen

E/MSYBII

(Not YetQuantified)

Phosphorus

FIGURE 2: The Planetary Boundaries Framework

1. Source: Neste. As of September 2019.

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As commitments to eliminating pollution and improving

the earth’s atmosphere strengthen, the range of solutions

required to address each specific source of pollution will

likely benefit a variety companies. In particular, companies

that operate in niche/specialist areas that are too small to

attract significant interest from new entrants, or those that

are already well established in a specific field, may benefit

the most. For example, Tomra Systems, which provides waste

collecting solutions, may benefit from government pledges

for capturing single-use plastics, as well as from food retailers

turning positive on the company’s reverse vending machines,

which enable a consumer to exchange their used beverage

bottles in return for cash.

Companies that make products to test water quality or

to monitor pollution in the water or air may also stand to

benefit. Halma is an example—the company has a long

track record of providing health, safety and environmentally

focused products, including some that are used to measure

the shelf life of food to reduce waste and thereby prevent

further pollution. At the same time, the company is taking

steps to improve its own environmental credentials by

reducing its carbon footprint.

Not Forgetting the S and the G

While analyzing companies from an environmental perspective

offers visibility into how their revenue may fare in the face of

evolving climate-focused initiatives, these considerations are

only one factor in determining a company’s attractiveness

from an investment standpoint. Indeed, social and governance

factors are equally paramount. For instance, a company that

creates a product or service that solves one environmental

problem—but does so at the expense of social, governance

or even other environmental factors—may ultimately face

significant challenges. And importantly, not all companies

involved in the sustainability space will have sustainable

business practices, which is why it is important for investors to

conduct the necessary due diligence. In our view, companies

with the following attributes look particularly well-positioned:

• strong franchises: for example, companies that

manufacture products that contribute to a cleaner

environment, while also taking steps to reduce their own

carbon footprint

• good management: alignment with the long-term

interests of minority shareholders

• sustainable business practices: no hidden E, S and G

risks—including environmental fines or lawsuits related to

business ethics—that pose a threat to financial stability

One of the better-known examples of environmental factors

conflicting with social or other considerations relates to

the use of palm oil in manufacturing. Very widely used

in everything from food production to renewable fuel

feedstock, palm oil has generated an abundance of negative

headlines for its ties to issues like air pollution, deforestation

and human trafficking. There are widespread and varying

efforts underway to combat these issues. Again, Neste is an

example—the company set up their own, EU Commission

approved, sustainability verification system for palm oil in 2014

and are using sustainably-produced, 100% certified and 100%

traceable palm oil as part of their renewable feedstock. The

company has even committed to eliminating this sustainable

palm oil altogether by 2024, while at the same time taking

active steps to improve the fair treatment of workers in the

palm oil industry. In our view, this is the type of progress and

forward momentum that can ultimately help improve the

discount rate required by investors and further unlock value.

“Companies that can materially contribute to the decarbonization of the environment may experience a tailwind going forward amid the

growing push for a carbon neutral economy. ”

BARINGS INSIG HT S MARCH 2021 5

From a governance standpoint, factors such as the structure,

diversity and independence of a company’s board can be significant

determining factors in a company’s overall attractiveness. In the

case of Neste, the board is 100% independent, with a roughly 40%

female representation, and the roles of the CEO and chairman are

split.2 Companies like Halma, too, look sound from a governance

perspective. While the company operates many subsidiaries,

corporate governance appears to be strong. Female representation

on the board has also remained at 40% over the past five years, but

the ratio has notably improved at the executive board level from 13%

to 45%.3 And finally, the company has a group-wide whistleblowing

policy that applies not only to its employees, but also to its joint

venture partners, suppliers, customers and distributors.

Key Takeaway

Clean energy initiatives and policies—like the EU Green Deal—will

impact the equity investment landscape for years to come. In the

face of growing regulation, some companies look better positioned

than others. In particular, those that are tackling or addressing

pertinent climate issues head-on, while doing so with sustainable

business practices, look likely to benefit, and could potentially

command a higher premium in the market going forward versus

peers with less favorable ESG dynamics.

At Barings, ESG analysis plays an integral role in our understanding

of the potential risks and opportunities that a company faces, and in

our investment decision-making. Our approach to ESG is anchored

by three principles:

• integrating ESG factors into fundamental, bottom-up investment

analysis

• taking a dynamic and forward-looking approach to analyzing a

company’s ESG factors

• actively engaging with management teams to improve ESG practices

We believe in engaging directly with corporate management teams to

drive better ESG practices and improved disclosure, rather than relying

on exclusion lists—which may fail to recognize the role certain, usually

carbon-intensive industries play in achieving a sustainable future. In

allowing us to quantify ESG risks and giving us a more comprehensive

view of a company’s future, this approach puts us in a position to

deliver potentially superior risk-adjusted returns over time—as we

seek to create a better outcome for people and the planet.

2. Source: Neste. As of February 2021.3. Source: Halma. As of December 2020.

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