Value through Values: Sustainability is Growth Investing
A strong position on climate, governance and inclusion is more than a question of good risk management — it’s also good business, says Bertie Whitehead, managing director and EMEA head of ESG in investment banking at Goldman Sachs. Investors are increasingly asking if companies are tapping into growth areas such as the energy transition and the waste-reducing circular economy, Whitehead says: “We used to call these megatrends, but it’s simply growth investing. This is where capital is going.”
The flipside of this effort is identifying and managing risks. This played out in the immediate aftermath of Russia’s invasion of Ukraine, as corporations rapidly revaluated their strategy. “We saw many companies putting values over value and withdrawing from the region,” Whitehead says. “Companies that were slower to respond found themselves under more than just visible social media pressure — stores were boycotted.”
We sat down with Whitehead to discuss how companies and investors are responding to the opportunities and risks around climate, governance and inclusion.
For some time, Europe has been seen as a leader in climate finance and investment, with a particularly supportive regulatory environment. How has that forced or helped clients evolve their posture?
What is interesting about Europe is that there was a joint journey from both regulators and capital allocators to move towards a sustainable future. This is different for instance from the U.S. where the lead was very much taken by the capital allocators and corporates initially.
This helped Europe set the lead on disclosure, from a corporate, a fund manager and financial institution perspective. And disclosure is key here — to use the axiom of “you can only manage what you measure” — and this gave Europe that head start.
Are there notable differences in approach between listed companies, private companies?
Absolutely, but this in part is down to the maturity of exposure, and in part down to geographical bias. A lot of developed economy companies have been exposed to the white heat of investor pressures for a number of years now, and they have seen how this translated into valuation differentials and voting patterns at annual meetings. So they had additional pressures to respond quicker.
For many private companies, the pressures were different, in part as their ownership structures were narrower and so they did not get the same breadth of pressures. Where private and public companies are similar is on some of the pressures from the other stakeholders—customers, employees and of course regulators.
But the maturity gap is closing and this means that there is growing sophistication in both private and public companies with both sets now increasingly collecting data, setting targets and communicating impact. The commercial opportunity is now in play.
How is the focus on sustainable investing impacting capital allocation in the private equity industry particularly?
At its heart, focusing on sustainability and ESG is good business practice. Identify and minimize risks. Protect margin from future compression. Pivot the business to growth.
The private sphere is often overlooked, when actually private equity funds are racing to create sustainable funds. In Europe alone, ESG private-equity assets under management has grown from 13% of funds in 2015 to 17.5% in 2020. If market expectations are correct that this will rise to be more than 20% in 2025, it means that more than 60% of new PE flows will need to be into ESG funds.
This is down to a push and pull. The push is that their investors — the asset owners — are demanding sustainable investment. The pull is that sustainable investing is growth investing — and better, deeper due diligence on risks! — but through a different lens.
This gives rise to different questions. For example, as the global economy transitions during what will be the most significant shift in capital in history, which companies are exposed to the high-growth areas of the market? And can you use data and policy to identify the risks are that idiosyncratic to each business and how well they are being managed?
Russia’s invasion of Ukraine in early 2022 forced certain companies to change their strategy in Eastern Europe and Russia. How are factors like climate, governance and inclusion shaping corporate strategy over the short, medium, and long term?
It should go without saying that no one wanted a humanitarian tragedy to be a catalyst for corporate strategy change.
In the immediate aftermath, we saw many companies putting values over value and withdrawing from the region. Those consumer-facing companies that were slower to respond found themselves under more than just visible social media pressure — stores were boycotted and, for some slower responding retailers, business is still very slow.
The medium term impact was then intense focus on energy availability, not least because of Europe’s dependence on Russian energy flows, and to restore generation capacity through whatever means possible, including coal. With gas prices across developing nations persistently high, that pressure remains.
The long tail is then a much greater understanding of energy security and resilient supply — through self-generation or trusted partnerships — including the use of hydrocarbons in the near term. It’s quite telling that the largest IPO in Europe since Russia’s invasion was for a hydrogen company, De Nora, that we were delighted to lead.
There is also a growing link between the E and less mentioned S. In many instances, you need the S to enable progress on environment. Look at, for instance, Brazil: To avoid deforestation you need a strong social policy to educate, incentivize and provide individuals with the tools to enable them to generate income without destroying forests.
The governance question is becoming universally important — namely do you truly know your supply chain from top to tail? This is leading to a far greater push to rapidly understand resiliencies.
For investors working to operationalize sustainability, data is critical. How are investors using sustainability data in their investment frameworks? What data are they using and what are they trying to assess?
Millions of data points on sustainability have been created, consumed and analyzed. Each fund manager has a slightly different input set, and these are vast and varied. Still, they are being used generally to understand two key things: how to preserve alpha, and how to further create it.
For the former, data and policies are being used to get a handle on each company’s idiosyncratic risks and how well they are being managed. Identifying these risks means that investors can adjust what they’re willing to pay.
The other side of the coin is opportunity: alpha creation. Is the company attaching itself to some of the more significant growth areas in the market such as the energy transition, inclusion — so accessing a wider pool of customers and removing historic frictions — the circular economy, or the growing population? We used to call these megatrends, but it’s more simply growth investing. This is where consumer money is going.
Climate, governance, and inclusion considerations are regularly considered in terms of risk and exposure—how are companies reframing their strategies to realize opportunities?
There is still a pervasive feeling that sustainability is either a luxury good — particularly recently — or a distraction from “pure business.” This couldn’t be farther than the truth: it’s also about maximizing your operating potential as a company. Treating employees well means lower staff turnover. Having inclusive hiring policies will yield the best people. Minimizing your environmental footprint can make for increased sales because customers are now really prioritizing the issue. This is driving M&A pivots, as our clients dispose of assets that generate higher carbon, or look to buy more sustainable, resilient businesses.
The data is instructive : the median EV/EBITDA (the ratio of enterprise value to earnings-before-interest-taxes-depreciation-amortization) multiple in LBO transactions between 2017-2021 was around 12.7 times. Our observations of sustainability themed transactions show multiples commonly in excess of the average, with some more than 50% above this. This is the premia in action.
How are clients considering sustainability and inclusion in the context of rising inflation and recession risks?
Put plainly, sustainability and ESG at scale haven’t travelled through a true recession yet. If the early stages of the pandemic are any guide, what we saw was an acceleration towards these factors — in particular the S and the protection of colleagues. Generally speaking, I think people vastly underestimate how far public opinion has progressed on issues related to climate, governance and inclusion – even since the start of the pandemic in 2020.
Now, to be pragmatic, of course companies cut back from growth investment during a recession. It happens all the time. Does this stand in the way of the long run trend of greater capex (or public opinion) to drive sustainable growth? Absolutely not.
On managing the cost of living and energy costs, according to Michele Della Vigna’s Carbonomics Research, if the state covers upfront implementation costs, household bills could be 50% lower in the future through renewables.
What do you see as the future for this space?
We are, in my view, now beyond the tipping point. Asset flows in Europe in both public and private spheres will be increasingly be dominated by sustainable and inclusive tilts. Capital will flow to those companies that can prove themselves to be risk insulators and growth companies.
Disclosure will enable this. But the pace of disclosure and data around key topics will, and should increase. Carbon data in a sustainability report can be two years old. Would you invest on the basis of two-year-old data? Or would you prefer real-time data from low earth orbit satellites with geo-tagged factories, logistics routes and all of the suppliers too? As a business owner, you will want assurance on compliance from your entire supply chain to ensure that customers have the confidence to buy your product. It’s a huge data mountain to climb and we’re on the foothills.
In my view, the risks aren’t around technology. There will be innovations and improvements, but the core technologies exist. The challenge is scaling and getting the abundant capital, in the right format, to the right projects.
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