Green investing with ESG
*ESG stands for Environmental, Social and Corporate Governance.
Climate risk overview
In terms of ESG trends, we're seeing an increasing awareness in how climate change is now becoming a central piece of business models, with firms pledging to reduce carbon emissions by 2050. This matters for the long term survival of firms since in the future, emissions could likely be taxed and regulated, see increasing costs, have reputational damage and threaten competitive positions. Firms that begin to prepare now, will be long term beneficiaries of a changing world.
ESG green bonds capital markets is now over $450 billion, or ten times what it was five years ago. There is now a growing urgency trend in companies to become more ESG attractive which is in line with most government goals and enables more environmental goals.
Climate change risk modeling for investment purposes is still in a relative stage of infancy. The two components that stand out are physical and transitional risks; natural disasters which are acute risks and rising sea levels which are chronic risks. Models for ESG going forward will need to transition away from analyzing generalized effects towards analyzing the materialized effects of climate change by region.
It is now clear that solar energy is more cost efficient than wind. Estimates say solar energy will see key growth over the next couple of years. Moreover, hydrogen is now jumping up the ranks in popularity. Hydrogen will boost green energy production, but might not have enough funding yet to overtake solar energy completely.
Solar shortcomings are that it takes 1-3 year to implement because construction requires lots of manpower, effort, time, and precision to finish on time (see section below on infrastructure for more insight on these issues). However, offshore wind is usually twice as long to implement with a 5-7 year journey to full construction. Offshore wind only has three turbine manufacturers globally and they are limited suppliers.
Solar has been helped by the low cost of sourcing from China. China currently produces 70-80% of global solar needs, and this dependence does not seem to be going anywhere anytime soon; India wants to participate in the effort, but the investment commitment is just not there yet.
Sustainable supply chains
Consumer expectations towards sustainability has increased over the last 10 years with customers not trading price and quality against sustainability at grocery stores. Consumers are more interested in the sourcing of raw materials which influences preferences for clothes, food and paper and will only continue to grow with the next generation of consumers (see section on Gen Z).
The apparel industry is a huge problem in ESG investing since they are major polluters. Imports come from far away and supply chains are conducive to huge CO2 emission levels. More specifically, the apparel supply chain is responsible for 10% of the world's CO2 emissions, and 20% of waste water worldwide coming from fabric dyeing. Levi Strauss currently stands out as an apparel ESG leader since they cut fossil fuel dependency, and initialized their future-led execution to protect the environment further.
Firms have off shored their supply chains mainly to China in order to exploit low cost arbitrage, but there is a changing attitude regarding the direction of supply chains especially with lessons learned from Covid-19. The shift comes from a change between shareholder's interest to what's called stakeholder's capitalism; as groups become concerned with their ESG status their supply chains move closer to domestic markets.
Key trends in Robotics, AI
Computer vision: enabling computers to see and analyze what they see is said to be a $10 billion market. This can be used in the manufacturing process to enhance product quality, reduce waste, improve productivity in a variety of markets such as consumer electronics, automotive and more. This technological development will work closely with large production equipment.
Reinforcement Learning: this refers to goal-oriented algorithms that help enable autonomous robots move through space like Boston Dynamics robots doing backflips. This set of robotics will help with directing focus through complex data sets and will see applications like news sorting, or credit loan processes.
Manufacturing: Cobots are collaborative robots which are important to propel the development of industrial production around the world. Cobots still don't represent a huge market presence with only just over 20,000 units at $1bn, but they show an attractive CAGR of 40% through 2023 estimates. China is currently the biggest industrial robotics market more than twice that of Europe and three times that of the US though the latter groups show more productivity.
3D printing: this market stands close to $10 billion annually and has applications in reduced waste materials, lower costs for small batch production, shorter time to market, flexibility in design. However, the speed is still the biggest remaining hurdle. In the medical and consumer markets there are projects in dental, implants, prosthetics, hearing aids, glasses, and shoes.
Logistics automation: this market is north of $50bn and the boom in eCommerce is raising the bar for supply chain efficiency as seen by Shopify's $500 million acquisition of 6 River Systems. Big players in this space include; Zebra, Daifuku, Kardex, and Manhattan Associates.
Network and security: Cybercrime is a real issue but luckily, AI is coming to the rescue. Last year, over 4000 data breaches hit organizations. By 2025, cybersecurity, the combination of data security, IT governance, and compliance, will surpass the $300 billion mark. The market is set to grow around 12% annually through 2022 as the private and public sectors both expand into cyber risk control. Top companies in this field are Rapid7, ServiceNow and Palo Alto Networks. They estimate that this AI technology could drive an increase of 20% in topline growth for firms in the coming years.
Business process: used to create a competitive edge to develop new, interactive and immersive client experiences which will reinvent business models. Cognitive Computing builds tech advancements that identifies tasks that software can't yet perform. Robotic process automation (RPA) will allow for manual repetitive tasks like data entry from emails to become automated so that workers can focus on leads and meetings instead.
Revenue generated from the direct and indirect application of AI software alone could grow to over $100 billion by 2025.
Household incomes show growth after stagnation
Since 1970, median salaries have increased overall. Most of the increase occurred between 1970 and 2000, a period that saw a 41% growth, or an annual growth rate of 1.2%. However, in the last two decades, the annual growth has been closer to 0.3%.
If the 2008 crisis had not affected growth, median salaries today would be closer to $90,000 instead of $75,000. Between 2000 and 2015, the median wages were about the same because the 2008 recession wiped out many savings. This is closer to a 15 year stagnation trend. In the past five years though some suggest that the recession is fully behind with an annual wage growth rate of 2.1%.
Upper income households have boomed upwards
The US middle class is shrinking while the upper income group is shooting for the stars, at least in terms of their ownership of the pie. It appears to be that there has been a reversal between how much of the pie middle income folks own compared to upper income brackets, see graph below. While middle class income have grown 49%, upper incomes have grown 64%. While the middle class of income is squeezed, the lower income bracket has seen a 43% increase in wages. Upper income folks own close to 50% of all existing income.
The richest are becoming richer faster
With more financial resources at the top, the wealthier groups have continued to accumulate more wealth through the compounding. The wealth gap between the poor and the rich has more than doubled from 1989 to 2016.
In 1989 the top 5% had 114 times as much wealth as the second quintile. By 2016 this multiple increased to 248 times the second quintile. The money has concentrated and stayed with certain groups, not trickling down quickly enough. While every advanced country has some type of economic inequality, the US is the highest of the G-7 nations.
Some words regarding Universal Basic Income (UBI)
McKinsey wrote an article in September discussing the findings of a recent 2 year long Finish experiment exploring UBI's effect on society. UBI is becoming more relevant in the media as questions regarding man-robot labor substitution become more prevalent in industry. UBI was popularized by Economics Nobel Prize winner Milton Friedman. The goal is to supplement income, not exist as a full on substitute.
The study: 2,000 unemployed people randomly selected received UBI instead of government allowances. The control group stayed on allowances.
Results: UBI led to a small increase in employment, a significant increase in well-being, and positive individual and societal feedback loops. While the results are small, they offered some type of insight into the effect UBI has on employment. However, many questions were left unanswered such as how does a government finance UBI, and to what extent did the experiment perform better than the help that already exists in Finland (housing allowances, child benefits, pensions, health insurance, tax breaks.)? The largest increase seems to be in well-being which is a great thing for positive externalities in a society.
Critique: Finland is a very wealthy and educated nation on average. It is a small country with little racial, religious, or immigration conflicts. Finland already offers one of the world's most prestigious health care systems, unemployment is low, and the currency is one of the strongest in the world in terms of price parity.
The pandemic had a powerful effect on the infrastructure industry, an industry known to have complicated timelines already. Infrastructure project gaps come up time and time again in the research where the gaps are the difference between the current funding amounts and the need for further funding on a project. Developing economies before Covid-19 were already missing $15 trillion globally. Governments are now pushed to make a decision between spending more, or cutting back to save.
The industry was already plagued with the following issues:
- Asset allocation and risk: the risk is not shared adequately enough among the parties, and investors are cornered. If projects go well profit margins are tight, and if things go badly the downsides are large. Risk and return asymmetry is pressuring investors out of certain projects. Perhaps policy makers can play a role in improving risk sharing and thus catalyze more investor spending in much needed projects.
- Climate change: with an increasing rate of urbanization, the industry must realize and mitigate its effect on climate pollution. A push for green infrastructure and urban planning is a much needed trend to work towards. Low-carbon solutions like wider sidewalks, bike paths, slow zones, car-free zones, and trees bring along many long term benefits, and are already part of the plan in developed hubs like Copenhagen, Singapore, and Berkeley.
- Technology involvement: Compared to other capital intensive industries, infrastructure is underinvested in technology, an add on that can help climate goals, improve safety, networks, and overall mobility. Stay tuned for developments there.
The pandemic has already hit the future of the industry as projects have been further delayed and demand disruptions have generated decreasing revenues (think about airports). However, it is known that governments use infrastructure spending as a way out of recessions because it simulates their economies.
256 projects in developing nations have been cancelled or delayed, but since an April peak, there has been a stabilization in the industry which could turn into a break away:
Most disruptions were due to travel limitations and challenged supply chains, which especially put projects from foreign investors behind. The overall industry is heavily reliant on Chinese manufacturers so if China is slowed, the rest of the world follows.
One indication that the infrastructure industry will improve after 2020 is that most of the top reasons for delays and cancellations were due to temporary reasons, and 20% of the delayed projects are already back on their feet after lockdowns have been lifted. The difficult aspect of these disruptions is that projects are often times interconnected: one hold up hurts another job. Funding in 2021 will become crucial, and helping investors get on more projects will be a big talking point.
According to the UN, Gen Z represents about 32% of the global population, or 2.5 billion people. According to Euromonitor, their income will reach around $70 trillion by 2040. Income-wise, they will surpass Millennials' income levels by 2030 with the US and Chinese markets set for the largest wallets. They are born between 1996 and 2016, are fiscally conservative, value social issues, delay marriage and having kids and 89% of them live in emerging markets, according to the UN.
India has more Gen Z people than the US and China combined according to the UN:
What kind of consumer is the Gen Z spender?
Key consumer characteristics include sustainability, insularity, and product over experience. Gen Z has been described as ''lonely'' in their social and consumer preferences. They are said to prefer (or perhaps are subject to) meeting online through online dating apps Tinder and Bumble, or TikTok and Instagram.
Mobile phones are clearly a large player in this type of consumer behavior from buying online to socializing via apps. Beware, asset managers, Gen Z is also open to new forms of financial tools, such as robo-advising and peer-to-peer transactions through mobiles. Crypto currencies are also more easily adopted by these spenders, who are technologically innate.
Key facts about Gen Z
Life defining events for Gen Z are: Trump election, Covid-19, Greta Thunberg, #MeToo, LGBT+ movement, electric and self driving cars. While 75% say the mobile phone is their device of choice, augmented reality and virtual reality will become the new defining technology of this generation.
The most popular hobby of our younglings is eSports, which competes with playing real sports like football, and Fortnite is the most in demand video game they play. They are digital natives, meaning they are born with technology and embrace it as a civic tool: from online education, to preference for infographics, to cancel culture, to influencers. They don't see technology as something from outside, but rather as part of who they are.
Current trends acceleration
Cable TV will lose its way by the time Gen Z becomes part of the work force; they have streaming services which they access through mobile phones or other devices, and they will not be buying TV services the same way their parents did.
eCommerce for Gen Z happens through influencers a lot more than you might expect and this makes sense considering the level of activity there is online. The share of US teens connected ''almost always'' every day has nearly doubled in three years to 45% of teens. This makes them the most internet addicted generation, and a gold mine for online influencers, content makers and online shops (not to include advertisement).
Payments will eventually be made entirely through peer to peer networks like Venmo, a Paypal app for quick peer to peer payment resolutions. Cash will also become obsolete and soon replaced by crypto currency.
Stock trends defined by Gen Z
Considering all of the above, it should become clear to you how Gen Z spenders should behave on average going forward. Big picture ideas are noted below:
- Streaming economy
- eSports; platforms, publishers, hardware, consoles
- eCommerce; retailers, solutions, logistics
- Online interactions; social media
- Fintech adoption
- Insular consumer; athleisure, affordable luxury, pets
- Health and wellness (mental and physical), sustainability
BoA Global Research