Sustainable Alpha: Dave Chen on global impacts

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Dave Chen, Equilibrium Capital Group

Sustainable Alpha features shared conversations with the best minds, portfolio managers and industry leaders working to maximize returns while prioritizing the environment, social and governance factors — what’s become short-handed in the industry as ESG. Sustainable Alpha highlights portfolio approaches and investment trends against the backdrop of broader themes such as resource constraints, policy changes and demographic shifts — all while shedding light on how ESG can impact your investments.

Sustainable Alpha conversations are led by John Wrenn, Senior VP, Investments for UBS. The Wrenn Ferguson Group has a combined experience of 200 years managing over 1.6 billion in assets, offering customized wealth management strategies for individuals, endowments and foundations. View the rest of his conversations with leaders in the sustainable investment community.

Here he's talking with Dave Chen, principal and founder of impact investing firm Equilibrium Capital Group. He is also a board member of the Federal Reserve Bank of San Francisco’s Portland Branch and chairman of the Oregon Innovation Council.

John Wrenn: How would you describe the impacts of a growing middle class in emerging economies and its implications for the global economy?

Dave Chen: I jokingly say that the issues and opportunities in sustainability can be summed up in one simple trend: One Chinese or Indian consumer starting to eat chicken and drive a car.

That move from a grain-based diet to a meat-based diet means that the grain that previous fed eight people now gets fed to livestock that feeds one person. A pound of chicken means three pounds of grain. This "productivity" swap takes place on a relatively fixed number of global productive acres.

There is a similar story for energy. It takes 50 calories of energy (in the form of fuel, fertilizers, electricity, transportation) to create one calorie of meat.

That pound of meat has similar implications for water consumption. And as food consumption grows, energy and water consumption grows, and greenhouse gas production also grows.

This isn't a judgment of whether eating meat is a good thing or not; it's simply a reality of the growing middle class. The magnitude is mind-boggling. We're not talking about one Indian or one Chinese consumer; we’re talking about more than 2 billion people moving toward middle class consumption patterns. In the near term, this middle class has already grown to two times the size of of the U.S. and it's just starting.

And that’s just a pound of chicken; we haven’t even started on the implications of 2 billion people driving.

JW: What trends should investors be paying attention to and how does sustainablility play a factor?

DC: At Equilibrium, we look at the mega trends behind the issue of sustainability: A growing middle-class population that drives resource constraint, most obviously of energy, water, food, the escalation of commodities, the implications of greenhouse gases and climate change, and the move toward urbanization. We see the issues and trends in sustainability through the investor lens of risk management and value creation opportunities.

JW: What are the kinds of questions you are considering when studying economic implications from trends like urbanization, resource constraints and rising fuel prices?

DC: Here are a few:

• Would you rather hold stock in a utility with 80 percent coal-fired assets or one with a 40 percent renewable portfolio and natural gas assets? Consider global regulations and measures here at home such as California Gov. Jerry Brown signing that state's aggressive 30 percent renewable portfolio standard.
• Would you rather own a green building portfolio that is energy and water efficient and has lower operating expense or own a portfolio of energy inefficient buildings? Assuming that you hold that portfolio for 10 or more years years, efficiency only accelerates the value and future proofing of your assets. Think about that in light of future carbon taxes. Think about that in light of the Chinese regulation announced in September 2010 that mandated building efficiency in investor-owned buildings. What if that building improved the prosperity of the immediate area? This translates into higher tenant occupancy, better rents, more robust neighborhood; all leading to better net operating income and greater appreciation. That's green or sustainable real estate translated into economics and impact.
• Would you invest in a timber real estate investment trust that has two revenues streams from their land: harvesting trees and selling land for real estate development? Or would you rather invest in a REIT that has the expertise to harvest the land sustainably for long-term use in biomass, timber, carbon credits, renewable energy, sustainable agriculture, and sustainable community development? That translates into both an expanded integrated set of revenue sources and protection against economic cycles.
• As fresh water becomes more constrained and with agriculture being a major water user, do you think the price of water is going up? We are watching companies looking very hard at the issue of cotton and its use of water as a future threat. Would you rather invest in a company that is actively looking for clothing materials that are less dependent on oil and water resources or one that ignores this escalating supply chain cost exposure?

Step back and try to think through the implications of these factors on risk and forward value in your portfolio of assets, whether that is a stock, a bond, a commodity, fund, or a hunk of land.

JW: Why are you interested in water as an investment?

DC: Water is non-discretionary. In the next 10 years, it will become an increasingly important asset. Right now it serves as a very attractive above average yield fixed income component of a portfolio and in many ways an inflation hedge. Water has grown in yield at twice the rate of the consumer price index. From an investment and economic standpoint, water is as critical as energy on a global basis for sustainable growth.

JW: How do you boil down sustainable investments?

DC: Sustainability is about massive shift in economics and value.

It is a disruption in huge industries like food, energy, water, shelter.

It will produce winners, losers, and new models.

Everyone understands the trends; few are investing on the implication and opportunity. In investor-speak, we call that information inefficiency. At Equilibrium Capital Group, we call it hidden alpha.

JW: Do you believe sustainable investments will produce better results?

DC: Looking back 15 years from now, we believe these sustainability trends will seem both obvious and logical — not much of an insight.

At the heart of it, we believe that investing in sustainability is just plain good investing. But it’s also an opportunity to combine returns with impact on the future.

Our job at Equilibrium is to find and invests in the asset managers and fund managers that are executing the most innovative investment strategies to find these hidden alphas based on sustainability macro-trends.