The economic and financial crisis, which erupted in 2008 in response to the implosion of subprime mortgages. Its effects linger, despite the distraction that the ‘artificially fueled’ (through corporate tax cuts encouraging share buybacks) bull stock market has caused in the United States, fears of another crash, and or another crisis, have raised questions about the sustainability of the capitalist system itself. There is much debate over what form such renewal should take without, outright, limiting the ‘profit motive’ or greed to such an extent as to disincentivize markets altogether. Therefore, most reforms have centered around the imposition of tougher regulations – intensifying fines and penalties for their violation – in the hopes of confining greed within an acceptable framework, balancing risks, opportunities and ‘transparency’. However, these reforms, do not propose to change the fundamentals of the market in a way that alleviates the effects of an financial and economic crisis on the general population: that is that part of the population that has no stake in the performance of stocks and bonds, yet regularly pays the highest price when those who do test the system’s limitations, as happened in October 1929 or September 2008.
While experts, economists, traders, politicians and regulators consider ways to make the markets more resilient – if that’s at all possible – there is an approach to investing that is available now, and that can improve your portfolio’s overall performance. In a word, it’s sustainability, or Environment-Social-Governance (ESG) to be more accurate.
The ESG Factor
One way of discerning the best stocks for long-term value is to integrate sustainability and finance. Investors should seek stocks, or often funds, that identify non-traditional sources of risk and value potential for investors. The research focuses on “extra-financial” drivers of investment risk and return, including companies’ performance on environmental, social, and strategic governance (ESG) issues. A company’s capacity to manage intangible issues such as these has strong implications for stock price performance, but management capacity is not always captured by conventional analytical methods. By identifying ESG risk and management capabilities, investors can uncover hidden risk and value potential.
ESG (once better known as Corporate Social Responsibility – CSR) is not necessarily about altruism, environmentalism, or even social responsibility. It’s a tool for profit. In aviation, sustainability may be described as a concern for managing risks such as climate change, noise, local environmental impacts, and social and economic development. In fact, airlines and aircraft manufacturers are excellent examples of how ESG benefits investors.
Environmental sustainability can reduce risk and enable firms to capitalize on strategic profit opportunities. While they are not a substitute for well-designed and enforced regulations, financial products and instruments can be used to promote environmentally preferable investments and the adoption of environmentally sound practices. They can, therefore, become an important element in the investment strategies of firms and project developers as well as of banks and financial other institutions. Responding to NGO pressure and recognizing the importance of environmental sustainability to financial risks and returns, banks and other financial institutions are increasingly taking environmental and social sustainability into account. Therefore, the link between environmental sustainability and profitability is becoming more important in the capital markets and other sectors.
Funds, (Sovereign Funds in particular), analysts and investors are increasingly recognizing the correlation between industrial companies’ environmental performance (eco-efficiency) and their competitiveness and financial performance. The consideration of ESG factors can only widen in the future, as the forces of tighter international environmental standards, tougher disclosure requirements, and globalized competition combine to increase the financial and competitive premium on superior eco-efficiency.
Over the last several years, international surveys by Salomon Brothers and others have documented a significant increase in the degree to which major financial institutions have become concerned with environmental risk as a core business issue. The most fundamental aspect to consider is that ESG-friendly companies generally demonstrate superior strategic and financial management across the board, and therefore tend to produce superior financial returns. In short, eco-efficiency turns out to be an extraordinarily good proxy for – and predictor of – superior corporate management, which in turn generates financial out-performance and shareholder value.
A superior attention to ESG can improve share value simply because practitioner-companies improve relations with regulators, customers, suppliers, employees and ultimately investors.ESG also leads to higher innovation capacity; especially, as explained below in sophisticated industrial sectors such as aerospace and defense.
Surprise: The Airline and Aerospace Industries Fit the ESG Model
The Aerospace and Defense Industry Has Been a Leader in Advancing Sustainability The aviation industry has been criticized for failing to progress to meet environmental concerns having been targeted by environmentalists (i.e. Greenpeace campaigns against Heathrow expansion) and journalists such as George Monbiot who present the idea that aviation and air travel are wrong and unethical – going as far as to suggest that air travel itself is unethical. (Source: “On the flight path to global meltdown”, The Guardian, Sept.21, 2006).
The risk to the industry is that governments may find it increasingly useful to target aviation, restrict travel, impose more taxes, and regulations.
Nevertheless, few industries have done more to integrate ESG strategies in their business models. It’s not because the managers running aerospace & defense are aerospace engineers by day and eco-warriors by night. It’s because, taking care to incorporate non-traditional risks, such as the environment or governance (ESG) is good business. It exposes companies to fewer risks. And this consideration is valid for aerospace as it is for all other business sectors. It makes much easier to navigate the many legal and social risks that can compromise profits, lowering the risk of lawsuits and consumer backlash or boycott campaigns.
Meanwhile, air traffic is growing rapidly, especially in Asia, raising concerns about increased pollution, while the airline industry is under pressure to tackle emissions. Boeing has certainly noted this. Its 787 was a direct response to customer demand for a more environmentally friendly and fuel efficient wide-body. It’s no wonder that Boeing has half a trillion dollars in backlog orders. General Electric (NYSE:GE) continues to enjoy strong demand for its GENX (GE Next Generation) jet engine for the 787 and Airbus A350 jetliners is expected to use 20% less fuel than the CF6 family of engines it replaces. The GENX uses composite fan blades, a high-pressure ratio compressor and a single annular combustor to reduce emissions. Rolls Royce’s Trent 1000 engine offers similar performance. In the quest for lower operational costs, Airbus remains confident in the A380. Production problems aside, the A380 is comparable to the most economical car on the market, where fuel efficiency is concerned (On a fuel/passenger/100km basis) and over 12% better than its closest rival. It is hoped that by purchasing such airplanes as the A-380 or the Boeing 787, customers will generate demand for such innovations in other aircraft. Lower fuel consumption also means lower emissions, such that there is a business case to reduce the average 1,700 lbs. of GHG’s/passenger emissions into the atmosphere.
Of course, ESG is not a panacea for profitability. Airlines’ financial performance is also tied to economic growth and trade. Economic recession and wars caused air travel to drop in the early 1990’s, and airlines were faced with excess capacity because of having ordered too many aircraft in the late 1980’s. In Europe, where governments owned or controlled several flag carriers, many airlines were privatized, forcing them to become more efficient in order to attract shareholders. Airlines that have already adapted or are adapting to the new realities, pursuing profits through innovation (which we maintain is synonymous with ‘socially responsible’ in the aviation industry) are those that will benefit financially from the changing regulatory environment.
Investing in aerospace means navigating, and even exploiting, the considerable geopolitical risks that increase as the globalization experiment collapses. But, it also means capitalizing on one of the industries that has taken the most significant steps in ESG, translating to superior management in the process. Since the 1960’s – the epoch of the Concorde, Boeing 747, DC-8 – aircraft manufacturers have managed to reduce fuel consumption by 70% – a feat unmatched by any other transportation industry. The progress has largely achieved through engine technology (larger fans producing more bypass thrust – as opposed to direct and more polluting exhaust thrust) and the use of lighter and composite materials (Boeing 787, Airbus 380 for instance) in fuselage and wings. While aviation will continue to use fossil fuels, rising fuel costs, emissions and security concerns are driving the need for alternative fuels.
A good part of the ‘ethical’ public believes that commercial aviation is a major contributor to ‘global warming’ or ‘climate change’ already has been proven and industry actions need to be adjusted accordingly. It’s true that the aerospace industry, until recently, has done little to help diffuse these negative perceptions, it has been among the most advanced in addressing the very concerns of ethically minded investors. The industry has been pushing for advanced technology, involving engine and airframe design, as well as flying techniques to reduce fuel consumption, emissions (and not just CO2) and noise pollution. In fact, working closely with aircraft manufacturers, the industry is well on its way to significantly reduce its current (estimated) 2% share of overall CO2 emissions over the next decade, even as it aims to produce carbon free technology in the next 50 years.
Midas Letter is provided as a source of information only, and is in no way to be construed as investment advice. James West, the author and publisher of the Midas Letter, is not authorized to provide investor advice, and provides this information only to readers who are interested in knowing what he is investing in and how he reaches such decisions.
Investing in emerging public companies involves a high degree of risk and investors in such companies could lose all their money. Always consult a duly accredited investment professional in your jurisdiction prior to making any investment decision.
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