Environmental, Social, Governance Strategy

We have outlined three broad themes that are currently impacting the environment, society, and governance, where we believe ESG investing can play a meaningful role:

Environment

Current issues: climate change and CleanTech

One of the major environmental concerns of our time is climate change. Daily average temperatures have risen by at least 1degreeC (2degrees F) since the middle of the last century. For investors concerned about the future of our planet, this is alarming.

Fortunately, we now have solutions available to help combat this trend. Alternative or “clean energy” in the form of Solar Photovoltaics and both Onshore and Offshore Windpower have fallen in cost dramatically over the last decade, nearly 90% as seen in the graph below. These technologies are now fully competitive with oil, coal, and gas on a market basis and stand to see rapid growth going forward as both economics and policy favor their deployment. As part of FBB’s ESG strategy, we look for ways to harness this and other environmental market trends to benefit our clients’ portfolios and meet their desire to invest in a sustainable manner.

Society

Current issues: Gender equality and corporate board membership

Taking social factors into account is increasingly important. We realize that societal factors should and do impact how well companies perform and are critical in shaping the world in which we live.

One of the social metrics that we evaluate looks at the share of a company’s board seats held by women. Studies have shown that having more women on a company’s board can lead to market outperformance over time. More diverse boards generally result in less groupthink, more varied perspectives, and improved decision-making over time. However, even today, only about one in five board members of large US companies are women. This is an ongoing challenge, but it is also an opportunity when it comes to investing. Companies that have the foresight to create boards with more diverse backgrounds and views may have more potential for success, and by identifying and investing in these companies, we aim to benefit our clients’ returns in the long run.

Governance

Current issue: Separation of CEO vs. Chairman roles

Governance is a crucial component in ensuring strong company performance. A common goal for better corporate governance is the separation of the CEO and Chairman of the Board roles. A company’s board selects and evaluates the CEO, so for any CEO to also be Chairman of their own board presents apparent conflicts of interest. A more truly independent board can, in theory, more ably hold a CEO accountable. The result should be better corporate governance over time, and ultimately, better shareholder returns. Increasingly, investors wish to see these roles separated, and by taking into account whether or not a company has done so, we are rewarding those companies that follow through.

FBB’s ESG Strategy: Investment Philosophy

As we have outlined in the thematic comments above, FBB Capital Partners believes that companies prioritizing a sustainable growth strategy can drive grass-roots improvements in the environment, society, and corporate governance. FBB also understands that investors are concerned with financial performance and the long-term impact of their holdings on society and the environment. We believe individuals interested in impacting their investment choices can generate returns while owning these socially responsible companies. FBB Capital’s ESG Strategy seeks to invest in sustainable growth companies where long-term secular change is under-appreciated by investors, leading to valuation improvement as fundamental results exceed investor expectations.

Our ESG research process starts by using internal due diligence and external resources to identify companies engaged in sustainable growth. We then narrow our focus to companies in the early stages of reshaping their entire business, suggesting a wide range of future earnings outcomes. Examples of catalysts driving this scale of business transformation include spin-offs, management change, restructuring, divestitures, acquisitions, and new product cycles. Many investors struggle to project future earnings for companies engaged in these far-reaching changes.

We then consider the concept of time arbitrage. A short-term bias among investors sometimes called the availability heuristic (2), can lead to an over-emphasis on current events and an under-emphasis on the future. In contrast, we attempt to fully value a company’s potential earnings over a multi-year period. If other investors under-appreciate future earnings, we seek to buy these future profits at a discounted price.

Ideal securities making up the ESG Equity Strategy have a high probability of future earnings at the upper end of a broad range of possibilities, paired with a stock price that gives little credit for this potential upside. By combining sustainability, fundamental outperformance, and reasonable equity valuations, we believe investors can accomplish two goals: generating returns while also positively impacting the environment, society, and governance.

Investor Considerations

FBB Capital’s ESG Equity Strategy places a high priority on owning companies with sustainable growth strategies. Our ESG Strategy also targets a total return, focusing on capital appreciation, supported by dividend income. The ESG Equity Strategy primarily uses equity securities but may include investments in other security types. Year-to-year market values may fluctuate meaningfully. An investment time horizon of five years or more is recommended, with participation in various market cycles for maximum total return potential.

Differences between this portfolio and traditional strategies may include but are not limited to above-average exposure to companies trying to improve the environment, society, and governance, high conviction and sizable equity positions relative to broader market indexes, and investments in multi-national companies based outside the U.S. The FBB Capital ESG Strategy also includes a range of investment styles from value, to aggressive growth, to growth at a reasonable price, to high dividend-yielding equities and may consist of exposure to “green bonds,” which funds climate change solutions, such as climate change mitigation or adaptation-related projects or programs.

While the FBB Capital ESG Equity Strategy seeks to outperform over a multi-year period, the Strategy also looks to take advantage of short-term market dislocations, which may involve a modest number of short-term investments, potentially short-term capital gains, if this approach is used in accounts which are not tax-advantaged.

The FBB Capital ESG strategy is typically suitable for a client’s[SO1] total portfolio or for clients with average risk tolerance. Given the functional elements of implementing the strategy, including regular periodic rebalancing, a dedicated account (preferably tax-deferred) is required. Also, given the strategy’s systematic nature, client investment restrictions may not be allowed except in certain circumstances.

FBB Capital Partners cannot guarantee that your investment goals or objectives will be met. All investments carry some degree of risk, including loss of principal. Prospective clients should note that changes to your investment portfolios may result in tax consequences to you, and we recommend seeking the advice of a tax professional before undertaking any investment strategy.

(1) As stated in the United Nations Principals of Responsible Investing.
https://www.unpri.org/download?ac=1398

(2) Human Behavior and the Efficiency of the Financial System, Robert J. Shiller, Yale University. (2001)
http://dido.wss.yale.edu/P/cp/p10a/p1025.pdf, page 1330.

(3) From the Stockholder to the Stakeholder: How Sustainability Can Drive Financial Outperformance, Gordon Clark, Andreas Feiner, and Michael Viehs, University of Oxford and Arabesque Partners, (2015).
http://www.arabesque.com/index.php?tt_down=51e2de00a30f88872897824d3e211b11

(4) BlackRock Targets Idealistic Millennials With Do-Good Investing, Margaret Collins and Sangwon Yoon, BloombergBusiness, October 12, 2015.
http://www.bloomberg.com/news/articles/2015-10-12/blackrock-tries-do-good-investing-after-millenials-convince-fink

Other sources referenced:
https://www.irena.org/publications/2020/Jun/Renewable-Power-Costs-in-2019
https://irena.org/Statistics/View-Data-by-Topic/Costs/Solar-Costs
https://www.marketwatch.com/story/something-amazing-happens-when-you-have-3-or-more-women-on-a-company-board-2018-03-08
https://hbr.org/2019/03/when-and-why-diversity-improves-your-boards-performance
https://hbr.org/2012/06/why-boards-need-more-women