Once a niche space within the world of financial products, green investment strategies have grown in terms of sophistication and diversity.
Investment management firm Wellington Management goes so far as to incorporate analysis of environmental, social and corporate governance (ESG) factors into its investment processes across the entire company. Bradford Stoesser, a global industry analyst with the firm who specializes in real estate, spoke with REIT magazine about how those considerations affect his recommendations.
REIT: Let’s start off with the question that always comes up when talking about the marriage of sustainability and investing: How does a green investing mission impact returns?
Bradford Stoesser: Our approach to sustainability comes from a return-oriented fundamental investing perspective. Our priority as a fiduciary is first and foremost to try to generate alpha on behalf of our clients, and we believe companies that outperform on the sustainability metrics should earn higher returns than those that underperform in sustainability over the long term.
The basis for our view has three components: first, tail risk avoidance; second, economic cost/savings opportunities; and third, relative opportunity versus risk exposure.
Tail risk avoidance means limiting investments in companies that we view as having outsized exposure to climate risk or litigation risk from poor management of environmental or social issues. Economic cost or cost savings describes the almost immediate positive profit-and-loss impact we believe we see from investment in energy efficiency. Third, the tie-breaker dimension, is where we seek to discern differentiation among peer property companies. For example, two apartment companies may be similar on fundamental, financial and valuation metrics, but one may distinguish itself in terms of ESG performance, which may tilt us toward ownership.
While not always immediately obvious or significant to the investment case in our process, this is the basic framework we apply. We expect to see a greater impact of these considerations if data and transparency increase and improve and if costs and risk implications intensify over time.
REIT: So if sustainable investing produces better returns, it raises the question of how.
Stoesser: Real estate is an area of the market in which we believe sustainability is very tangible.
By our estimates, a high percentage, approximately 40 percent, of greenhouse gas emissions come from buildings. We live in buildings, businesses maintain space to conduct commerce and warehouses need to be used to store goods. Hence, we see immediate ways property can directly impact the environment and our way of life.
Property companies make choices every day that not only affect near-term shareholder value, but also have a longer-term environmental impact. For example, companies can build office space that improves productivity for employees. It’s clear to us that these types of value creation that support the bottom line through smart investment can add value longer term by contributing to more enduring sources of value creation.
While benefits accrue to both tenants and occupants, some portion of the benefits should also accrue to the landlords via higher rents and higher property values. We believe these benefits should compound over time for companies that can consistently exceed expectations or raise the bar in their industries and, consequently, should benefit shareholders.
REIT: Is it possible that some investors are simply willing to pay a premium for the reputational benefits, rather than operational advantages?
Stoesser: Yes, it’s possible that some investors are focused on sustainability for sustainability’s sake or ESG and impact investing for the public relations benefits more than the investment merits. Ultimately, we think companies need to offer products and services that warrant the price, even if there is sustainability good will or a premium for “doing good.” Some stocks will move based on this trade, which is why we continue to rely on our fundamental analysis of traditional financial metrics.
For equity valuation to move permanently higher or for a stock to rerate favorably, we believe a company needs to add real value in some form.
REIT: Is Wellington Management taking more of an activist posture towards the companies in which it invests? What could that look like in action? How would this orientation affect your investment decisions?
Stoesser: Wellington Management as a firm does not have an activist posture. I think of myself as taking a more “active,” rather than “activist,” posture towards the companies in which we invest or might consider investing.
I use the word activism as a reference to our team’s focus on engaging with companies as active owners of our clients’ investments. We look for relative risk-reward opportunities, rather than companies that simply screen well on sustainability metrics—and this may mean companies that have weak, but improving, performance on sustainability metrics.
The primary way that this plays out in our interactions with companies is that we ask a lot of questions that go beyond traditional financial performance and get to the mindset of management and how decisions are made.
Management quality is an important part of our process, and we might encourage company management teams to improve governance policies if we see practices that could get in the way of our investment. Ultimately, we view the biggest impact we can have on company behavior as what we do with our shares, be it via a proxy vote, engagement with management teams or our ownership level.
REIT: I’ve heard you talk about “stranded” real estate assets in the past. What are those, and why should they be important to investors?
Stoesser: We think of stranded assets as assets that are no longer usable within their “useful life.” In a property context, these could be buildings located in places no longer habitable or places where climate change makes use unprofitable.
We believe investors and companies are underestimating how significant such exposure really is. The challenge is that many of these risks have a long fuse and can be overlooked under traditional discounted cash flow timelines.
REIT: Many of those who follow the investing marketplace would argue—persuasively—that certain areas of the world, such as Europe, lead the United States in terms of green investing and sustainability issues. Why? To what extent do you see the U.S. catching up, if at all?
Stoesser: This is a particular challenge for managers attempting to serve clients in multiple geographies, and the gap in how institutional investors approach ESG and impact investing is striking. It is not clear to us exactly why Europe and Australia are so far ahead of the U.S. in terms of sustainable investment and ESG issues. It seems it will take significant change in personal experience or contact with environmental destruction or a different economic reality for the U.S. to move quickly to embracing sustainability issues.
That being said, millennials seem more eager to embrace green investing and sustainability, and as that generation begins to outearn Generation X and the baby boomers in the coming decades, I believe we may see significant change.
Asia is even further behind; however, some of our clients in that region have started to show interest in ESG and have asked us to explain how we consider such issues within our investment process.
As a global industry analyst at Wellington Management, Bradford Stoesser specializes in real estate companies and REITs. His area of coverage includes North American, South American and European commercial property. He is also responsible for managing the U.S. REIT and global REIT sector funds as well as the REIT subportfolios in research-based investment accounts.
Prior to joining Wellington Management in 2005, Stoesser worked as a securities analyst at Morgan Stanley Investment Management where he covered REITs (1998 – 2002). He is currently a member of the NAREIT Real Estate Investment Advisory Council.
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