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Impact Investing Forum 2022
London. April 28-29, 2022.
When thinking of a company that’s the posterchild for ESG (environmental, social, governance), many investors come up with Tesla TSLA . Thus, it’s no surprise that the EV maker would be included in many ESG or impact funds. Additionally, many EV companies have high valuations like Tesla, although they also might be included in numerous ESG or impact funds.
As a result, value investors might not have opportunities to invest in ESG while still following their value investing framework. However, one fund aims to change that. Lyrical Asset Management’s Global Impact Value Equity Strategy (GIVES) may be the only true value impact fund in the world.
In an interview, Dan Kaskawits and John Mullins of Lyrical International and Lyrical’s GIVES fund outlined their strategy and how they maintain their value investing focus while still investing with impact.
Background on Lyrical’s GIVES fund
The fund managers believe their fund is unique because it trades at a P/E multiple of 13 times while also delivering clear, measurable impact. Kaskawits and Mullins note that many investors want to own companies that are positively impacting the world, but they don’t want to pay the sizable multiples carried by most impact funds.
The Lyrical team opines that the world is full of ESG and impact funds, but most are not sensitive to valuation, leaving them holding companies with extremely high P/E ratios. In their flagship Lyrical International deep value fund, they look for companies with value and quality characteristics that can be analyzed. They follow a similar strategy with their GIVES fund, although it is also an impact fund.
“It is rare to find impact companies with attractive valuations, but we have found 22 companies working effectively to solve major global problems that are also great value investments,” Kaskawits said. “In GIVES, we are still looking for value, quality, and analyzability, but beyond that, we also require that each company makes an impact, which means the company’s core operations must improve the world in a significant way.”
What makes a company an impact company?
To qualify as an impact business, companies must possess four criteria. They must be material, measurable, intentional and sustainable. Material means that at least half of the company’s revenue must be directly tied to one of the United Nations’ Sustainable Development Goals. Kaskawits and Mullins see the UN’s 17 Sustainable Development Goals as major problems the world needs to solve.
Additionally, the company’s impact must be measurable, which means the Lyrical team must be able to quantify the positive change it is making. Third, the company must be intentional about the impact it is making, and positive change must be deeply rooted in its culture and business.
Finally, the company must be sustainable, meaning that bad things can’t offset the good things it is doing. Kaskawits and Mullins state that every company has negative characteristics, but they analyze each company’s negative aspects to ensure that they are relatively small.
Impact versus ESG
“Impact investing is more than just ESG,” Mullins explained. “Impact is about creating something positive, where ESG is more about avoiding the negative. For an impact company, making money and solving a problem are one and the same; the more of a problem the company solves, the more money they make. We view positive ESG companies, on the other hand, more as good corporate citizens that strive to do better.”
He gave Hitachi as an example of a company in their GIVES portfolio. Mullins says Hitachi is an excellent ESG company because it has admirable goals to reduce its impact on the environment, such as committing to net zero carbon emissions by 2050.
He adds that Hitachi is an impact company because it’s the number one global producer of smart grid technology, which is estimated to enable savings of about $350 billion from reduced environmental damage in the U.S. alone.
Value investing and impact investing
Kaskawits and Mullins decided to develop an impact strategy using value investing as a guide because they felt that impact investors were ignoring value stocks. When they looked at the impact investing industry, they saw many portfolios that were much more expensive than theirs but with similar impact exposure.
They also knew that many of their companies had characteristics focusing on environmental or social problems. Kaskawits and Mullins thought that the best way to generate sustainable returns in the impact space was to invest using value investing as their foundation. Additionally, they felt that shining a light on impact companies in the value space could help get them the recognition and stock price they deserve.
“Our objective is to generate the highest long-term returns by investing in companies that are focused on achieving both strong financial returns and social and/or environmental impact,” Kaskawits said. “We use value investing as a guide for impact investing because the price you pay for an investment matters. Price is what you pay; impact and earnings are what you get. To generate the highest investment returns, valuation is a critical component.”
Evolution of tactics
Kaskawits and Mullins have long incorporated ESG analysis into their assessment of a company’s quality and analyzability. Companies must have sound, responsible business practices for them to be comfortable underwriting their future cash flows.
Historically, their focus was primarily on risk mitigation, but that focus has shifted over time, especially as investors started to see ESG as more important. Some of the companies Kaskawits and Mullins invested in were exposed to opportunities tied to environmental or social issues. Over time, their approach evolved from risk mitigation to a focus on opportunity, which they said is the heart of impact investing.
“The trigger to launch the impact fund was when Lyrical started to invest globally,” Mullins states. “Prior to that, in 2019, we couldn’t find enough impact investments within only the U.S. markets. Cheap, good, and simple businesses are rare, and within these stocks, ones that are creating a positive environmental or social impact are even more scarce.”
The development of impact investing
Impact investing has changed a great deal over the years, and much change is still needed. Kaskawits and Mullins pointed out that measuring impact is still in the early days. They have found that most large public companies report their emissions and diversity and inclusion metrics but fall far short of capturing their true impact on the world.
The Lyrical team builds an impact statement for each of their companies to go alongside their income statement. They predict that this practice will become common in the next five to 10 years. Kaskawits and Mullins add that the first step is to standardize impact measurement like GAAP reporting for financial statements. They are encouraged by the momentum they’ve seen so far.
Kaskawits uses the French laundry service business Elis as an example. He expects the company to reduce its water consumption by about 100 billion liters over the next three years. Kaskawits explained that by centralizing the function of cleaning linens and uniforms, Elis dramatically reduces the amount of water and energy it uses from outsourcing cleaning compared to insourced cleaning.
“Amazingly, it took us five calls with the company’s CEO over the past year to get to this level of measurement,” Kaskawits says. “Over time, we expect that companies will put more resources towards measuring and reporting the impact that they generate.”
How impact investing will make a difference
It will take some time for impact investing to make a difference in the world, but Kaskawits and Mullins feel they are pushing the UN’s Sustainable Development Goals forward. They believe that for-profit organizations must act to solve the significant threats the world faces.
The Lyrical team note that philanthropy is powerful but small, accounting for approximately 5% of global government spending. They added that governments are often too slow-moving and bureaucratic to be counted on to drive real change, which leaves us with for-profit organizations playing a pivotal role in reaching the UN’s sustainable goals. Kaskawits and Mullins believe that as capital allocators, they can help businesses push the world toward those goals.
“We invest capital in companies that are making a positive societal impact, thereby increasing their valuations and lowering their cost of capital,” Mullins explained. “Through long-term engagement, we have built strong relationships with company management, who share our dual objectives of creating a positive societal impact and achieving financial returns. We work with our portfolio companies to measure and report their impact, helping them gain the recognition they deserve, which we believe should also drive stock price appreciation.”
Kaskawits and Mullins believe that in order to succeed, they must first generate good financial returns. Kaskawits explained that good financial returns through impact investing should result in increased impact investment and greater benefits for the world. He added that this is why their approach combines the financial returns from value investing with the societal and financial returns from impact investing.
“If we can outperform broad indices while owning world-changing businesses, we believe we can help turn impact investing from a niche into a mainstream investment approach,” Kaskawits said. “As more funds flow into impact investing, we expect more companies will reshape their approaches to solving global challenges like the SDGs. This in turn could cause the valuations of those companies to rise and drive more investors into impact investing. GIVES was founded to drive this virtuous cycle forward.”
About two-thirds of the companies in Lyrical’s GIVES portfolio generate positive change around climate action. Kaskawits and Mullins highlight Flex as one of their investments. It’s a significant contributor to renewable solar energy through its NexTracker subsidiary, the number one producer of solar trackers in the world.
Solar trackers automatically move solar panels throughout the day, boosting solar power production by 15% to 30% per panel. Tthis isn’t an easy task due to changing weather conditions, and Flex’s NexTracker is widely seen as having the industry’s best technology. NexTracker’s market share is almost twice that of the number two competitor, Array Technologies.
Solar trackers are installed on over 50 gigawatts of solar energy production. The Lyrical team estimates that Flex allows for at least 7.5 gigawatts of incremental solar production, roughly equivalent to the generation from over 3,000 utility-scale wind turbines.
They added that the rest of Flex’s business also drives positive change because it is an outsourced manufacturing business, resulting in significantly less waste and energy consumption than less efficient insourced manufacturing.
“We see Flex as one of the few inexpensive, positive impact companies in the world,” Mullins said. “Flex is valued today at only 10 times forward earnings, and we estimate the stock has 50% upside to fair value, based on our five-year forward earnings estimate.”
The company also has optionality with its NexTracker business, which it is reviewing. NexTracker’s publicly traded peer, Array Technologies, trades at 45 times forward earnings. Applying Array’s multiple to Flex’s NexTracker business and adding a P/E multiple of 15 times to the rest of the business results in a share price 115% higher than where Flex trades today.
“Like Flex, many of the companies in our GIVES portfolio are making a significant positive impact that is not yet appreciated, and this is a place where we can help,” Kaskawits summarized. “As long-term investors, we have strong relationships with our companies, and we have begun working with them to help communicate their impact stories.”