Mr McGuire’s one word of advice to Benjamin Bratton in The Graduate — “plastics” — may have been a good career move in 1967, but in 2020 it needs updating, hence our title above.
Finding Election-Agnostic Themes
As the U.S. gets closer to a divisive election, with binary outcomes possible on a variety of policy fronts, we have been on the lookout for enduring themes that will continue to attract investor attention regardless of the results in November.
We’ve been discussing tech themes for some time — focusing on the beneficiaries of the business digitization that has accelerated markedly as a result of the pandemic lockdowns. We’ve mentioned that biopharmaceutical companies have also seen their share prices benefit from the public’s new attentiveness to the direct importance of medical innovation in their lives.
Beyond tech and biopharma, however, there are other themes that remain robust or are strengthening as the world moves into a covid management phase and rapidly recovers from the lockdown-induced recession.
Earlier in the year, before covid appeared, it seemed that the “hot” theme for 2020 was going to be the mainstreaming of ESG — the incorporation of environmental, social, and governance metrics in investment decision-making. ESG analysis and offerings from many major brokerage firms and other analysts have been getting more robust over the past few years, with the result that concerned investors have a lot more data available to them to monitor and evaluate their target firms’ performance in these areas.
As we’ve noted in the past, however, while we are not skeptical about investors’ overarching desire to see their investment dollars supporting their values, we are skeptical that ESG analysis really tells investors much of substance. For one thing, large companies can afford to game ESG analytics to raise their rankings and their prominence in ESG funds. Those funds often end up looking remarkably like large-cap developed-market growth funds, replete with software and other tech. In our view, that explains the recent outperformance of some funds. However, ESG funds also typically charge a premium for their management fees, which can hurt performance in the long run.
On balance, we don’t feel that investors who are interested in ESG will be well-served by resorting to ESG exchange-traded or mutual funds. By performing their own research and selecting individual securities, they will be more able to construct a portfolio that is distinct from the usual large-cap indexes.
ESG: From Boutique Conceits To Enduring Themes
The push for ESG is not happening in a cultural and political vacuum. Part of the reason that some companies try to game their ESG metrics — a process long called “greenwashing” — is public pressure. However, public pressure is meaningful — if it is enduring, and not transient, it can have a variety of effects, from shifting consumption patterns to higher price-to-earnings multiples for beneficiaries. When public preferences merge into and dovetail with regulatory pressure, the stage can be set for the emergence of significant and lasting investment themes.
We think that is happening now in several areas related to ESG. An obvious one, given the remarkable rise in Tesla [NASDAQ: TSLA] shares, the saga of Nikola’s [NASDAQ: NKLA] rise and fall, and the ongoing lassitude in the hydrocarbon energy space, is the electrification of transport. Climate change is a complex issue, subject to severe disagreements and political recriminations on all sides. However, investors do not need to reach a settled conclusion about the science, or the advisability of emergent policies, to believe that the theme has reached “escape velocity.” We are moving towards the decarbonization of the global economy, regardless of one’s political, economic, or scientific opinion about the advisability of that course or the specific ways in which it is being pursued and implemented. Investors with a long-term horizon would be ill-advised to ignore this theme.
Plastic Pollution
The theme of decarbonization is obviously linked to high public awareness and regulatory concern about the risks posed by anthropogenic climate change. However, second only to concern about climate change in public consciousness, according to developed-world opinion polling, is concern about plastic pollution, particularly in the world’s oceans. The theme of decarbonization suggests a host of economic winners and losers — from battery and vehicle disruptors to legacy hydrocarbon extractors who may face permanently impaired earnings multiples. The same holds true for the issue of plastic pollution, those who are creating solutions to it, and the old guard who will eventually have to change or die as public opinion and the regulatory climate turn against them.
A “plastic Rubicon” may have been crossed in 2017 due to the so-called “Attenborough effect.” The famed British environmentalist and documentary filmmaker Sir David Attenborough devoted an episode of his Blue Planet series to plastic pollution in the world’s oceans. A segment on a mother pilot whale grieving over her calf — whose death Attenborough attributed to toxicity from ocean plastic — went viral, and sensibly shifted the public’s sense of urgency about the issue. (Interested readers can view a clip from the episode here.)
Of all the plastic produced since 1950, more than half — 4.6 billion tons — is still in the environment.
In the era of social media, events like this can change the culture, have profound economic ramifications, and transform firms’ public images — just consider the #MeToo movement.
With pressure rising on plastic, and particularly on single-use and packaging plastic (which accounts for half of global plastic production and much of the plastic pollution of oceans), there are several trajectories that might occur with regulation and public opinion.
First, increased recycling efforts. On the whole, about 8% of plastic waste is recycled globally. In Europe it’s about 30%; in the developing world, which is the source of most ocean plastic pollution, it’s less than 1%. Recycling efforts will certainly increase, and will result in a greater throughput for the major waste management companies who benefit. Still, analysts estimate that even if global recycling rates reached 50% — quite a stretch — it would not eliminate the accumulation of plastic in oceans. Globally, recycling efforts took a nosedive in 2017 when China shut down to the reception of foreign waste imports. Much of the plastic that previously went to China is now being incinerated — a process with its own environmental problematic. And the appetite of the developing world for plastic items and the middle-class convenience they bring means that plastic production is likely to continue to be robust, outstripping efforts at recycling compliance.
Second, bans on certain plastic products and taxes on others. These regulatory regimes will reduce the cost spread between current single-use plastics and alternatives — bio-sourced and biodegradable plastics. Currently, these environmentally friendly alternatives are two to three times the price of their conventional analogues. Consumers will pay the difference, though competition and technological innovation will also moderate it. (The polyhydroxyalkanoates, or PHAs, mentioned in our headline, are in this class of new bio-sourced and biodegradable plastics.)
Third, a shift to paper, glass, metal, and bioplastics. Regulation and public opinion will lead to innovation in paper packaging; some packaging companies have entirely divested their plastic production capacity. Others are pure-play in paper and renewable packaging, and will benefit, particularly during the period in which bioplastic alternatives are still in development.
Finally, new forms of “recycling” may be developed and brought to scale. Chemical recycling breaks polymers back into monomers, and permits the products of this process to be used as fuel or as feedstock for entirely new plastic production. There are pilot enterprises in this area, even a handful of public companies, but they will likely need support from tax and other regulatory regimes in order to achieve commercial viability.
Investment implications: The global movement against single-use plastic objects and plastic packaging is likely to continue and to accelerate, driven by consumer preference and pressure and by new regulations. The companies set to benefit from this trend are unlikely to be present with any meaningful weight in the mainstream ESG funds, and investors would be better advised to research single securities: waste management companies that will benefit from increased recycling volumes; disruptors who are creating novel bio-sourced and biodegradable types of plastics; packaging companies that have embraced sustainable and more readily recyclable materials; and disruptive recycling companies that are creating new plastic recycling technologies, such as chemical recycling.
