EMO - ClearBridge ESG Investment Strategy Q4 2023 Portfolio Manager Commentary

2023-10-19 09:35:00 ET

Summary

• ClearBridge is a leading global asset manager committed to active management. Research-based stock selection guides our investment approach, with our strategies reflecting the highest-conviction ideas of our portfolio managers.
• The push to halt biodiversity loss is increasingly demanding attention alongside climate change as a major environmental concern for investors.
• The materiality of biodiversity issues for public equities helps explain why ClearBridge assesses evolving nature-related dependencies, impacts, risks and opportunities with holdings across sectors.
• Nature-positive revenue opportunities tend to be tied to companies with products that either substitute for a high-impact product or reduce impact from existing economic activity, and both are well-represented in ClearBridge portfolios.

By Neal Austria | David Hochstim, CFA | Mary Jane McQuillen | Stephen Rigo, CFA

The Company's Role as Steward of Biodiversity

The push to halt biodiversity loss is increasingly demanding attention alongside climate change as a major environmental concern for investors. As we explore elsewhere in a recent ClearBridge introduction and discussion of the topic, the term biodiversity, meaning the variety of life on the planet or in a given ecosystem, is emerging as an umbrella concept for several related environmental concerns. These include issues tied to changes in land usage (such as deforestation), natural resource overexploitation, pollution and the effects of climate change.

On the international stage, in an agreement recalling the 2015 Paris Agreement, attendees of the 2022 United Nations Biodiversity Conference adopted the Kunming-Montreal Global Biodiversity Framework ((GBF)), a plan for member countries to take urgent action to halt and reverse biodiversity loss and to conserve and sustainably use biodiversity.

As a result, regulation is stepping up. In May, an EU regulation on deforestation-free supply chains, for example, began requiring companies to confirm imported products have not been produced on land subject to deforestation or forest degradation, with fines of at least 4% of the company’s annual income in the EU at stake.

In September, the Taskforce on Nature-Related Financial Disclosures (TNFD), which was launched in 2021, published recommendations on the types of biodiversity disclosures companies can and should be making. These generally involve companies disclosing how their businesses both impact and depend on nature, what related material risks and opportunities they are assessing, and what metrics and targets they are using to measure and improve. As the TNFD points out, “Present and future cash flows depend on the flow of nature’s inputs to business and accelerating nature loss poses a growing risk to businesses and capital providers.”

The materiality of biodiversity issues for public equities helps explain why ClearBridge has, over 35+ years of our ESG integration approach, assessed evolving nature-related dependencies, impacts, risks and opportunities with holdings across sectors. To support our fundamental research and steer capital in a nature-positive way, ClearBridge encourages, among other things, assessment and disclosure of nature-related impacts and dependencies within the value chain, development of biodiversity and deforestation policies, responsible waste and water management, transparency into lending practices, and consideration of local affected communities.

Nature-positive revenue opportunities tend to be tied to companies with products that either substitute for a high-impact product (ClearBridge holding Ball’s aluminum containers reduce the need for mining ore and extracting oil and are a substitute for single-use plastic, a major polluter) or reduce impact (ClearBridge holding Deere’s precision agriculture technologies limit pollution in the form of chemical pesticides and herbicides). Both types are found across ClearBridge portfolios, as well as companies providing key financing for nature-positive solutions.

Reducing Impact: Untroubling Waters

Water looms large as a high-impact natural resource, both in its use in business and its importance to virtually every ecosystem. Of companies disclosing on water via CDP, formerly the Carbon Disclosure Project, that are exposed to substantive impacts on their business from water, most anticipate that water issues could limit the growth of their business through reducing/disrupting production capacity, closure of operations or constraints to growth (Exhibit 1).

Exhibit 1: Potential Impacts of Water Risk in Direct Operations and Supply Chain

Long-time ClearBridge holding Ecolab ( ECL ) stands out as a responsible steward of water resources and a company able to reduce impact from use of water across the economy. Ecolab offers water-saving solutions for laundries used by health care, hospitality and food and beverage industries. Products and services include industrial water pre-treatment systems, industrial water reuse, water-efficient conveyor lubrication systems and wastewater treatment. For a major hotel chain, Ecolab’s chemical product delivery service replaces single-use drums of cleaning chemical, reducing waste and improving work safety, while its warewashing and housekeeping solutions reduce wash time, water usage and water temperature for food prep wares as well as plastic packaging used in housekeeping services. Ecolab estimates 57 million gallons of water savings as well as 1,400 metric tons of GHG emissions annually for the hotel chain as a result.

Ecolab has committed to helping its customers conserve 300 billion gallons of water a year, equivalent to the annual drinking water needs of 1 billion people by 2030, through reducing water withdrawal needs in customers’ operations. Separately, Ecolab also has a target to restore >50% of its absolute water withdrawal at high-risk sites through collaboration with NGOs and local communities. Ecolab is also a co-founder of the Water Resilience Coalition, a CEO-led movement and part of the United Nations Global Compact aiming to preserve the world’s freshwater resources through action in water-stressed basins.

Reducing Impact: Sustainable Forestry

There are also benefits for companies that recognize and mitigate deforestation risks (Exhibit 2). Broadly, these may include, increased brand value, demand for certified or deforestation-free materials, availability of products with reduced environmental impact, supply chain transparency and resilience. ¹

Exhibit 2: Potential Financial Impact of Reported Forest-Related Opportunities (Billions)

Home Depot has long been a leader in advancing sustainable forestry, and its wood products can have a significant impact, as timber rates at the top of high-risk commodities responsible for most agriculture-related deforestation (Exhibit 3). The home improvement retailer adopted its first wood purchasing policy in 1999, pledging to give preference to sustainably sourced wood and to eliminate wood purchases from endangered regions around the world.

Biodiversity-boosting efforts at Home Depot ( HD ) have included tracing the origin of all the wood products it sells. This forms part of the process of verifying sustainable production, which it does using the certification standards of the Forest Stewardship Council (FSC). Since 2000 Home Depot has developed programs to purchase FSC wood products, such as doors, boards and patio furniture, from over 60 global suppliers. It has also moved more than 90% of its cedar purchases to second-and third-growth forests, with the rest coming from areas with local community stakeholder review.

Exhibit 3: High-Risk Commodities for Agriculture-Related Deforestation

Suppliers preferred by Home Depot such as Mendocino Redwood Company also help maintain sustainable forests through building forests’ wildfire resilience. For example, Mendocino practices fuel reduction by removing excess burnable materials that helps wildfires stay closer to the ground where they can be more safely controlled by firefighters before they reach the forest canopy.

Substituting Impact: Preventing Deforestation

ClearBridge holding Trex has redefined the decking industry with a business model that addresses two key drivers of biodiversity loss, deforestation and pollution, by substituting high-impact products. Instead of relying on virgin wood, Trex makes composite decking for residential and commercial customers using 95% recycled wood fibers and plastic waste. In 2022, Trex recycled 337 million pounds of waste polyethylene, a plastic commonly used for plastic bags and bottles, as it produced its high-end decking. Wood decks stopped using arsenic treatments in 2004, which has shortened their life span, dramatically increasing the number of decks that need to be replaced. Trex’s products help fill this need in a way that preserves forests, reduces a major source of pollution in oceans, and lowers customers’ total costs of ownership, since Trex’s decks have much longer lifespans relative to natural lumber decks.

Financing Biodiversity

In addition to business models that support biodiversity, it is also important to provide financing for efforts to improve biodiversity. Large financial firms such as ClearBridge holding JPMorgan Chase (JPM) have a key role here through green bond underwritings that support natural capital protection. In 2021 JPM announced a target to finance and facilitate $1 trillion toward green initiatives by 2030 as part of its broader $2.5 billion sustainable development target. The green initiatives include biodiversity-linked areas such as water management, circular economy and waste management, in addition to conservation and biodiversity, which focuses on improving terrestrial and aquatic biodiversity ecosystems or forests.

As part of this target, in 2022 JPM served as the lead underwriter for a $350 million green bond issued by The Nature Conservancy, the largest green bond issuance by a conservation nonprofit ever. The issuance is expected to help The Nature Conservancy avoid or sequester 3 billion metric tons of carbon dioxide equivalent (CO2e), and conserve 650 million hectares of healthy land, 30 million hectares of freshwater and 4 billion hectares of oceans.

Nature-Based Carbon Credits: Early Stages

JPM also highlights the value of nature-based carbon credits: these are credits a company can purchase to fund nature-based solutions to climate change to help offset its own emissions. For JPM, in addition to sourcing renewable energy to reduce its carbon footprint, it also purchases high-quality nature-based carbon credits that help restore the natural world, helping to offset the remainder of its emissions. One purchase in 2022 was from the Indus Delta Blue Carbon Project in southeastern Pakistan, one of the largest mangrove forest restoration projects in the world. Mangroves are among the world’s most diverse and vulnerable ecosystems and are effective carbon sinks; in this case they are also important habitats for endangered and threatened species and serve as a protective barrier, mitigating potential damage from hurricanes and tsunamis.

Conclusion

Improving biodiversity is already an economic concern for many companies. While developing standardized measurements of biodiversity remains an industry challenge, international agreements are spurring policy action, and the materiality of biodiversity for companies is poised to increase. As it does, ClearBridge will continue to analyze and engage companies on nature-related risks and opportunities, seeking to build more resilient businesses in a more resilient world.

Neal Austria, Senior Analyst - Consumer Discretionary

David Hochstim, CFA, Senior Analyst - Financials

Mary Jane McQuillen, Head of ESG, Portfolio Mgr.

Stephen Rigo, CFA, Portfolio Manager

¹ "The Forest Transition: From Risk to Resilience," Global Forests Report 2023, CDP. July 2023. Page 36.

Past performance is no guarantee of future results. Copyright © 2023 ClearBridge Investments. All opinions and data included in this commentary are as of the publication date and are subject to change. The opinions and views expressed herein are of the author and may differ from other portfolio managers or the firm as a whole, and are not intended to be a forecast of future events, a guarantee of future results or investment advice. This information should not be used as the sole basis to make any investment decision. The statistics have been obtained from sources believed to be reliable, but the accuracy and completeness of this information cannot be guaranteed. Neither ClearBridge Investments, LLC nor its information providers are responsible for any damages or losses arising from any use of this information.

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