The Green Alpha approach to fossil fuels and portfolio construction differs from that of other fund managers and divesting activists. As a top-down, global growth equity manager, our approach is to model, envision, and construct sustainable portfolios that we believe represent the "next economy." To clarify, by "'sustainable" we mean the definition according to the original Latin root word sustineo, which refers to something that can persist indefinitely without interruption. So for us, portfolio construction involves searching for and investing in the most innovative means of economic efficiency gains from all areas of human endeavor, the result being a series of all-capitalization, cross-sector, cross-industry, global, solutions-oriented stock strategies.
The next economy in this context then means an economic system existing in a world where humanity, and the nature that supports us, can both thrive indefinitely.
Our portfolio-construction process doesn't actually begin with the portfolio itself, or even with individual stocks. We begin by defining the primary threats to our society, resources, and way of life -- threats that could disrupt both human economies and their underlying ecosystems. The list of these threats is unfortunately long and well known, and it includes dangers such as global warming, extreme weather, resource scarcity, increasing population, food and, and water crises. The technologies, approaches, and innovative ideas with the highest potential for helping to address and mitigate these issues, while also providing gains in economic efficiencies, provide the basis upon which we assemble portfolios.
Within this context, it's clear that fossil fuels, which have the power to disrupt the indefinite thriving of both economies and ecosystems, and which are the cause of many key threats, do not represent solutions to our more daunting challenges. Therefore, they have no place in our portfolios. So, at Green Alpha, we have never considered having fossil fuels in our portfolios.
For us, there has never been a question of divesting from fossil fuels, because there has never been the possibility of investing in them.
Figure 1: Green Alpha's portfolio construction process
We go about assembling fossil fuel-free portfolios by using a five-step process, shown in simplified form in the Venn diagram in Figure 1. The alpha coefficient at the center of the diagram represents the intersection of practical applications of growth, fundamentals, and innovation. In brief, the five components of our portfolio construction process are:
1. Evaluate the Earth-level macroeconomic picture. What are the main threats that have the power to disrupt our life and ecosystems? For this, we do research in climate science and policy study, such as reading the works of professor James Hansen of Columbia University and Lester Brown at the Earth Policy Institute.
2. Having identified key threats to our well-being, our next step is to research the scientific consensus about technological and business approaches that are likely to succeed in addressing and mitigating these threats.
3. We then attempt to ascertain which of those solutions can be applied practically, at a large scale, and in a manner that is not only economically affordable but also capable of generating additional production and economic activity.
4. The fourth step is to assemble a list of the companies that meet the criteria established in step three. This involves time-intensive data gathering.
5. The final step is where Green Alpha begins to look more like a traditional investment management firm. Here, we apply quantitative bottom-up fundamental analyses to determine which of the companies identified in step four are at the best intersection of growth and value, while being fundamentally healthy and exhibiting high growth potential. As we like to say, we "Graham-Dodd" these companies to death.
The output of this process, represented in Figure 2, is a set of actual sectors and companies in which we invest. Through the construction process (back in Figure 1), we have now mapped the hypothetical next economy onto the actual, existing economy. By analyzing critical issues confronting economies (and their underlying ecosystems), our process naturally gives rise to identification of attractive growth sectors, sampled in Figure 2 on the outermost ring. This, in turn, gives our portfolios diversification across dozens of sectors and industries, including many in providers of energy efficiencies and renewable energies that together can, in portfolio analytics terms, replace the role of fossil fuels, all while solving, rather than contributing to, our largest economic and ecological threats. Here, it's important to note that we have yet to identify any downside performance that can be directly attributed to not having fossil-fuel securities in our portfolios.
Figure 2: Mapping the next economy onto the present economy
Sustainable operations in companies from nearly all industries, including energy, transportation, agriculture, infrastructure, commerce, communications, and many others (yes, including water, but no, never oil), form the basis of the emerging next economy.
In theory, as well as practice, we have seen and continue to believe that innovation-based economic efficiency gains provide the clearest path to long-term equity performance.
Moreover, we think that capturing the infinite resource of human innovation is far more powerful than capturing the diminishing power* of fossil fuels.
*For a discussion of the diminishing importance of fossil fuels as a component of global energy mix over the next couple of decades, we suggest starting with this piece from Bloomberg New Energy Finance.