Achieving Alpha Through Sustainability

Heyns is a founding partner at the UK-based Osmosis Investment Management LLC. His firm partnered recently with Calvert Investments to develop the “Calvert–Osmosis Model of Resource Efficiency World Strategy,” which leverages a unique quantitative methodology within institutional client portfolios and separately managed accounts to identify and select sustainably run companies for purchase.

Heyns says the strategy is unique in that it leverages underappreciated and underutilized data related to the use of resources and the production of waste. In basic terms, Osmosis rates security-issuing companies on the types of resources and energy required to produce one unit of value—for instance, how many gallons of water or watt-hours of electricity does it take a manufacturer to create a single unit of product? And how much waste is coming out the back end that must be processed in one way or another?

The calculation allows Osmosis asset managers to identify which companies are run most efficiently, whether within a single industry or across different sectors of the economy. And when these considerations are merged with more traditional performance and profitability evaluations, a powerful portfolio building model emerges, Heyns says.  

“This methodology gives us an opportunity to do a new type of information arbitrage,” Heyns explains. “We are still investors that are driven by returns, but we’re using sustainability to do that and identify where the best returns are.”

The idea is that, when a stock picker is considering, say, a field of construction firms that all look like relatively attractive investments, the best option is going to be the construction firm that produces the least amount of waste and requires the least amount of energy to produce value. This is true both in the short term, when the company will pay less in energy costs and to process waste, as well as in the long term, as issues like water and resource scarcity become ever-more-material to the daily operation of companies and economies.

Heyns says that, by making stock selections based on these factors, Osmosis can reliably deliver between 400 and 500 basis points of uncorrelated alpha in client portfolios. That’s probably the most important detail to consider within the retirement planning space, as the Department of Labor (DOL) has affirmed in a number of advisory publications that sustainability factors must be considered secondarily to the economics of any investment being contemplated by a plan regulated by the Employee Retirement Income Security Act (ERISA).

In other words, according to the DOL, noneconomic factors such as resource efficiency can serve at most as a tiebreaker when retirement plan fiduciaries are considering investment choices. That holds true even for plans at issue-dedicated nonprofits and other social organizations, where participants may be more willing to consider ethics during the investment process.

Despite the fiduciary hurdle, experts anticipate certain sustainability factors—namely climate risk, energy pricing and resource scarcity—to become significantly more material in long-term investment analysis and therefore to become more important to retirement plan investors in the years ahead. Heyns agrees wholeheartedly with the assessment that energy pricing and resource scarcity are quickly becoming hugely important to portfolio strategies.

“I am confident that within 10 years, and perhaps even five, everyone will be doing the sort of energy-waste analysis that we are doing within our strategy,” he says. “Water especially is quickly becoming one of the most restrained resources in global markets, and of course there is the carbon issue. You cannot get around these facts when considering company performance.”

Heyns feels that as resource-use efficiency gets factored more and more into various types of active management strategies, it will not be such a significant challenge for plan sponsors and advisers to justify their use of “ESG” investing–short for Environmental, Social and Governance—in the eyes of the DOL or other regulators.

“It’s a pragmatic approach that we are taking to stock selection and it’s motivated by performance,” he explains. “We are not managing portfolios on the intent of corporate management at the companies we buy, but on their current operational efficiency. That is certainly material.”