Investing in transitions

While lots of investors are still stuck in the ESG/CSR stage (see my previous article), advanced investors are investing in transitions: they invest in those companies and industries that contribute to successfully navigating transitions (in food, energy, mobility, finance, health, etc.) towards an economy within social and planetary boundaries. They understand that picking transition winners helps them to have both impact and good financial returns. However, they typically lack the tools and data to show that they contribute to transitions. We are trying to change this.

Tools for transition analysis

On the tools side, sophisticated investors aim to value companies in transition. But transition management and corporate finance are separate disciplines. In this RSM working paper, we connect the two disciplines by developing a model of expected transition losses. It appears that adaptation to transition is a key determinant of a company’s long-term value. Companies that are early in the game can reap the first mover benefits. Companies that adapt later experience higher adaptation costs and may even not survive. The transition model helps companies to sharpen their strategy and cope with major sustainability transitions that are currently happening.

Data for transition analysis

On the data side, investors typically have data that map investee companies’ policies and footprints, as supplied by traditional ESG data providers. However, they typically lack clarity on:

· Transition exposures: to what extent is the company’s business model likely to change as a result of transitions? This tends to be a function not just of footprints, but also of competitive positions. For example, polluters that are less pollutive than peers can actually win in transitions.

· Transition adaptability: to what extent can the company adapt its business model to the new normal that arises due to transitions? This will depend issues such as management quality and the company’s strategic options.

· Contribution to transitions: to what extent does the company provide the solutions to other companies’ problems or to changing consumer needs arising from transitions?

Obtaining clarity on these issues requires through qualitative analysis, which is typically feasible for a concentrated portfolio, but not for a very diversified one. The key here lies in marrying the quantitative and the qualitative: both having raw data on transition exposures and to tap analyst knowledge on adaptability and contributions to transitions. Man+machine, just like in chess. How adaptive are you as an investor?