Let’s do this! So in my welcome post I mentioned one of the goals of this blog is to help me be (and stay) to the point. I’m so glad I was able to do that right of the bat with this first post… not! This first post ended up to be so long I decided to split it up in three parts. The first part will outline the general thesis and provide some context. The second and third one will present interesting ways to play the general theme. Now, with this introduction, let’s start.

The basic idea of this first thesis is to profit from the ESG/Sustainable investing trend (hype) we have been and still are witnessing. ESG stands for Environmental, Social and Governance, and is basically a measure of the ‘goodness’ of a company, mainly to the environment and society. ESG proponents predicate that companies that improve their ‘goodness’ will become more profitable, valuable and make the world a better place for everybody. In my experience, companies that claim to be ESG-complaint generally focus on E and S, and less on G. The point here is that the company ‘does good’. Also, I see many peers not differentiating between ESG integration and sustainable investing (and Green for that matter) and putting them in the same bucket (as indeed many times there’s a big overlap). I will do the same and use the terms mixed together throughout this post (apologies to the purists). However, this post is not intended to discuss whether ESG is good, bad, hypocritical or whatever. This thesis is about playing a very significant trend.

I have to start by mentioning that I personally don’t believe that the trend towards ESG is adding much value. Please don’t get me wrong; I believe that every company should strive to make the world a better place through their products and services, though I’m sceptical regarding how much value is added with ESG/sustainable investing. To the contrary, I believe it makes the life of active managers in general more difficult. Some of my peers are now tied to Sustainalytics (a company that analyses the ESG character of companies and gives them a rating) to decide if they can or cannot take a new position in an interesting company. In addition, I find the literature about how ESG adds value generally weak. For those interested, I’ve added a very good post from Aswath Damodaran summarising the spurious relationship between ESG and company value.

However, that does not mean we should not try to profit from this trend. 

Before going into specific ways to play this theme (at least how I do it), it is important to provide some context regarding the market and to keep this in mind when doing work on potential investments:

• Point 1. ESG investing is very real and is here to stay. Investors should not ignore this trend and its impact.

I would like to use an example of a friend fund manager who 4-5 years ago started to notice valuations of certain Scandinavian companies moving upwards, from expensive to extremely expensive – and staying at elevated levels. He called the company and several analysts and all gave the same answer; they were seeing lots of interest/flows given the ‘sustainable’ character of the company. Also, the company got even more expensive after Sustainalytics started to cover them (and give them a rating). Companies like Sustainalytics are already having a big impact om valuations and I believe this will only get worse. With respect to my friend he mentioned he would never become ‘sustainable’ and buy into such nonsensical valuations. You can guess what happened some time later; a couple of big clients told them they were changing their mandates and now need their investments to be branded ‘ESG-ok’ or else divest. 

• Point 2. The US is strongly lagging Europe in the trend/flows towards sustainability. Investors should take this as a sign of things (flows) to come and as an opportunity as well.

We do not know whether US investors will move to sustainability as vigorously as their European counterparts, however we do know that the trend in Europe is not abating, and is actually accelerating. The conclusion is that even though the US might not reach the same level of assets under management in ESG/sustainable funds, I believe the probability of accelerating US flows towards sustainable (or similar) funds in the near future to be very high.

• Point 3. Another important point in the trend towards sustainability is the directionality of the flows.

It is not similar to the divergence between large cap growth and small cap value where at some point one can expect a (very large) reversal of flows. I believe the fund flows towards ESG investing to be mainly one-directional. Today demand for companies with a sustainable character vastly outpaces supply. Though this will certainly cause excesses and bubbles here and there – think Tesla – (and opportunities on the other side), it will not revert anytime soon, if ever. Asset managers will not go back to be ‘unsustainable’. Certainly the ESG hype can become less pronounced at some point (e.g. as ‘sustainable’ becomes the new normal), but that means less flows, not a reversal of the flows. In order to become ‘sustainable’ or branded ‘ESG-ok’, asset managers (and their clients) have to change their mandates, adjust prospectuses, (internal) guidelines, risk (monitoring) controls, etc. That is a process that will not be reversed easily. Think about the changes the gigantic but very slow moving Norwegian and Dutch pension funds have made to move towards ESG and sustainability. This is still ongoing and they will not revert anytime soon.

The bottom line is that this space is very popular today and I expect it will continue to be so for some time. It has a massive tailwind and people are willing pay up to own – and some even must.

ESG SPACs

Given the above, the question now is how to profit from the ESG hype. I have found spacs, and particularly spac-warrants, to be good vehicles to play trends/hypes (and one of the main reasons why they are so popular anno 2020).

Spacs are Special Purpose Acquisition Vehicles. These are public companies that only possess cash and are actively looking to acquire a private company. Both companies merge, and the private company now become public. Spacs are interesting vehicles and this process of going public via a spac has several differences compared to a regular initial public offering:

• Spacs can move very quickly, closing a business combination in 2,3 months compared to >6 months for a regular IPO, and are thus able to play into trends more quickly.
• Regular IPO trajectories have a SEC mandated silent period prior to listing. In contrast, spacs able to sell their business combination before the closing of the business combination (and do so).
• Many funds cannot or will not buy into spacs prior to the closing of the business combination due to a variety of reasons, such as uncertainty regarding the closing of the business combination, low liquidity of the spac, or general antagonism/aversion towards spacs.
• As a consequence of the silent period, lock-up and the banks in the syndicate, regular IPOs have new analyst coverage only after a specific period, generally a month or so. Today, we are starting to see new analyst coverage of new spac business combinations even before closing of the business combination (NFIN as example).

The next few day I’ll present three ‘ESG’ spacs. It is not my intention to go much into the details of the products and the proposed business combinations and make this write-up overly lengthy. I will describe how I invest in these securities and what I’m mainly looking for in each.

For each spac I try to assess how quickly the share price can reach $18 (from the starting price of $10) and how ‘easy it is to sell the particular ESG story’. The $18 is because that’s when the warrants are worth ~$6.5 (up from $1-$2). At $18, the warrants are generally bought out (its a bit more complicated but for the sake of the post I’ll keep it simple). With respect to how ‘easy it is to sell the story’, I mainly look at how ESG/sustainable/green the story is, the valuation (based on fully diluted shares) and comps.

Tomorrow and Wednesday I’ll look at three examples of ‘ESG spacs’ which I believe will do well. Please keep the previous discussion regarding the market trends in mind. Also, as I finished this post today, I’ll use today’s opening prices as the basis to keep track.

I imagine this first post was not your average bread and butter, but I’ll promise I’ll keep it short(er) and sweet(er) from now on!

ToffCap

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