Finding ESG Opportunities in a Difficult Market

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Crystal Maloney, CFA, CPA, CMA

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Crystal Maloney, head of equity research at CIBC Asset Management.

It’s been a challenging period year-to-date for sustainability focused investors, with the biggest headwind coming from the performance of energy stocks, which are up 33% year-to-date April for the Toronto Stock Exchange and 35% for the S&P 500. The energy sector carries more severe environmental risks than other sectors and, as such, sustainability, or ESG focused strategies, tend to be underexposed to energy. Being underweight energy led many ESG strategies to underperform broad-based indices due to sector allocation. This under-performance gap was reduced by many by being overweight industrial. Our CIBC Sustainable Canadian Equity Fund mitigated this detraction from sector allocation versus the broader market by being overweight the outperforming communications services sector, and through strong stock selection. Which also allowed us to outperform our comparable investment universes, such as the Morningstar Canada X Fossil Fuel Index.

Taking a longer term perspective, however, we believe that investors can stick to their ESG goals without sacrificing return. Longer term results still show market beating returns for many sustainable stock strategies. According to Morningstar, over the past five years, the Morningstar US Sustainability Index closely tracked the Morningstar US Market Index, both grew 15.5%. And the sustainability leaders index saw gains of 17.3%. Overall, 71% of Morningstar Sustainability Indexes have outperformed their traditional market equivalent over the past five years.

We’re seeing many opportunities in the Canadian market, and with the volatile market conditions of late that is creating opportunities for stock picking. Telus is an example of an ESG leader that we quite like. It has industry leading ESG practices with detailed carbon and diversity metrics. They disclose emission reduction targets along with progress. They also disclose employees by designated groups, and are widely held with executive composition and compensation tied to ESG performance.

We believe that Telus is best positioned for the next two or three years relative to its peers, and to benefit from the improving wireless market, while reducing costs through the transition of 5G and unlimited plans. With 90% of their base transition to Fibre to the home, Telus is set up to take market share in Western Canada ahead of Rogers entering the market. And its stock has yet to reflect the potential of telehealth and agriculture.

Second opportunity that we quite like is Magna International. This is an ESG leader that has pulled back recently. Magna’s corporate strategy is centered around vehicle electrification, improving fuel economy, and reducing emissions. We expect the significant pent up demand and historically low system inventory levels to support robust profitable sales growth for the next few years. The market has priced in the near term slow down and the semiconductor supply chain issues that are plaguing the industry will eventually be worked out. This inventory rebuild will provide a significant tailwind and we expect to see significant earnings growth and Cashflow from the company, which has a strong balance sheet and an attractive valuation.

Another company we like is in the renewable energy space, one that will benefit from decarbonization and energy transition. Brookfield Renewable is one of the world’s largest pure play renewable investors. Its portfolio of renewable generation assets is critical in the climate transition. One hundred percent of revenues are sourced from renewable energy. We believe that the current trading price offers an attractive entry point into one of the highest quality pure play renewable names in the Canadian market. The company has an ability to execute its growth plans on a self-funded basis, and we see it as a very attractive opportunity in these markets.