Information technology and sustainability both represent major economic transformations. Sometimes linked, but by no means always.
The second quarter of 2020 has been remarkable in a few ways. The most obvious is just how positive it has been for equity markets. One of our two benchmarks, the MSCI World index, rose 20.0%.
This took the index return for the first half of 2020 to 1.3%. This innocuous-looking number is in fact a quite startling statistic. The most profound global health event in a century, and yet equity markets actually rose.
Extraordinary returns from Information Technology and Communication Services
But there are other very striking figures within that performance. Perhaps the most important, is the contribution from the Information Technology (“IT”) sector. A sector return of 22.3% more than doubled the next-best sector over the six months. The Communication Services (“CS”) sector, was also in positive territory, albeit not as healthy as IT. This sector is made up largely of companies previously classified as IT.
In our own attribution, IT was also a standout: but a negative one. It was our largest negative sector attribution, again more than twice the runner-up. This has been something of a pattern recently. Repeating the same analysis over three years, we can see IT was the strongest sector. And our comparative underweight, and selection, has been our biggest drag on relative performance.
Of course, this is the sort of thing we should notice and think about. And likewise, we would expect our clients to. But it has become of particular interest recently.
That is because IT has become hugely popular in the now burgeoning world of sustainable investment. At the start of this month, two separate surveys identified Microsoft, Alphabet and Apple as all being in the top five most popular stocks in funds that claim to use environmental, social and governance (“ESG”) criteria. In one of those surveys, they were joined by Visa; in the other, by Mastercard.
Most IT companies are not providing solutions to sustainability challenges
We are often asked about why we are less exposed than our apparent peers. But as our clients well know, we invest in companies that provide products or services that directly address critical sustainability challenges. As a very minimum, half of their business will be focused on this. For most of the companies we invest in, it is the whole of their business. This is perhaps a defining example of what it is to be an impact fund, as opposed to a strategy based primarily on environmental, social and governance (“ESG”) factors.
By contrast, sustainable funds with large weights towards IT are generally using ESG tools to pick their stocks. Before investing, their managers will be looking closely at how a company conducts itself. But they do not need a company to be providing a sustainability solution in the goods and services it provides. In fact, the bulk of the IT and CS companies on the market at the moment don’t fit that definition. There is no lock-step relationship between their unit sales growth and positive social or environmental outcomes.
Most IT and CS companies are “neutral” from an impact standpoint. Their core businesses and the vast majority of their revenues are derived from selling consumer devices (like Apple), advertising space and data (Google and Facebook), platform software (Microsoft), electronic payments (Visa and Mastercard) or anything at all that consumers will buy (Amazon). These are not what we would consider positive impact products at WHEB, and they therefore do not qualify in our investable universe.
If anything, the most common trait of most large technology companies is that they improve consumer experiences. And that may or may not be sustainable.
This of course begs the question, why do so many ESG managers end up with a big weight in IT? What is it about IT companies that makes them look like they have particularly sustainable business models?
There are a couple of possible answers. IT companies tend to have smaller environmental footprints. There is no physical manufacturing in software. Much of technology hardware manufacturing is outsourced. On paper, IT companies can present very low greenhouse gas emissions, for instance. These small footprints mean that they also tend to avoid the controversies which often result in a company falling foul of a negative screen.
Moreover, ESG aside, many IT businesses are compelling investments. They are asset-light, scalable, and often with high proportions of recurring revenue. The very largest ones have built up formidable competitive defences.
IT companies that do address sustainability challenges
We appreciate attractive business models and low-risk ESG profiles. But for us, the key is to connect these traits with real impact. That’s what makes us confident in the long-term future and growth of our companies. It is the incredible power and potential of technology used to promote sustainability that really makes us enthusiastic about the IT stocks we do invest in.
And we are, indeed, enthusiastic. Our portfolio may have less IT exposure than the broader market, and a lot less than the average ESG fund. But we hold roughly twice the weighting of our investable universe of sustainable impact companies. We think IT will solve some of the key sustainability challenges.
We invest in Cerner and HMS Holdings, in our Health theme, which provide software to help deliver better healthcare outcomes. In our Resource Efficiency theme, Ansys and Autodesk create software to empower designers to create ever more energy and resource efficient products. And we invest in Infineon, Littelfuse and Silicon Labs. These companies make semiconducting equipment which helps control electric power, provide circuit safety, and connect the “internet of things”. By doing so they bring forward the electrification of everything from cars to power generation, with a lighter environmental footprint.
Information Technology is reshaping the sustainability challenge just as it reshapes the world. Not every piece of technology is sustainable. But technology companies with a genuine and direct application to sustainability are compellingly impactful.
 Surveys by RBC Capital Markets and Morgan Stanley