November 7, 2017
The Power of the Millennial
There are approximately 80M U.S. individuals that fall within the Millennial generation (1980-2000), which is roughly 20M people larger than the Baby Boomers. Millennials, it is estimated, will inherit $30T in financial and non-financial assets in North America alone over the next several decades (peak 2031-2045). As this generation’s wealth increases, what implications does this have for companies and the factors that influence where this cohort will invest?
According to the US Trust survey, 88% of Millennials believe that social or environmental impact is important to investment decisions and 80% of Millennials expressed an interest in or owned social impact investments. This is an impressive increase from the 57% and 39%, respectively, expressed by the Baby Boomers. Millennials are searching for ways to use their wealth to help the world as well as their families. Their mantra: do well while doing good. Sustainable, responsible and impact investing (SRI) is a broad spectrum, anything from investing in start-ups that bring clean water and electricity to underserved parts of the world to avoiding investments in tobacco companies. One segment of this category that has held the spotlight recently is SRI focused on sustainability.
Sustainable companies focus on making long-term investments for the future that go above and beyond government mandate. Today’s investors see sustainability as a competitive advantage, and many company executives are reaffirming this belief. According to a McKinsey research report, companies pursue sustainability because it has a material financial impact. A sustainability issue can potentially cost a company between 25-70% of EBITDA, as shown in Exhibit 1 below. Wells Fargo is a good example and shows that setting targets with the right intentions but the wrong incentives can undermine the entire goal. The opening of fraudulent accounts at Wells Fargo was the result of individuals breaking company policy in order to meet sales targets that focused on short-term profits over long-term sustainable results. While the company collected $2M in fraudulent fees, it ultimately cost them $185M in fines and $110M in payments to customers who had fraudulent accounts opened in their names.
Used with permission from McKinsey & Company. Profits with purpose: How organizing for sustainability can benefit the bottom line. July 2014.
The positive side of focusing on sustainability is that it can result in new innovative products or potential cost savings. When Lockheed Martin focused on reducing its wood waste from packaging, the result was that the company found $7.5M in savings at an investment cost of only $240,000. This is a return on investment of 3025%.
Sustainability is typically evaluated through environmental, social and corporate governance (ESG) factors, but these evaluation tools are still in their infancy. A multitude of companies are popping up to provide rankings on ESG factors, but so far academic research has had mixed results (depending on which paper you read) finding a material link between ESG factors and long-term investment performance. This is not to say that there is no link, but perhaps investors are not monitoring the appropriate factors. One recent paper found that if you separate out certain ESG factors to only look at those deemed “material” for a particular industry, you can find a positive correlation to investment performance. These mixed results are further exacerbated by the fact that not all companies disclose ESG information, especially smaller companies that lack the additional resources to track this type of information. In addition, just because a company ranks well on ESG factors does not mean that the company will continue to rank well in the future. Volkswagen is a prime example of this. Forbes ranked Volkswagen number 7 in their list of companies with the best corporate social responsibility in 2012, but we all know how that story drastically changed with the emissions scandal in 2015. While more research needs to be done on how to best evaluate sustainability, what we do know is that there is non-quantifiable information available to determine if a company’s management is focused on the long-term. Sustainable practices, such as fair labor practices, good environmental stewardship, and diverse leadership, have all been proven to support long-term success.
What unites sustainable companies is their history of using innovation to achieve long-term business objectives while constantly looking to what will serve them best in the future. Some companies that are considered examples of sustainable investments might surprise you (ConocoPhillips (COP), Allergan (AGN), UPS (UPS)) as they are in industries not commonly associated with SRI investments. With all the headlines on pharmaceuticals’ aggressive pricing tactics, you wouldn’t expect to see AGN listed as a sustainable company; however, pharmaceutical companies discover and distribute lifesaving drugs. Allergan was the first company to issue a social contract with patients promising to limit price increases and capping them at 10% annually.
While we do not screen for ESG criteria, we see an overlap in the characteristics that define our investments. As contrarian, value investors, we look for investments that we believe can generate excess returns over the long-term. These companies focus on making investments that will benefit them in the years ahead not just the months ahead. Management teams are focused on strategic long-term goals that set the company on course for sustainable business models. In addition, we look for companies that use capital efficiently, whether that is returning it to shareholders or reinvesting it in the company. Many of the common portfolio holdings in SRI mutual funds today are also in our portfolios (GILD, AGN, AAPL, FB, BAC).
In addition to driving long-term strategic decisions, sustainability is also becoming a marketing tactic for companies. According to a 2015 Cone Communications Millennial CSR Study, “more than 9-in-10 millennials would switch brands to one associated with a cause,” and millennials are “prepared to make personal sacrifices to make an impact on issues they care about, whether that’s paying more for a product, sharing products rather than buying, or taking a pay cut to work for a responsible company.” Companies have the opportunity to gain market share and brand loyalty by focusing on sustainability and communicating that focus to customers. In a market where margins are being pushed down by price competition, being able to demand a higher price from consumers presents a unique opportunity. Even outside of the millennial generation, 66% of global respondents said they were willing to pay more for a product if it comes from a sustainable brand, according to a 2015 Nielsen Study.
As sustainability gains importance with investors and consumers, and as Millennials begin to exert more influence in the markets, we believe many of the companies we see as good long-term investments today are poised to further benefit. If 85% of the estimated $30T in inheritance goes to sustainable investing, the industry would increase 386%, from $6.6T today to $32.1T by 2045. At $32.1T, sustainable investing would be larger than the current market cap of the S&P 500 by $10.7T. With this type of market influence, companies and investment professionals should start paying attention.
The views expressed in this report reflect those of Miller Value Partners portfolio manager(s) as of the date of the report. Any views are subject to change at any time based on market or other conditions, and Miller Value Partners disclaims any responsibility to update such views. The information presented should not be considered a recommendation to purchase or sell any security and should not be relied upon as investment advice. It should not be assumed that any purchase or sale decisions will be profitable or will equal the performance of any security mentioned. Past performance is no guarantee of future results.
©2017 Miller Value Partners, LLC