We do both top-down and bottom-up assessments of companies regarding key environment and climate change risks and/or opportunities for each sector. Preparedness and ability to address climate change and other environmental risks are embedded within this analysis and lead us to identify leaders and laggards within sector, industry and sub-industry. We use this research to drive critical assessment of management quality in all sectors.
In high environmental risk commodity end-markets we search for companies that could be beneficiaries of a trend toward pricing in externalities. Within the Materials sector, we invest in metal recyclers instead of miners because they should both rise in periods of scarcity of raw materials, but incorporating the cost of environmental degradation would hurt miners' profitability. Based on our deep probe of the building materials industry, we believe cement manufacturing is one of the most exposed businesses to climate change considerations. However, we found distributors of plumbing equipment that should grow alongside construction materials companies albeit without the risk of economic pressure from rising carbon-related costs.
In assessment at the stock level, we model three scenarios for the company's future revenues and profitability and valuation:- a base case, an optimistic and a pessimistic case. These take into account the operating environment, regulatory changes including climate regulations, disruption from other models of product/market strategy, consumer preferences for more sustainable products/services, pricing and cost pressures caused by climate and other societal changes. They enable us to model and estimate the probabilities of potential return and risk. Our scenarios differ by product, service industry and sector considerations. We can model more favorable or proximal positive outcomes for solutions providers, allowing us to reflect the changing mix of a company's products or favorable market conditions. Scenarios differ by magnitude and direction of outcomes. Over the years, our timelines, probabilities, and discount rates have to change, as the cumulative effects of climate change become clearer. Regulations, and opportunities will likely change, and we try to model these in our thinking. Such developments may move the base case in more favorable or unfavorable directions, with greater disparity between best and worst cases, changing the risk/reward for our investment opportunity set.