Turning Points interviews Jamie Padkin, Senior Analyst from Osmosis Investment Management

Welcome to Turning Points, Clearway Capital Solutions Podcast Series, where we talk to leading investment managers and general partners in the respective asset classes about the evolution of their markets and how they're responding to these changes. Established in 2008, Clearway Capital Solutions is an independent and privately-owned company providing business development and capital advisory services to investment managers in alternative and traditional asset classes, who are seeking to gauge with Australian and New Zealand investors and their consultants. The Turning Points Podcast Series provides listeners with direct access to the insights of our investment partners. Today we are joined by Jamie Patkin, senior analyst from Osmosis Investment Management. Osmosis manages develop market equity portfolios using a proprietary investment database, more model of resource efficiency, to identify companies utilising objective publicly-discoves data, which are generating greater economic value per resource input, rent energy consumption, water consumption and waste production than their sector peers. Osmosis believes that forward-thinking companies that take a proactive approach to a more sustainable future, deliver greater value to their shareholders. Osmosis manages core, active, global utility, systematic quantitative strategies to generate a great repeatable alpha in resource sufficient global, emerging and regional-based equity portfolios. Osmosis was established in the UK in 2009, launched its first environmental funding in 2010 and started managing the first of the more strategies in late 2011. Assets on the management have grown to over $16 billion USD currently. Hi Jamie, thanks for joining us today on Turning Points. Could you start by providing some historical background on Osmosis Investment Management? Hi Janice, thank you for having me. Yes of course, as you mentioned earlier, Osmosis is a senior investment manager with an AM of about $15 billion USD at the moment, and all of this capital is running according to our thesis that resource sufficient companies are going to outform the long run. So we believe that companies that are more, that are on a sector relative to basis, companies that are more efficiently turning their natural capital into economic capital, are going to be those that can deliver the greatest shareholder value, and we look at this by measuring their carbon emissions, their water consumption and their waste generation. And we also believe the time for the transition is now, and so actually we don't look at any future targets, and instead we just focus on the measurable and sustainable current data points that the companies disclose themselves. Please tell us briefly about yourself and your role at Osmosis. Of course, I joined Osmosis about three and a half years ago, and I work in the research team, and I particularly focus on the environmental research side. My role spans both quantitative and fundamental research, and I particularly focus on the effective use of environmental data in portfolio construction, with the aim of creating strategies that not only provide our investors with strong risk adjusted returns, but also measurable environmental impacts as well. So historically, we've always looked at the developed markets, but of the last year and a half, I've been heading up a team working on expanding our approach to also look at the emerging markets as well. Thanks, Jamie. As you mentioned, resource sufficiency has been successfully applied in developed market equities for many years. What is this specific motivation to extend the process to emerging markets? So as a firm, we've always believed that resource sufficiency should work in any region or any market we're applied, as long as we can find that there's high enough quality data to make these meaningful sort of corporate assessments and comparisons between companies. So I suppose the journey really started when we approached back in 2017 by a client who asked us to build them in emerging markets product then, but at the time we looked into the disclosed environmental data and decided that there wasn't enough high enough quality or quantity data to proceed with building them a product at that time. So but after that, the questions from our clients never really went away, which led us to pick the product up again early last year in 2023 to see what had changed. We're really, really pleasantly surprised by our findings. So we've done a lot of data collection, validation, standardization, and cleaning. And we're now very pleased to say that we are confident that the data quality and the quantity in the emerging markets is of a high enough standard that we can make these meaningful resource efficiency assessments. We are, I think, particularly excites about the emerging markets, not only because of the environmental benefits, but also because a lot of what we see in the emerging markets actually mirrors what we saw in the developed markets in the past. So while at a high level it seems as though we are breaching new territory and in some ways we are breaching new territory, it's also exciting that we're able to bring our developed market expertise and apply it to the emerging markets to hopefully be able to understand the landscape better and we would hope again to create a better quality product at the end of it. You've kind of already touched on it, but disclosure levels in developed markets have been gradually improving from a relatively high base. Can you provide some colour on levels and the quality of disclosure, cost geographies in industry sectors in emerging markets? And are there laggards and how does this most has tackled that problem? So over the course of this project we've done a lot of data collection as well as cleaning and validation that we were talking about earlier. We have this sort of persistent belief across both the developed markets and now the emerging markets that you can't simply rely on data providers themselves and that you really need to understand each data point and to be able to go to be able to make these relevant comparisons you really need to have a feel of each and every single data point there. So in this data collection and validation process we've been into a vast number of sustainability reports and have created this emerging market database that pretty much across the board we've been really encouraged by both the quality and the quantities of this data available. So while there are differences to the developed markets in some respects, so particularly in terms of some of the industries represented or perhaps from magnitude to the intensities within the universe, in many ways we see there's actually very little difference between the quality of the data and the emerging markets and the quality in the developed markets. It's an example of this might be the difference between TSMC and Nvidia and in fact we don't really see that TSMC's data, well we don't see TSMC's data as any lower quality than Nvidia's data and actually we see really strong, really strong reporting practices across the board driven by regulations from governments but also driven by stock exchanges as well and so it's finally driven by strong investor interest too. So hopefully we look forward to adding more of our fuel to that fire. But in terms of the data quality, sorry the quantity as well, the data availability side, the emerging markets are only slightly behind their developed markets counterparts. So at the moment we see that the availability of data is only about 15% behind the development markets. So of the 1100 companies that we consider to be in this new emerging market universe which we're defining as the sort of MSCI emerging markets X financials and REITs, we see upwards of 700 of these as what we would define as disclosers. So that's companies that discloser any two or three of carbon emissions water consumption and waste generation. So this is really exciting and significantly higher than I think what we expected at the beginning of this project. Jamie, China is a large emerging market. How have disclosure levels evolved in this job? Yes, it's a really interesting question. I think China is actually a really interesting country in terms of the disclosure levels themselves and the quality of the data. And at first glance, from the disclosure level side, it seems to be a step below the rest of the emerging markets, simply in terms of the amount of data disclosed and it actually often looks like it's dragging the average down. But when you dig in a bit deeper into the data, there are some really interesting comparisons that we can draw between China and in the emerging markets and the US in the developed markets. So they're both in some way, but so I'd buy some way, the largest company in their respective indexes. So I kind of say the largest country in their respective indexes, and they both have disclosure rates that lag the rest of the index by some way. So the US currently has disclosure rate of about 70% and although China is lower than that, it has similar disclosure rates to what the US did in about 2020. And maybe even more interestingly, it actually has a higher disclosure rate now than the US did back when we launched our flagship core equity fund in 2017. And I suppose while there are generally some questions regarding the data credibility, we actually haven't seen any evidence or any indication that the data is of any lower quality than what we'd collect in any other region. In the future, we also expect Chinese disclosure rates to increase. Earlier this year, the country's three largest stock exchange and announced the publication of new sustainability reporting guidelines, which is going to include mandatory reporting for lots of the larger companies on a whole range of ESG topics. And that's, I think, going to come into effect in 2023. So although China is potentially our first glance, it looks like it might be an issue in the index. Actually, we're not worried about it and we don't actually foresee it as being an issue now or in the future. Arguably, engagement will have a greater impact in emerging markets and development markets. Is this the case and how is osmosis evolving to extract that elephant? So as a systematic and quantitative investor, engagement has quite a specific role in our investment process, as we're never going to over-underwear a company solely based on a meeting that we've had with management team, but engagement does play a really key part in our research process. And we've often talked to management about to sort of stand their reported data and maybe to clarify any misunderstandings or really push companies to disclose. So in 2023, we engaged over 100 companies in the emerging markets and on track to roll out a non-disclosure campaign similar to what we do in the development markets to engage all of the non-disclosure in the index and really push them to disclose. Emerging, I suppose, engagement might have a bigger impact in the emerging markets simply due to the lower disclosure rates sort of allows us with more room for improvement there. But I think what's really, really encouraging is that the company needs that we've talked to seem to be taking their sustainability efforts as well as their sustainability reporting really seriously, and actually have been really receptive to suggestions on how to improve their reporting in the future. So we're really interested to see how changes that we suggested or changes that they might have talked about will change in the coming reporting cycles. The signal between resource efficiency and well-managed companies is strong in developed market equities. Is this mirroring in emerging markets? I think that quite a key part of the reason this research is so exciting is that we can see it as a sort of out of sample test for our resource efficiency signal. So I think this entirely new data set is allowing us to see if this worries sickness pervasive across a different universe. So one of my colleagues, Dr. Tom Stefan, has done a lot of work looking at the characteristics of resource efficient and resource inefficient companies in the emerging markets, and actually we see really very similar exposures to what we see in the developed markets. In our research environment, we see the on a sector relative basis, resource efficient companies are typically more profitable, they have higher asset turnover, which is revenue that companies generate from their assets. They look a bit more expensive, we're looking at book to price ratio, and they tend to be a little bigger than they have resource intensive counterparts. So it seems that resource efficiency as an investment signal is picking up well-managed companies across both the emerging markets and the developed markets, but I think what's particularly interesting is how similar the exposures are to the characteristics across both universes. So I really think this not only allows us to leverage our developed market expertise to make the signal easier for us to understand in the emerging markets, but also I suppose looking at the other way, this positive out of sample test also really strongly reinforces the efficacy of this signal in the developed markets as well. As most of this research shows a wider resource efficiency distribution across emerging market countries and regions, what does this mean for portfolio construction versus the developed market portfolio? So yeah, you're right. In the emerging markets, we do see that there's a wider intensity distribution of companies. So we see that the leaders are further ahead and the lagging to further behind compared to the developed markets where the ranges are a lot smaller. We do see that in some sort of geography, as geographies is different as well, probably more geographically related in the developed markets, which is slightly more homogenous. And in the emerging markets, we do see that the country operation really does often affect the quality and the quantity of reporting, but much of this is due to the advanced regulatory environment that we see in some particular emerging market countries. But I think looking at portfolio construction across both the emerging markets and the developed markets and our thesis as a whole, we are really looking to identify and go along the leaders and then go short to underweight the laggards. And so from that standpoint, we hope that the wider range of intensities allow us to have a greater arbitrage opportunity there. There are also some really exciting knock-on effects after creating these portfolios from an environmental perspective, where these wider distributions are going to allow us sort of much greater environmental reductions for the same amount of active risk in the emerging markets versus the developed markets. So we don't actually see these wider intensity distributions as being an issue at all. And in fact, we see it as a really exciting opportunity to really maximise the impact we're making to hopefully have a strong view on both the leaders and the laggards. You mentioned there is a strong regulatory environment across many emerging market countries. How does that look at the moment and how do you see that changing in the future? So we've been really pleasantly surprised by how advanced a lot of the environmental regulations are in the emerging markets. And a first thing we've been particularly interested by is that the first stock exchange globally to require the mandatory inclusion of environmental data in their integrated reporting was actually Johannesburg Stock Exchange in South Africa, who have required sustainability reporting on a compiler explained basis since 2010. So there are sort of a whole range of different reporting methodologies and regulations in the emerging markets, but perhaps most notably are Taiwan and China. So in 2022, Taiwan introduced a new disclosure mandate whereby all companies listed and either the Taiwan Stock Exchange or the tape exchange are required to disclose ESG performance indicators in their reporting and companies that are listed and either exchange are required to follow globally recognized frameworks like TCFD, SASB and GRI. So in India as well, disclosure rates have been increasing a lot over recent years, and this is partially down to a regulatory change from these securities and exchange board of India. That requires the top 1000 listed companies on both the bomb based stock exchange and the national stock exchange to disclose their ESG data by the end of the financial year 2023. And so there's other countries as well that might not be mandatory, but are still adding sort of fuel to this fire too. So the example is Brazil, who recently introduced a new sustainability index called the ISCB3, which is hoping to increase transparency across disclosure regulations and practices. So this needs to be a lot of focus on environmental regulation across the board in the emerging markets. And we're looking forward to seeing what we already do see in some ways as being reflected in the quality and quantity of data disclosed. We're excited to see how this progressed in the future too. In conclusion, emerging market equities as an asset class have struggled relative to the developed market counterparts for a considerable period, which has seen some investors shun the asset class apart from relative valuations relying on standard metrics. What makes this asset class compelling going forward from the perspective of osmosis and their resource efficiency approach? So I know a lot of reasons to be excited about the emerging market equities as an asset class. At osmosis, we aren't necessarily trying to convince investors that the emerging markets are more excited in the developed markets. I think there are a lot of opportunities across both, particularly as related to the sustainability space. What we're really trying to convince people, I think, is investors that already have emerging market exposure and convince them that there's a smarter and more targeted and evidence-based approach to sustainability in this space. That's also hopefully going to be able to target financial eye performance. But I think there were sort of three main reasons that we're so excited about this new research. So I think firstly, we're really excited to be able to try to target this sustainable alpha in this new universe, and the initial testing in both the research environment and in optimized portfolios, sort of yielding some really, really interesting results. I think secondly, we're really excited about this strengthening of this resource efficiency signal or resource efficiency factor across both universes. And I think we're excited to be able to integrate our insights that we're gaining from the emerging markets into our developed markets thesis, and likewise, the other way, the insights that we already have in the developed markets into our emerging markets thesis, and there's sort of strength in it that can happen both ways here. But I think finally, we're really excited about the environmental impacts that we can have from this new research into the emerging markets. The more that we can cover, the more of the world that we can cover at Osmosis, both in terms of geographies and industries, the more that we can reward these sustainability leaders and the companies that are really striving to increase their environmental performance across the world. So we're really excited about this new project, and we are looking forward to hopefully launching our first emerging market product in the coming months. Jamie, thanks for joining us on joining us once.