Inside a Green Portfolio
First Affirmative Financial Network, an asset manager focusing on sustainable, responsible, impact investing, engaged us in a discussion around some of our portfolio-management practices and about the next economy in general. We thought they had some great questions and that the information they were looking for is relevant to the global discussion around the economic transition to sustainability and how people can invest in that. Our thanks to First Affirmative for permission to share their discussion with us here on our blog.
- First Affirmative asked, "While reviewing sub-advisor returns over the summer, we discovered a folio with a one-year annualized return of 50.48%. That makes you go back and run the history calculations again, because seeing an entire folio with that type of performance over 12 months is, to put it mildly, rare. It's been a little more than 4 months since we ran the numbers, how is the Sierra Club Green Alpha portfolio doing now?
The YTD return for the SCGA portfolio is now 89% through 11/18/2013. Some people have asked us if this is merely the result of exposure to the explosive solar sector. In part, yes it is. The SCGA folio has exposure along the value chain in solar and, in aggregate, has been about 15% allocated to that sector throughout 2013. However, cross-sector, cross-industry diversification is always key to our strategies, and we've also seen performance leaders in the transportation, consumer discretionary, communications & networking, and construction supplies and fixtures sectors -- each with a representative returning triple-digit gains so far this year. Where we've seen selections that have underperformed this year in the SCGA folio are in energy efficiency consulting/engineering, smart meters, and high-efficiency agricultural irrigation sectors.
- "We noticed that Green Alpha bought Canadian Solar in December 2011. You bought Solar City a few days later. And, most importantly, you bought Tesla Motors the same day you bought Canadian Solar. Betting on Elon Musk at the end of 2011 has turned out to be a brilliant move. But, how do these decisions relate to investment philosophy, portfolio strategy, and future performance? As always, past performance is no guarantee of future results."
We actually came by our selections of SCTY and TSLA independently of each other, as each represented a solution to a different need important in the transition to the next economy: energy and zero-emissions transportation, respectively.
SCTY seemed brilliant to us: not truly a solar company, but an electricity utility installing both distributed and centralized power generation capacity that, once installed, will earn ratepayer checks indefinitely with very little additional capex required on the part of the company. Think about that: What if you could build a huge coal-burning plant and sell the electricity for 20 or more years, get the income from that, but never have to pay for the coal, only need a fraction of the workforce, and not have to worry about GHG or toxic emissions? The thing would just sit there and print money. SCTY is all of that, plus, it's not exposed to the additional risks inherent in the panel-manufacturing business -- they just buy the best value panels they can from their preferred manufacturers. Every installation SCTY completes is a 20-plus year revenue stream. So, they're installing as fast as they can, forgoing profits now for much larger profits later. Honestly, we were a bit shocked when they IPO'd at only $8/share. And if you're worried about their negative EPS today, don't be; every dollar they spend installing now is going to result in a decades-long income stream. If they wanted to show positive EPS now, today, they could it simply by slowing expansion and collecting the revenue from their existing installments. But they know that's not the way forward, and so do we.
The new piece about SolarCity is that they have managed to securitize debt financing of new solar power projects. Their new bonds are moving project financing forward, and give credibility to both SCTY and the industry. Wall Street has embraced the debt, giving the new bonds a BBB+ rating, meaning SCTY's cost of capital can be relatively low. This innovation also means there are good new sources of income for sustainability-oriented investors and managers.
The only material risk we foresee for SCTY is the political backlash (primarily in the U.S.) caused by their success at stealing market share from traditional utilities and fossil fuels companies. The attempts by Sen. Jeff Sessions attempts to discredit the company are one example. But his overreach in comparing SolarCity to Solyndra reveals a profound failure to understand either firm's business model, the industry, or the energy markets in general.
TSLA was different. We identified it as of its IPO date as the only traded company that is an electric vehicle (EV) pure play. In those days, Tesla was only selling a few Roadsters, and although it had grand ambitions, it was still pretty speculative, even at the mid $20s price range. Yet it was well capitalized, had a well-conceived long-term plan, a proven management team, and lots of enthusiasm from the Roadster's early adopters. All those things considered, we knew it should find a home in our Green Alpha Next Economy Index (GANEX), if we wanted the index to really represent as much of the next economy as possible, including transportation sectors.
By the end of 2011, TSLA had moved up some -- to the low $30s -- but was generally trending sideways as few analysts covered it then and some who did were still pooh-poohing the whole idea of EVs. So, there was not much stock movement, but meanwhile the company had made great strides. Its long-promised Model S was being driven -- to rave reviews -- by beta testers, and the company promised first deliveries in 1H 2012. Furthermore the company was promising to be able to deliver up to 6,000 units per month sometime in 2013. Now, at the time, we knew this would up the ante for TSLA and could bring it within striking range of profitability, so we took the leap of approving it for portfolios other than GANEX -- albeit at relatively low weights and still at speculative positions. By the end of 2012, the Model S was indeed shipping and getting all kinds of rave reviews. And, the share price had gone to the low-mid $30s, or more or less what we had hoped for. By this time, though, the growth story was really clicking together. Now we knew about plans for the so-called "Gen 3" or mass market, $35,000 Tesla, and had had time to think about their drive train, battery, and IP deals with Toyota, Daimler-Benz, Panasonic, and more. All this added up to huge growth potential, so we were getting more bullish and adding a little more weight to positions.
What happened to the share price in 2013 has entirely eclipsed our expectations. Far from continuing to grow organically into their potential, shares of TSLA got way out ahead of present earnings. Yes, there were additional positive milestones this year like the company paying off its federal loans 11 years early and turning a profit for the first time but, still, we were taken aback. At highs in the $190s, you really had to believe the TSLA growth story and that they could achieve revs from all of the above sources without a major setback. Those of you in our folios know that we took the position in half in the $120s in early July and again in the $160s in August. As much as we love well-executed zero-emissions transport, the run was too much. We still believe in the growth story, and we think TSLA will, in time, be a major force in the auto industry, but this climb will not be linear, and there will likely be stumbles along the way. There will be more and more competitors in the EV space (BMW, for one), and there will be price movements that coincide with economic conditions, of course. And yet, signs are beginning to show other possible long-term revenue drivers for TSLA, such as royalties on their IP, for example the new patents they hold for advanced air-metal batteries. Given management's track record of execution on previous projects, you can look for us to add again if the growth prospects ever get back ahead of the share price.
Canadian Solar (CSIQ), long one of our favorites on the basis of its ability to produce high-quality panels at scale at very competitive costs, and its ability to do so in dozens of markets around the world, all with the backing of China's central bank, finally started to realize its potential this year and trade up into a more reasonable valuation (for example, late in 2012, the company had a price-to-book ratio of 0.2; now it has risen to p/b of 2.8 as it has risen approximately 800% year-to-date, which is a much more realistic valuation, but still below the average price-to-book of the average S&P 500 company). We sold half the position of CSIQ in SCGA in October of this year, purely on the basis that the folio was becoming too concentrated in that stock -- the run had taken it over a 10% weighting -- not because we believed it had yet reached fair valuation. Stated more simply, we took some profits out of the position.
- "Now that you're also managing a mutual fund along the lines of the folio available to us, it's interesting to have more ways to evaluate your process and discipline. The Shelton Green Alpha Fund (NEXTX) has more than a six-month track record now -- how's it doing?"
The Shelton Green Alpha fund is up about 42% inception-to-date, from its start date of March 12, 2013 through November 18, 2013. We designed NEXTX to act more like a core holding than SCGA does, primarily by giving higher weight targets to larger-cap, lower-beta, and dividend-paying equities than we do in SCGA. So, although it is an equity growth strategy, it's quite a bit less aggressive than SCGA. For example, NEXTX avoids micro-caps, where SCGA usually has one or two. Micro-caps can be great drivers of performance, but there is some art required in selecting them, and they're more speculative; with small-cap stocks in general, it's important to look beyond the numbers for events that can drive valuations.
- "What else should First Affirmative's nationwide network of advisors know to better understand your folios and mutual fund?"
We think it's important to understand that we come to asset management in a different way. For us, portfolio management and selecting stocks all comes down to answering one question: How can we spur a sufficiently rapid transition toward a world in which humanity and the nature that supports it can both thrive indefinitely? We believe the only way to approach this question is to look outside of the context of modern portfolio theory (which insists that you start with some list of companies and then screen down to some smaller list), and to take fund management back to straight research and start it from scratch. We began by going back to fundamentals; looking at the fund building challenge from a blank slate perspective. The way forward is to drive economic efficiencies so far that we will maintain and even improve our standards of living while simultaneously reducing our planetary impact to the point where our underlying ecosystems can begin to recover. The only way to accomplish that, in turn, is via our only truly infinite resource, human innovation. Our future depends on maintaining and increasing our rates of innovation. So that's where we look. That's where we start.
Garvin Jabusch is ofounder and chief investment officer of Green Alpha® Advisors, LLC. He is co-manager of the Shelton Green Alpha Fund (NEXTX), of the Green Alpha Next Economy Index, the Green Alpha Growth & Income Portfolio and of the Sierra Club Green Alpha Portfolio. He also authors the Sierra Club's green economics blog, "Green Alpha's Next Economy."