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Q&A with Blue Ocean Investment Partners Founder Ted Holmes, Chief Operating Officer Peter Jayawardena

04 October 2021 Amena Saiyid

As the world transitions away from a fossil fuel-reliant economy toward a net-zero one, investors are quick to label their offerings as ESG-compliant, but what does that really mean.

ESG refers to environmental, social, and governance criteria that companies use to measure the sustainability of an investment. At the heart of ESG investing is the idea that companies are more likely to succeed and deliver strong returns if they create value for all their stakeholders—employees, customers, suppliers, and wider society including the environment—and not just the company owners.

London-based Blue Ocean Investment Partners (Blue Ocean), which is a signatory to the Principles of Responsible Investment, describes itself as an independent pure ESG boutique firm that specializes in non-mainstream companies in developed markets.

Net-Zero Business Daily spoke to Blue Ocean Founder Ted Holmes, and Chief Operating Officer Peter Jayawardena, to help understand what makes the firm "pure ESG," in contrast to other asset managers. They also discussed climate disclosure laws and regulations in the works in the US, EU, UK, Singapore, and Switzerland.

Holmes, a 20-year veteran of UBS, started process of selecting and vetting firms for investment in November 2017 after laying down what he calls a set of "first principles" that he said would avoid "the mistakes" he saw elsewhere, eliminating a lot of procedures he said didn't add value for the clients. In May 2018, the firm launched a pure ESG portfolio with six names that has grown to 11 today. Jayawardena, whose previous positions in the past 30 years include COO of Cygnus Asset Management and Mako Investment Management, joined the firm in September 2020 after serving as the Chief Financial Officer at Clipperdata.

Net-Zero Business Daily: You both describe Blue Ocean Investment Partners as a pure ESG firm. Can you discuss your philosophy, and explain how it differs from the approach of other investment houses?

Holmes: That is a big question. At one point, the ESG team reported to me at UBS. So, I'm well aware of what UBS was doing and how they migrated over time. So, pure ESG? Completely different between our pure ESG approach and the more normal ESG approach.

We don't look at all the disclosures. It's about going back to the first principles I mentioned, and asking what does this company actually do? What the company says it does and how it does it? For instance, does it harm the planet, does it harm people, or does it make things better? And part of that is looking at the totality. If you're in a heavy polluting industry, or use a lot of water, or you put a lot of carbon in the air, I just don't want to be involved in that at all.

And a lot of that has to do with our strategy. If you work at UBS or Credit Suisse, your clients expect you to have really broad strategies. So, for you to not be invested in energy, or to not be invested in mining, that's a little more difficult to do, because they've asked you to have these broad mandates.

But we've narrowed our mandate down to say, "we just want these pure ESG companies, and we want innovative companies." So, to me, the two of them really go together. And when I look back over my time at UBS, that's exactly the kind of companies I've always invested in.

Net-Zero Business Daily: Hypothetically speaking, why would an investor with, say, $10 million or $15 million, or whatever large sum you pick, choose Blue Ocean over another investment house?

Holmes: Just from an ESG perspective, we are avoiding companies if they do environmental or social harm or if their governance isn't right. In other words, if we see that there's an issue with any of those three measures, we just completely take it out of our universe from the very beginning.

One of the things that I fundamentally believe is that we're in this technological revolution, and when you go through these types of revolutions, the entire economy changes over, so we're looking at these innovators who are on the leading edge of really benefiting from and driving this change.

If you go back to when cars were invented, you as an investor don't want to have any exposure to buggy whips and horses and instead you want all your exposure to be in automobiles. In this case, you want your exposure to be in the things that are now replacing the old automobiles, as we go to the next revolution.

This last age we were in was one of mass production, of automobiles and oil. And if you think about what happened over the last 100 years or so that we had this massive growth of the economy, it was really around these key factors. The new revolution is around information technology and telecommunications. And advances in those fields are helping to push and drive green technologies.

So that's exactly the kind of development we're looking for. So, if you're an investor, you want to have an overexposure to these green developments over the long run because that's where the market is shifting. If you go into a typical [financial] product, it's going to be a tiny percentage of the portfolio, because they're going to have most of the money in these bigger cap names, whereas we're focused on non-mainstream names. We are looking at smaller companies that are still liquid. So, it's an exposure that would be very difficult to get in a more typical product, and that's where I think we add the value and the spice.

Net-Zero Business Daily: Can you talk about the companies that you would back?

Jayawardena: That's the other thing to remember. They're not exactly emerging, they've emerged. They're liquid companies that are listed on developed markets. So, we're not investing in countries that have illiquid markets or emerging countries. We are interested in developed markets, like the US, Europe.

Our portfolio currently is primarily in the US. The other point is we are investing in companies of the future, or companies that are looking ahead. If you take Microsoft as it was 20-25 years ago and it came to the market now, we would have been looked at them and said, "hey, these guys could make a difference in the world."

Net-Zero Business Daily: What kind of marginal gains can investors expect against similar portfolios? In other words, how do your companies benchmark ESG performance?

Holmes: Our strategy is to give concentrated exposure to pure ESG innovators. I don't think there are other products that are designed exactly the same way. In order to compare, we use the S&P 500 as our competitor only because it's the world's best-known benchmark. We ask if we are adding value with our strategy or not, on an annualized basis. Since our inception, we've been able to grow investors' money by about 30% per year where the markets went up by 17% per year, so not quite doubling.

Net-Zero Business Daily: What's in the "secret sauce" that is allowing you to nearly double the value?

Holmes: It all comes back to the philosophy and process I spoke about before. So, when we go through and look at the companies, we start with pure ESG: what the companies do, how they do it and who's doing it? Is there any issue with the E, the S, and the G? If so, we throw those companies out.

And then we start to look at other characteristics of the business. The idea is, does this company add value to the world—either the planet or people? Is it led by people who we think are the right people, and are they aligned with their shareholders over the long term? And do they have sustainable competitive advantages? And why do I believe those are there?

I guess the last thing is that it's in the early stages of market development. So, they're at 1% penetration of the market that they're creating, often creating a new market. And we think that they will be the leader. At some point, could you say they could be 10, 20, 30, 40 times the size that they are currently, because they are so early in the market development. So, that's all on the qualitative side. The last thing we put on top of that is then I go through and do a valuation, thinking about what I think the possibilities are for where the company could go on a long-term basis. And there I use scenarios. We use those then to say, if my scenarios are correct, this is where the value is today, and now it's cheap. A lot of times, companies have amazing growth and may be amazing businesses, but it's already priced for that. And so we go through two phases. One, identifying the right company as a whole, and then figuring out the ones we think are actually cheap today in the market. It's a very disciplined process-oriented approach that we take.

Net-Zero Business Daily: Could you talk about the sectors where Blue Ocean is not comfortable investing?

Holmes: We don't look in emerging markets, and I think what you've seen happening in China is one of the reasons we stay away from emerging markets. Part of our philosophy is let's find these companies that are in control of their own destinies and whether they have the right management team to get them there.

As I was saying at the very front end of the call, I call it a gating process. A lot of investors will have these criteria and will weigh these differently. Whereas we use gates so you have to clear every single one of them. If you fail any one of them you're just out of consideration altogether.

I would rather be with the companies that are not polluting because I don't support those types of companies. Part of that is that I don't want to be involved in those transitions. The other part is I'm not sure there's good evidence that these companies can make the transition. They may have a lot of capital, they may have big businesses now, but every company I've ever looked at once revenues start going south or their business models change, it just becomes this cycle that they go through. And in the end, the company is nothing like what you thought it was when the transition started.

Net-Zero Business Daily: Shifting gears, what is your take on disclosure rules that are in the works in Switzerland, Singapore, UK, EU, and the US?

Jayawardena: How many days do you have to discuss this?

If you go back 25 years ago, ESG as a title didn't exist. It's become something, let's say over the last 10 years, and it's certainly grown over the last five. Where we see [disclosure rules] as useful is that the market will have to really deliver to what ESG is rather than having a branding exercise and nothing changes within the portfolio.

And that is something that we welcome because the danger of people getting into ESG on the assumption of what is said is that sooner or later people are going to start saying, "well, that's not ESG." And because of this, all sorts of stuff comes out of it. So, it's a very good thing that the regulators are starting to say, "well, hang on a second, you know, just because you're a big house, you can't simply say ESG if you are not really doing ESG."

It's not fair—and very dangerous from an investor perspective—because people really want to get invested in ESG or a sustainable product where you can choose and know that it is truly ESG and not someone greenwashing. I think the regulators are doing this. It's the correct time because it's growing too fast, and too many [firms] are launching these products. And if they wish to claim that, then they should play by the same rules and provide clarity about what they are doing.

Net-Zero Business Daily: Singapore is proposing to phase in disclosure requirements for various sectors. Peter, in your email you described Singapore's climate disclosure proposal as "timid." Could you elaborate, and also what do you make of Singapore's proposal to phase in disclosure across various industrial sectors?

Jayawardena: There is ice still on the ground in the south of Spain even though it's early September when it's normally still really hot. So when you look at the ice on the ground and you look at the scientific evidence of the reports that have come out, which are damning, suggesting we may have crossed a tipping point, you have got to ask why would a regulator or any exchange, take the position to put in all these years for compliance, saying, "well, you know, you could apply it, but you could explain it away too."

What are you going to do by explaining why you're not complying? There has to be compliance—full stop. If you're going to change, you've got to change. Anything in-between is suggestive to the market that the regulator's mindset is also uncertain, willing to allow things as they are to run. Either you believe, you know, we have serious issues with climate change or you don't. If you do, you have to start saving lives. There cannot be an excuse.

Net-Zero Business Daily: Do you believe that all economic sectors should be required to disclose at the same time, or should the disclosure requirements be phased in, as the UK, Switzerland, and Singapore are proposing?

Jayawardena: I go back to the context, and the context is really important. Because if you're at that point, that tipping point, do we really have that much time to wait for companies to explain and comply? Or must they start doing things today? They should have started doing this earlier. When did we sign the Paris accord? 2015. And then you sort of look at it and say, "well, times passed by, and nothing's really changed." Nothing dramatic has happened. So, we're waiting yet for more time. What is it that we're waiting for until you really cross over?

I think the US Securities and Exchange Commission (SEC) is taking the right approach. The reason I called [the Singapore climate disclosure proposal] timid is somewhat confrontational. But that's where you need to make a stand because the Singaporeans are simply saying "well, over the next three years, you can still comply and explain." That says to me there's something really wrong. It needs to be much more robust. Because we need more rules for industry. We need goals for individuals and for government. The question that was in the Singapore consultation paper that led me to say it is timid, is where they say, "Do you agree with us not enforcing reporting requirements?" And. I just thought, "well, hang on a second, the regulator is biasing the question."

At least in my mind, if you ask someone, do you think it shouldn't be implemented? Do you agree that we shouldn't have a really structured set of reporting requirements? Of course, everyone's going to say, "yes, of course, let's wait." So why would you ask such a question if you haven't already determined we're going to wait.

Net-Zero Business Daily: And finally, what about Switzerland's climate disclosure approach?

Jayawardena: Switzerland began its process earlier than the Singaporeans, but I do think both these jurisdictions now need to go back and revisit their plans and ask, "do we need to start accelerating things?" Because it's difficult to see it. Let's assume that when they initially looked at it, they thought it was fine. But now they need to relook at it and say, "well, maybe the process needs to be accelerated, especially given the SEC's stance." And if the SEC can push through mandatory reporting then I think the question is why can't others? If we're going to try and do this across the world, because climate change is not geographic, it's not jurisdictional, it is worldwide, the only way we're going to achieve it is if all the regulators step up.

Posted 04 October 2021 by Amena Saiyid, Senior Climate & Energy Research Analyst, IHS Markit

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