24 FEB, 2023
By Corrado Gaudenzi
The current pattern of production and consumption could jeopardize future generations. Undoubtedly, if we maintain the current rate of extraction of non-renewable materials, we risk a massive depletion of natural resources in the coming decades. In this context, public regulators and private organizations recognize the unfeasibility of the current economic model. They all agree that the way to reverse this pattern and decouple economic development from resource and environmental degradation is only possible through the transition from a linear economy to a circular economy (CE).
Today, all manufacturing processes of goods and services involve a significant environmental cost. With the aim of minimizing it, this new economic model arises that promotes the optimization of materials and waste by extending their useful life, in short, a system that takes advantage of existing resources and gives a new life to the waste we generate. We in the asset management industry also believe that we have a fiduciary duty to play a dual role in this transition. On the one hand, as active investors, we have the task of pushing companies to adopt this model. On the other, we must integrate the estimated financial consequences of the change it would entail into the investment process itself.
However, the absence of a well-defined taxonomy and key performance indicators could pose a major challenge to the industry’s transition. Although companies and financial regulators have made great strides towards creating a common language in the field of sustainability, this language is not yet properly adapted to measure the circular economy from an investor’s perspective.
So how can we contribute to this dialogue? Through a framework, developed and applied in-house, with a modular and adaptable approach that assesses the degree of circularity of companies through three dimensions: the production process, the business model and the quality of the initiatives taken. In this regard, it is worth noting that our analysis reveals that companies are currently focusing on the transformation of the production process, although new business models are beginning to emerge. Also, and in parallel, on a scale of 0 to 10, the degree of circularity of large public companies is only 0.6, indicating considerable room for improvement.
Investing in the leading companies that are more oriented on this transformation path gives companies a competitive advantage over their peers, due to their ability to anticipate market trends. In the medium and long term, it is expected that it will be the firms that lead the circular economy that will achieve more stable profits and cash flows, as well as higher levels of customer loyalty.