Why ESG Funds Crossed the $1 Trillion Mark

In this episode of Market Foolery, Chris Hill chats with Motley Fool analyst Jason Moser about the latest news and earnings reports from Wall Street. They discuss the resiliency of tech stocks and how corporations are embracing ESG investing. Finally, they take a listener's question about seeing any postpandemic pent-up demand in a very niche industry and much more.

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This video was recorded on August 11, 2020.

Chris Hill: It's Tuesday August 11. Welcome to Market Foolery. I'm Chris Hill. With me today, freshly shaven, he looks 10 years younger, it's Jason Moser. Good to see you.

Jason Moser: I like the 10. Some said 5, some said 10. I'm going with the 10; I'm not even split in the middle there. Let's say 10.

Hill: We have got a lot of money going into ESG investing. We're going to talk about that. We're going to dip into the Fool mailbag. Let's start, though, with Lumentum (LITE 3.00%), which is a stock I know you've had on your radar for a while. Fourth-quarter results were better than expected. That, plus guidance for the new fiscal year, was enough to push Lumentum shares up 4% this morning. This is an optical networking company and, I hasten to add, a supplier to a little company called Apple.

Moser: Yes. You know, among other things. And it's really been interesting to watch these tech component companies over the past few quarters, particularly during this pandemic, because I think what they're showing is their resiliency, right. They are very busy right now. And a lot of that has to do with the buildout of 5G networks and just general advancements in technology, the Internet of Things. I mean, we're entering a time where things are becoming more connected and more useful and more immersive. And this certainly plays right into Lumentum's specialty. I mean, this is something, I think a business is going to be very relevant in the coming decade as technology continues to evolve and connect and do more things.

And Lumentum is in the business of optical products, chips, lasers, things like that. They're really known well for -- and I've talked about this technology before, VCSEL, vertical cavity surface emitting lasers, and that ultimately is the technology that is really key behind 3D sensing, which is very key to immersive technology and all of the cool things that our phones and other devices are doing these days. And the neat thing about momentum, too, is, while they are a big supplier to Apple, they are not just an Apple supplier. They are very much a supplier in the Android world as well. So they are pretty much device agnostic, which opens up that opportunity for them.

Interesting history behind the company. They spun off from JDS Uniphase in 2015, have done really well for themselves. But if we look at the actual results from the quarter... I mean, strong results, they were very clear in the call that, while the ongoing drama with Huawei is something that is affecting some companies maybe more than others in this value chain, Lumentum is actually coping with that situation very, very nicely. They're just becoming less and less reliant on Huawei, whereas Huawei is, kind of, reliant on Lumentum's technology, and finding themselves a little bit of a bind.

But we've seen this cycle, right now, is starting to really pick up steam, and Lumentum, in a market where a lot of companies are pulling back on guidance or not offering any guidance whatsoever, Lumentum actually guided higher for the fiscal first quarter than Wall Street estimates had pegged them at. And it sounds like it's shaping up to be a good fiscal year to come. One of the greatest performers in our Augmented Reality service thus far, Chris. Ask Lumentum or ask a doctor if Lumentum is right for you, right; that's the Chris Hill joke. I love it, I can't get enough of it.

Hill: [laughs] When you look at their relationship with Apple, we have seen other companies do very well for a couple of years because they are "a key supplier to Apple," and that works out really well...until it doesn't, until Apple says, you know what, we're going to go with someone else, we're going to do this on our own. When you look at Lumentum, obviously it's great to have the Apple business. Do you look at them and think, boy! I would love them to find a way to be less reliant on Apple? Or do you look at them and say, you know what, yeah, they've got other people they're supplying to. They're not going to crumble, if six months from now Apple decides to move on?

Moser: Yeah, I mean that is always a double-edged sword right; I mean, it's nice to have, but it cuts both ways. And certainly, big customers can command some pricing, which impacts margins. We've seen, through the course of time, really, kind of the opposite story play out for Lumentum. When they spun out from JDS Uniphase in 2015, when they went on their own, I mean, not only have they been able to grow earnings at a compound annual rate of 47%, but they have seen gross margin expansion from 33% to 47%, operating margin expansion from 5% to 27%. So they're doing a very good job, not only serving their current customers but growing that customer base as well.

And like I mentioned, having that exposure to the Android world as well really does take a lot of the pressure off. I think that probably frees them up a little bit to feel like they can do more things as opposed to trying to make sure that they're [laughs] just doing one thing really well and serving one particular customer.

I mean, you never want to see them lose a big customer like an Apple, but the flip side to that is that it does seem like, No. 1, Lumentum really is the market leader in this space, particularly when it comes to that VCSEL technology. There are other competitors out there, II-VI [II-VI, Inc.] playing in that sandbox, but really, Lumentum does something really well, and I suspect that their customers are very happy with that, and I don't think there are any red flags on the horizon that investors should be worried about in regard to customer concentration.

Hill: ESG investing is something we don't talk about all that often on this show. ESG stands for environmental, social, and governance. Maybe we need to start talking about it more, because assets under management in ESG funds have crossed the $1 trillion mark for the first time ever. This is according to data compiled by Morningstar. You and I were chatting a little bit this morning, Jason. This is going beyond just funds. We're seeing large corporations starting to invest in ESG, whether it's hiring executives for the C-suite of their businesses or just starting to deploy, in some cases, hundreds of millions of dollars.

Moser: Yeah. I mean, from a fund perspective, this is really customer service in its purest form, isn't it? I mean, you find out what the people want and then you give it to them. And I think for probably a long time, most investors didn't really realize that ESG investing was necessarily a thing that was gaining traction or presented all these types of opportunities, but, you know, it's kind of that Field of Dreams, right, if you build it, they will come. And it seems like we're seeing more and more, not only governments and municipalities buying into it and investing in it, we're seeing more fund managers buying into it, renaming funds, redirecting funds. We're seeing corporations starting to actually raise money based on Green Bond Framework. Certainly, Visa just made some news here in that regard.

And it's interesting to see the formality here, behind this Green Bond Framework. Like, if you read through Visa's issuance of these bonds, I mean, they're very clear as to what they're trying to do, right. Finance the transition to low-carbon operations, align with sustainability, the issuance of Green Bonds will hopefully inspire other companies to do the same thing. But there's an organization and an association called the ICMA, the International City/County Management Association, and this is the world's leading association of professional city and county managers and local governments. And there are actually Green Bond guidelines that are used in order to, really, guide how investment firms, how companies formalize and carry out these types of investments, and they really are things that are all geared toward sustainable measures, renewable energy, green building, sustainable water management.

And I think Visa is going to be one of just many companies that does this, but they're going to be issuing an annual report on the use of the proceeds from their Green Bond Fund and their environmental impact going forward. And I think that'll provide the transparency and accountability that will lead toward more interest in the space and, hopefully, a decade from now we'll be looking at a firmly different mindset in the way we view how we use resources in the world and whatnot, around the investing community around the world. I think this is really the beginning of a change in mindset that will hopefully last for many, many years to come.

Hill: And there are a couple of different ways you can look at this, but I think in every way that you look at this, this is a growing trend. So one way to look at it is just, how are businesses spending money on power? And increasingly, over the past decade, you'll see a story here or there about, like, oh, this large company just, you know, invested a bunch of money in solar panels for their warehouses, and that's going to power their warehouse. They're going to get their energy that way. You can also look at it just from the standpoint of, I was going to say activist investors, but that's [laughs] more on like the hedge funds -- just, sort of, individual investors.

Larry Fink from BlackRock made some comments a couple of weeks ago about just, sort of, ESG as a trend as more and more investors start to care more about where their investment dollars are going.

Moser: Yeah. And I mean, it wasn't all that long ago when -- I think it was Larry Fink who really came out on the front lines of this change, talking about how important it was for him, to him not only personally but also for the company and for the investing community and the world at the end of the day, [laughs] you know, being able to adopt these types of mindset changes and these philosophies and these new ways of doing things. And you know, it just takes a little bit to get the movement started.

I mean, investing at the end of the day is -- I mean, we want to feel good doing it, of course, but really, we're investing for a reason, right; we're investing to make money and achieve the goals that we've set out for ourselves. And I think, you know, for a long time, it was just seen as maybe a more expensive way of doing business, ESG, and we are getting to the point now where that's just not the case, and therefore it starts presenting more attractive investment opportunities. And when you start talking about making opportunities to make more money, well, the investor [laughs] community's ears perk up and that brings more people into the fold. And you know, it doesn't take too long and you have a movement on your hands, and it seems like we're at that point now, which is nice.

Hill: Our email address is [email protected].

We got a question from Etamar in Israel; I hope I'm pronouncing his name correctly; apologies if I'm not. He writes, "I listen to your podcast on my drive to work. On one of these drives recently, I was reminded of the wedding industry and the fact that most people I know are either postponing their wedding or scaling it down significantly due to the pandemic. Is there any way to invest in some future increase in wedding activity, or do you think that these couples may be routing their money elsewhere? I would appreciate some input. Thanks, and keep up the great work."

I love this question, because of the way this guy is thinking. You know, just thinking in terms of, here's this industry, it's depressed right now, what does a rebound look like, and is there a way to invest in it? And before I hand off to you, Jason, one of the things that stood out in his email was the phrase when he said, "Most people I know are either postponing their wedding or scaling it down significantly," and that's the part that I look at and think -- you know, we've talked before about how, in the past, there would be a natural disaster of some sort, a hurricane, a blizzard, that kind of thing, and monthly auto sales take a hit, but oftentimes they rebound the following month. But that doesn't happen for restaurant sales, because people aren't going to [laughs] go out and eat twice as much food as a result of that. This is one of those things.

Like, I want to see every industry have the opportunity to rebound, but you know, when I think about the wedding industry, it really does seem like it's not going to be a V-shaped recovery.

Moser: No, no. And I mean, you definitely can't make up for missed weddings. Obviously, postponed weddings, a bit of a different thing, but people, generally speaking, aren't going to go out and get extra married if they had to postpone it or delay it [laughs] or whatever. But it's a massive market, I mean, you and I are married. You guys have been married for -- I don't know how long you and Karen have been married for, you know, probably longer than my wife and I've been married. But there's a lot that goes into [laughs] a wedding, right; it's expensive. And I mean, you're talking about a $75 billion market, and it's growing. The average wedding costs somewhere in the neighborhood of $33,000; that is not chump change.

And so, I think it's reasonable to assume going forward that there might be a different perception on how people view weddings. I mean, that millennial mindset or future generations, Gen Z, may think of it a little bit differently. I don't think that's going to be something that extends to the greater population. I think there are still going to be plenty of people that value that time in their lives, that occasion.

You know, weddings are very small-business focused, so then you start thinking about what businesses really support these small businesses? And there are some of the usual suspects out there. We talk about companies like Square or companies like Shopify, and I'll throw Stripe in there -- even though Stripe isn't publicly traded, but Stripe powers a lot of Shopify's payments. But you talk about caterers, you talk about photographers, you talk about all the service providers for a wedding. Aa lot of them are just small businesses that are running their operations with one or two of these businesses in mind. And Shopify actually has some pretty cool stuff in regards [laughs] to wedding registry app builds, too. If you are a company that does that stuff, Shopify has tools where you can build a registry. Wayfair, another great idea there that has been catering to that market and building out registries and figuring out more ways to participate in that space as well. I think Pinterest is always a fascinating one, just because of the nature of the platform.

I think one thing that's probably not as disrupted, even for people who say, well, we're going to cut back and spend less on the wedding, I think, travel is probably not as disrupted. I think people still probably, after the wedding is all said and done, however they do it, they're probably going to want to go somewhere, a traditional honeymoon. And I think there is probably going to be a lot of pent-up demand in regard to travel that could come to the surface here over the next several years.

And perhaps housing as well. I mean, you know, getting married is one of those things that, you know, you start thinking about settling down and perhaps buying a house and whatnot. So I think it's helpful to look at all of the markets that really service this ultimate wedding market, right; the before, the during, and the after, because there's so much in play here.

But, yeah, I'd imagine any headwinds it's facing now, I think there are some areas that'll pick some steam back up once it's all said and done.

Hill: I hadn't thought of the wedding registries before you mentioned it, but that could be something that maybe provides some insight. I could imagine 6 months from now on in the earnings call, or 12 months from now, maybe some retailers talking about the wedding registry business that they've got, whether it's Bed Bath & Beyond or Target or whoever it is, I could see that sort of thing. But until then, yeah, it's hard to get insight, because as you said, so much of this industry is those small businesses out there.

Moser: Yeah. And we will see in time companies like Wayfair, I think, even Etsy really, we'll get in here and talk more about this. But they do shine a light on things like registries and the benefits there. I mean, Wayfair, that was something relatively recent that they were starting to put more attention to, developing wedding registries and playing more of a part in that market, because it is such a big one. I mean, we just said it right there, I mean, the wedding industry, generally speaking, it's about a $75 billion market. It is growing. I mean, we talk about looking for large and growing market opportunities as investors, weddings are no exception. It's just trying to spot the companies and the value chain that are really worth our time. And, you know, those aren't necessarily as obvious, but they are there.

Hill: Jason Moser, thanks for being here.

Moser: Thank you.

As always, people on the program may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear.

That's going to do it for this edition of Market Foolery. The show is mixed by Dan Boyd. I'm Chris Hill. Thanks for listening. We'll see you tomorrow.