Chris Hughes: Can ESG targets reconcile with GMOs?

The need to feed an expanding population while reducing the high greenhouse gas emissions from agriculture means that agriculture must become more efficient. One solution is greater use of genetic technology in seed production. However, genetically modified organisms (GMOs) remain a nightmare for many ESG funds who are wary of the unintended consequences of intervening in the food chain (the so-called precautionary principle).

The difficulty with this cautious stance is that it becomes more difficult to maintain if it exacerbates the risk of a food crisis. So some investors are now betting that the ESG position will change.

The environmental impact of agriculture cannot be ignored. This activity is responsible for about a quarter of global emissions, according to the United Nations Intergovernmental Panel on Climate Change (IPCC). Deforestation for farmland harms biodiversity and there is a continuing need to reduce the toxicity of pesticides and herbicides.

Countering this, however, is a very serious social consideration. Demand for farmed food is heading toward a reading that would be 61% higher in 2050 compared to 2020, according to analysts at UBS Group AG. While agricultural yields have been improving, it is important to accelerate to avoid a shortfall in crop supplies possibly early in the next decade, UBS reckons. Without such improvements, according to the research, the additional arable land needed to meet demand is equivalent to the combined area of ​​the UK, France, Belgium and the Netherlands.

Could the problem be solved by changing eating habits, reducing the need for certain crops, or reducing food waste? UBS considers a scenario in which consumers in higher-income countries eat less meat, population grows at the low end of UN estimates, and there is a reduction in both food waste and biofuel use. There would be enough food supply, but there would be no reforestation. So efforts to promote biodiversity would suffer.

This means that meeting environmental and social goals will require solutions that address supply and demand together. Industries that allow it could generate $1.3 trillion in annual revenue by 2050, UBS forecasts. Seeds and phytogenetics stand out, given their potential to increase agricultural yield.

However, direct investment opportunities are rare. Two publicly traded companies, Bayer AG — the German group that bought controversial GM seed pioneer Monsanto in 2018 — and Corteva Inc. — spun off from the Dow Chemical-Dupont merger in 2019 — dominate the industry. of the seeds. Third-ranked ChemChina’s Syngenta is considering going public but it is unclear when.

Which brings us to the recent arrival of activist funds at Bayer, such as Inclusive Capital Partners LP — which focuses on social impact — established by Jeff Ubben, founder of investment firm ValueAct Capital.

Activists look for stocks that trade below perceived fair value, with identifiable catalysts to close the gap. Bayer’s market valuation suffers a significant discount to Corteva, even allowing for the fact that half of its business is in pharmaceuticals. The obvious triggers for closing the discount are: a settlement settlement claiming that glyphosate-containing herbicides cause cancer; a management change; and listing a stake in the agricultural science business to attract investors dissuaded by Bayer’s conglomerate structure.

But in addition to these conventional value drivers, there is the possibility that the ESG attitude towards the agricultural science sector will change radically. For some ESG funds and indices, companies that generate more than a fraction of their revenue from GMOs are just as much off limits as companies involved in tobacco, gambling and nuclear weapons. The question is whether, globally, there will be a shift towards perceiving food genetics technology as necessary to achieve decarbonisation, which in turn would lead to higher ESG ratings.

Outside the United States, the world has had doubts about the acceptance of GMOs in the food chain. But the evidence is mounting to support the investment thesis.

The corporate and investor debate is beginning to include the issue of emissions from food production. French dairy giant Danone SA said last month it was aiming for a 30% reduction in methane emissions from its fresh milk supply chain by 2030. Others will come under pressure to make similar commitments. MSCI Inc. modified its ESG exclusion criteria last year and companies involved in GMOs are now less likely to raise a red flag. Some analysts also point out that so-called gene editing is potentially more acceptable to the public and regulators than genetic modification, since gene editing involves altering a plant’s DNA without introducing a foreign gene, as is the case with GMOs.

Financial markets can help by allocating capital to companies best positioned to prevent a food crisis. But the “G” branch of the ESG component will also be of great importance. The need for large research and development budgets means that agricultural science is likely to be concentrated in the hands of a few powerful players. Good governance will be crucial. A limited number of seed producers, who could sell fertilizers and crop protection chemicals to the same customers, is not ideal (especially considering the need for biodiversity).

This industry needs not only activists, but long-term, active investors who provide the best scrutiny that public markets have to offer.