To properly manage investment risk, it helps to pay attention to factors many investors ignore or by default embrace because they invest arbitrarily in index funds. In this note, scrutiny is drawn to one potential weak link in a business plan – hazards in company–specific supplier relations. What is shared herein may be disturbing to any reader, especially one, say, driving their Tesla while eating a piece of chocolate.
The mantra that differentiates is “it is not so much what one owns in their investment portfolios that matters – but what is avoided that is critical”. In strong contrast to the most popular index funds which own all large companies and industries, steering clear of certain investment sectors entirely is wise when, for example, regulatory issues are uncertain (large banks) or when the competitive environment is unhealthy (autos, airlines). Additionally, beware of supplier relationships of manufacturers and consumer products companies who source globally and risk backlash (legal and otherwise) from issues like pollution or slave/child labor.
Garbage in, Garbage Out
Let’s draw focus to sources of supply for two heavily consumed products that pose supply risks to investors: electric cars and chocolate. Management teams of companies selling these products may be doing all that they can to address supply chain challenges, but genuine fixes are mostly out of their control. As has also been true with Middle East oil for ages, sophisticated companies are willing to extract goods and use labor in developing areas (i.e. Africa, Central America, India) but local governance is such that humanitarian and environmental controls are generally lacking.
In the case of chocolate, West Africa produces around 65% of the world’s cocoa beans. Well–documented cases of child and slave labor practices in cocoa–producing countries were historically ignored by large chocolate companies.
Fortunately, expositive media reporting and a general desire by corporations to act more sustainably led to the 2007 formation of the International Cocoa Initiative (I.C.I) in Switzerland which works to ensure that growers are more protective of child labor rights. Their annual report cites a goal to help another 375,000 children in the next few years which likely means that millions of young workers are still being overlooked.
Let’s turn our attention to the popular lithium rechargeable batteries for phones, laptops and especially electric cars which are ultimately powered by one’s local electric utility. Worth noting is about 64% of the electric–grid in America is still using fossil fuels, of which 43% is coal, so, depending upon where you power up, the cars themselves run “clean” but may actually be partly coal–fired by the utility.
Moreover, electric vehicle popularity has made the demand skyrocket for a rare ingredient needed for batteries – the element cobalt. More than 60% of cobalt is mined in the Democratic Republic of Congo (DRC), a near lawless country that has witnessed millions of deaths due to conflict in the last few decades. Child/slave labor and environmental concerns in DRC are also well chronicled and concerning to any company using lithium rechargeable batteries – especially on the scale anticipated by electric vehicles. It is an area where we hope innovation and new discoveries may one day lead to an improved humanitarian, environmental and investing landscape.
While investors should be wary of heavy users of cocoa and cobalt, there are many other industries where sourcing of supplies is troublesome such as with tea, tobacco, palm oil and sugar. When looking at the full scale of a particular company’s operation it is wise to identify all “weak links in the operating chain”. If portfolios are indexed, however, it may be impossible to limit direct exposure to these areas (don’t ask, don’t tell?).
Unless hiding in a bamboo yurt eating berries and leaves, one is going to encounter the perils outlined herein living a modern life. Endeavor to avoid the most obvious uncertainties – and if that approach is deemed more sustainable than most, all the better.
This commentary is for informational purposes only and the opinions expressed herein are those solely of Andrew Burns, an advisor and principal at Hamilton Point Investment Advisors, LLC, in Chapel Hill, North Carolina. This material should not be considered financial advice. HP–19–54