Lauren Taylor Wolfe and Christian Asmar are activist investors: They angle for change at companies in order to generate superior returns for their investors—they just don’t do it in the way that Carl Icahn and Bill Ackman have made famous.

After spending a decade at activist hedge fund Blue Harbour Group, the duo launched Impactive Capital in 2019, with $250 million from the California State Teachers’ Retirement System. The concentrated hedge fund, which owns eight to 10 small companies, now oversees more than $1 billion in assets. (Blue Harbour closed in 2020 after operating for 16 years.)

Governance—especially when it comes to improving capital allocation and operational improvements—is the bread and butter of many activists. Impactive pays close attention to these factors, but differs from traditional activists by also pushing companies on the environmental and social parts of the ESG triad, in ways meaningful to their businesses. And Wolfe and Asmar stick with companies for at least three years to reap the returns.

Wolfe, 41, began her career as a consultant to banks and technology companies, and worked in a family office investing in small and private companies before joining Blue Harbour. There she met Asmar, 38, who previously worked in investment banking and as an analyst on Morgan Stanley’s infrastructure fund.

Like other value investors of their generation, they lean toward quality businesses with widening competitive advantages and the ability to generate free cash flow significantly in excess of what’s implied in their stock prices. They look for companies that can deliver a high-teens to low-20s percent annual return on their investments, identifying businesses where ESG improvements can help contribute to some of those returns.

Barron’s caught up with Wolfe and Asmar to learn more about their version of activism, how more female mechanics could unlock value at an auto dealer, and why green ammonia excites them. An edited version of our discussion follows.

How do you define activism?

Lauren Taylor Wolfe: There’s a broad spectrum of activists. On one side are the more hostile activists—like Carl Icahn, Will Ackman, and Starboard Value—all of whom I respect and who generate good returns.

Most activists are looking for a quick fix—forcing a company to sell a business or buy back shares. We are looking for long-term, systemic change that will make companies more competitive, which makes them more profitable and valuable. But that requires patience and stamina. Our approach is one of humility, where we demonstrate to management how working with us can drive substantial returns. That has led to [companies] inviting us on the board, instead of proxy contests.

How does the ESG view fit in?

Wolfe: While researching companies at Blue Harbour, we realized—and particularly among the younger generation—that customers and employees were voting their dollars and time, their two most important assets, in ways that aligned closely with their values. That meant increasingly thinking about climate change and diversity, equity and inclusion. We saw a huge opportunity to use tools, particularly on the social and environmental side, to drive return.

What do you think of Warren Buffett’s recent resistance to ESG?

Wolfe: When you reduce your investment universe, you reduce your opportunity for return. But if Buffett saw how we link it to accelerated returns and the economic case, it’s hard to refute. We are helping companies lower their cost of capital and that is a competitive advantage.

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Christian Asmar: Every company has a responsibility to be a good ESG actor. The ESG opportunity is a factor in every one of our investments. Having a long-term horizon—three to five years—has enabled us to come to companies with ideas around ESG that are thoughtful, substantive, and tied to returns. For example, making investment in energy efficiency only [shows returns] if you are invested in the stock for a couple years.

Large investors such as BlackRock (BLK), StateStreet, and Vanguard are paying more attention to ESG. How is your view different?

Wolfe: Some have a list of 10 to 15 principles or best practices. The problem is that five may be value-neutral, three may be value-destructive, and a couple may be value-creative. We focus companies to prioritize those [best practices] that we think will drive the most profitability and long-term value.

What is an example where you see a change related to ESG accelerating longer-term returns?

Asmar: We bought Wyndham Hotels & Resorts (WH), which focuses on the economy to midprice part of the market, with the thesis it would be resilient in a downturn, considering we were in year seven of an expansion. A once-in-a-century lockdown wasn’t in my spreadsheet. But [upon reassessing during the pandemic], the core things we liked—its franchise model and economic resilience—were still intact. We added to it. And because it’s the world’s largest hotel franchise, any ESG changes it made would have a big impact.

What types of changes have you suggested to management?

Asmar: In high-end hotels, guests can opt to not have their rooms cleaned to help the environment. We thought linking that to a loyalty program would be a good idea, for example, offering $5 toward the loyalty program and saving roughly $20 from not cleaning the room. The loyalty program is part of its [competitive] moat, so it’s good ESG and also good business. These changes need a chance to work into the operating metrics. One reason it’s tough for shorter-term investors to make authentic ESG changes is because it takes time.

Where else are you focused on environmental-related changes?

Wolfe: KBR (KBR) is thought of as an engineering and construction group, but that was the KBR of seven years ago, when over 80% of revenue came from liquefied natural gas, oil rigs, and engineering and construction contracts. In 2014, Stuart Brodie came in as chief executive and materially changed the business. Today, more than 80% of revenue is from government services—higher-growth areas like space, defense, intelligence, cybersecurity; 18% is its sustainable technology solutions. KBR has announced that it is exiting the low-quality engineering and construction business; no one has realized that. We are adamant they dial up investment to the sustainable piece of the business, especially green ammonia.

How will green ammonia, made from renewable sources, create value for KBR shareholders?

Wolfe: We are going to be a less greenhouse-based economy [driven by coal and gas], and move more toward a hydrogen-based one. Global companies— PepsiCo (PEP), Danone (DANOY), Unilever (UL), H&M (HNNMY), Novo Nordisk (NVO)—are launching decarbonization goals, with pledges to reduce [carbon footprints] 20%-30% by 2030 and by 2050 get to net zero [or carbon neutral, by reducing their own emissions and offsetting the rest with investments in green projects].

How will that create value for KBR shareholders?

Wolfe: We think there’s $150 million in Ebitda [earnings before interest, taxes, depreciation, and amortization] in KBR’s sustainable business. KBR says it will double Ebitda over the next three to four years. We think it will be greater than that; much of the growth will come from the ammonia business as companies decarbonize. KBR is expected to generate $1.5 billion in free cash flow and $1.5 billion in debt capacity over the next couple years. We want to help them accelerate mergers and acquisitions in this business to help them triple earnings overall.

How can social change generate shareholder returns?

Wolfe: Asbury Automotive Group (ABG) is an auto dealer—a great type of business because they are locally branded monopolies. But they are misunderstood because in the past they were cyclical, with a larger portion of profits coming from new and used cars. Today, they are like a razor-and-blade businesses. Two-thirds of profitability in a normal, nonpandemic environment is driven by parts and services.

We bought Asbury at around seven times earnings, and see a multidecade M&A opportunity for auto dealers. About 85% are privately held in hands of individuals, many of whom are approaching retirement. But when we looked at the utilization of the parts-and-service business—the highest-quality and highest-margin part of the business—it was stuck at 50%, for Asbury and the industry. They attributed it to a shortage of technicians. We asked if they considered paying [workers] more; they had. But they were overlooking a candidate pool—women, who represent less than 2% of mechanics but dominate as consumers.

How does Asbury address a structural issue like that?

Wolfe: We put them in touch with female owned-and-operated auto collision centers. They invested to make themselves more attractive—for example, investing in locker rooms and bathrooms for women. They are the first publicly listed auto dealer to offer paid maternity leave, have two shifts to allow for child and elder care, and are thinking about a four-day workweek.

How do you persuade a company to make those types of investments?

Wolfe: If they could increase the utilization of their parts-and-service bays by 10%, it would increase the business’s overall enterprise value 20%. Near the end of 2020, we helped management lay out the building blocks to achieving long-term goals. It develops a level of trust with management. We aren’t running proxy contents, paying crisis management and lawyers, and waiting two years to get influence.