In the second and final part of this series, ESG Clarity spoke to three further managers of responsibly invested funds to find out how they were positioned ahead of the coronavirus sell-off, the changes they made throughout the sharp movements and their outlooks for their portfolio holdings.
It has been well documented that ESG holdings held up better than non-ESG peers during the market falls, with many pointing to the durability of franchises, sustainability of businesses in a downturn and ability to adapt and innovate in these markets as reasons why they have managed to outperform.
With this in mind, we asked fund managers across the ESG universe how they adjusted portfolios and, if higher-rated ESG stocks are potentially looking more fully valued than non-ESG stocks, how will they continue to generate superior returns?
Alex Rowe, manager of the Nomura Global Sustainable Equity Fund
A common theme emerging from the outperformance of ESG funds during the coronavirus volatility was significant positions in healthcare and technology, and little to no exposure to energy and oil.
Alex Rowe, responsible for the running of the Nomura Global Sustainable Equity Fund, said these are areas the portfolio was exposed to as they are “quality stocks thinking about the true impact they have on the environment, society, customers and shareholders.”
“Healthcare has done very well recently, helped by the Democrats nomination of Joseph Biden – it would have been a negative if Bernie Sanders had gone through,” he said.
“We have a lot of healthcare and especially those involved in medical equipment and those that are prioritising drugs that are valuable in the fight against covid-19.”
For example, the portfolio has exposure to Gilead Science, traditionally a leader in HIV treatment but has been working with global authorities in the fight has against covid-19. “The performance here has been strong,” Rowe commented.
Tech companies, he added, are “world leaders from an environmental perspective” due to their commitment to be powered by renewables and also, they are adding value to society in general.
“We have seen a big shift towards the society – companies have had to shift their focus in light of the recent crisis, and it will be interesting to see if it stays with us.”
Rowe admitted some more cyclical names in the fund did not perform as well, and as a result, he has been rotating some of the high-performing healthcare names into more industrial, cyclical positions.
Commenting on the cheaper valuations in oil stocks, Rowe said: “We are not going to buy oil and gas just because they are cheap. We also struggled to find banks and some insurance companies that fit our criteria. They also give portfolios more active risk and a lot of similar funds were hurt by this in the 2016 US elections.
“If the oil price soars and there is a sudden snapback in the economy, these funds will definitely underperform over the short term.
“But over the long term, quality outperforms. That is a massive megatrend and we hope that people that invest in these funds are ok with some short-term underperformance.
“There has been a cloud over sustainable investing as people are worried they are giving up performance, but the opposite is true over the long term.”
He also said the outperformance of ESG funds could potentially attract some performance chasing investors and it would not be helpful to have money “rushing in and out of funds”, but he pointed out that overall the assets under management in sustainable strategies is still quite low.
“My goal would be for investors to understand it is not a choice between sustainability/impact and performance but to have performance with a positive impact – that connection is not there yet,” he said.
Matt Evans, manager of the Ninety One UK Sustainable Equity Fund
The underlying philosophy of the Ninety One UK Sustainable Equity Fund is based on three key pillars of sustainability; financial sustainability (of returns/cash generation); internal sustainability (managing ESG risks and opportunities) and external sustainability (products/services delivering towards a sustainable future), and fund manager Matt Evans said there are significant opportunities in all market conditions to create this kind of portfolio.
“In the recent volatility, I am not going to argue with the point that our fund benefitted because it held no oil and gas – but that is not the only reason. That contributed and gave us a boost, but the oil price could recover, and we could see these sectors unwind, but that has not changed our philosophy,” he said.
In order to reduce risk in the recent sell-off, Evans said he widened out the number of holdings in the portfolio and held a slightly higher cash weighting, but overall the fund saw a “big distribution of returns”. As a result, he “proactively trimmed some positions across sectors where valuations were full, reinvesting to take advantage of valuation opportunities as they arose and where we felt we could get better returns without compromise”, while he also participated in some new issues.
For example, Calisen, the smart meter systems company, was introduced to the portfolio.
“This will play a key, long term role in the future energy network and roll out of smart meters. There was an interesting valuation opportunity, the technology is fairly well proven, and it is an uncorrelated business to general GDP.”
He added the team “took the top off some higher valuations” in ITM and Ceres Power, both UK-based companies involved in electrolysers for Hydrogen production and solid oxide fuel cells.
“They carried out some fundraising in 2019, signed some commercial agreements and benefited from strategic partners investing directly, Linde into ITM and Bosch into Ceres. We thought the commercial deals and fundraising would drive returns over the next five to seven years, but what actually happened is the share price went up a lot quicker than expected. Consequently, we recycled some of that exposure elsewhere, whilst retaining a holding within the companies based on our expectation that they could generate strong financial returns as they deliver products that are set to play a critical role in decarbonisation.”
Evans is cautious on the wider outlook saying the next six to 18 months is “very uncertain” and likely to be a lot tougher than initial expectations.
“We are looking at the portfolio constantly and we are very fortunate to be in the UK and been able to have very good access – we were able to speak to companies in the first two to three weeks of the downturn.”
Companies that have very good ESG credentials, he added, and the most effective use of resources as well as those that have been able to adapt most effectively “have been on the front foot” and this will lead to companies thinking about “how they can re-jig to remain sustainable in the future”.
“All companies have a responsibility here,” he added.
David Harrison, lead fund manager and investment analyst of the Rathbone Global Sustainability Fund
An extension of the group’s Ethical Bond Fund, the Rathbone Global Sustainability Fund focused on owning high-quality equities, that have a clear commitment to sustainability, very strong management teams, strong market positions, according to manager David Harrison. It has no oil, gas or mining and certain parts of the industrial sector and has a strict policy on animal testing.
“Performance has been robust throughout the volatility due to the quality bias. We are focused on companies that are sustainable, that are market leaders, have low leverage, a strong financial position – this runs through the fund. Having these durable franchises has seen us through this downturn,” he said.
Like the other funds mentioned, this too has large weightings in technology and healthcare.
“Tech has been a good performer we have owned a number of fundamentally good businesses that have strong activity aligned with sustainability.
“Microsoft has been a beneficiary; it is well insulated to what is going and has been able to accelerate the trend to more digital work practices.
“Uncertainty will persevere but in technology there is a clear tailwind still and a sustainability driver. It remains a large position in the fund as we believe these drivers will be powerful.”
In healthcare, most pharmaceutical companies are excluded from the portfolio due to a lack of transparency on animal testing, but Harrison said the fund holds medical technology companies as they can see more certainty over future revenues. An example is Thermo Fisher Scientific, a laboratory testing and equipment business listed in the US.
“It makes a fair amount of equipment featured in any laboratory and, unfortunately, there is a big tailwind for that currently.”
He added that in industrials, even though the fund has more high-quality names from the sector, there remains a lot of uncertainty on how the economic recovery will hit industrial orders. However, Harrison is maintaining the position.
“We are looking at the balance sheets and talking to management. It will be tough short term, but we will stick it out.”
During the market pull-back, the manager also added several new positions.
“We had a bench of 20 names where the valuation or the timing hadn’t been right where the downturn created opportunities in several companies.
“We bought into Thermo Fisher and US personal goods company Clorox, which is the market leader in disinfectant and bleach. We had been engaging with them for six months and the valuation became attractive. We also bought Hannon Armstrong Sustainable Finance, the US provider of financing to sustainability projects such as energy efficiency programmes. We wanted these names that before we hadn’t been able to buy at the right price,” he explained.
Harrison added that covid-19 had placed more emphasis on social and governance issues within companies, when previously the emphasis was on environmental.
“We would argue that sustainable stocks enhance their financial returns over the long term as the businesses are more durable and able to weather the storm better. Covid-19 has prompted the question ‘are companies doing the right thing for their customers and communities?’”.
