European equities: investing in a new environment

Has the new interest rate environment changed your long-standing negative investment view on European banks?

The underweight to banks has been, well, for me, a career-long kind of structural position and probably one of the longest duration alpha generating decisions for any European equity manager in the last 5, 10, 20, 30, 50 years has been [to] avoid banks or seriously underweight them.

And structurally I don’t see too much reason to change that view. But what we have changed recently, curtesy of the changed interest rate environment, is we have narrowed the underweight.

So, we are not as underweight as we were on banks and we kind of started to make a move around about September, and that was mainly to reflect the changing and changed interest rate environment and admittedly an element of portfolio risk control/risk management versus our benchmark*. I see banks, as always, as a tactical situation. But that might be tactical for several months, it might be 12 months, it might be 18 months, but I don’t really see intrinsic investment merit on a multi-year view on European banks.

*benchmark is the MSCI Europe Index

Is your exposure to big oil driven by the price of the commodity?

We used the sell-off in oil stocks around June of 2022 to make a more meaningful overweight decision. So, we bought big oil in 2022. This was not tactical. We see this as part of a long wave mean reversion. A long wave rehabilitation of energy in global investment portfolios.

Cancel culture, curtsey of ESG, came to oil. But I don’t think that will mitigate the rehabilitation of energy in global portfolios.

If we look at energy’s percentage of the MSCI World index, back in ‘08 that peaked at around 14%. As oil started to be ‘cancelled’ in investment portfolios, it actually troughed at 2.5% of the MSCI World. So down from 14% to 2.5%. It is now about 5%. We would be very surprised if that didn’t mean revert to 10% or thereabout.

So, we’re in oil as a structural decision. I think it’s a very good question to ask: ‘well how do you make sure that’s not just a play on the commodity?’. You can’t divorce it from the commodity. And you see that in the day to day moves when brent moves from 90 dollars to 88 dollars, oil stocks underperform on that day or that week, but you have to look through that.

I think we think the demand destruction that would be required for the commodity, ie. oil demand, would have to be of such magnitude or such a magnitude that we are not going to see. Yes, there will be demand destruction because we are entering recession in many if not most parts of the world but we would be awfully surprised if that is sufficient to drive the oil price below 60 dollars.

As an active manager, how do you measure ESG risks?

I think one of the things we have tried to be very consistent in our messaging to our clients and indeed the way that we practice money management is in ESG. We are sort of, I guess, fairly early and a [little] bit contrarian and in a sense unpopular with our messaging which was please don’t turn this into cancel culture. It’s about not cancelling those industries but when you invest you invest and engage and you hold the feet to the fire of those management teams in their capital allocation, in their decisions.

And I think one of the frustrations we felt when ESG first came on the scene if you like a couple of years ago was this crazy scorecard type investing that seemed to come in. You rule something out just because it has a score of this. Now whether your data provider is Sustainalytics or MSCI or S&P, what you can find is the data has not been cleaned. This was unscientific data, so you could have one data provider excluding a cement company but the other saying its fine.

We said look, do not go down the road of scorecard investing. And we said and it’s still in our presentations – don’t be surprised to see ESG 2.0. And you might see 3.0. In other words, its iterative. And you are now seeing some of the more draconian asset management messages of ‘this is excluded, that’s excluded’ you are actually seeing, being dialled back saying ‘we didn’t quite mean that.

Add what we really meant by that is ESG delta – the rate of change, the rate of improvement. Where is a company coming from and where is it going to. Is it taking the right steps at the right pace to meet independently set and monitored targets on E and S and G.

We can’t just choose one of the initials. It can’t be E and the E’s got a lot of the noise and attention for sometimes valid and sometimes not valid reasons. We have always engaged on the S, we have always engaged on the G and we have increased our engagement on the E. So, for us nothing has changed.