Hamish Chamberlayne, Portfolio Manager for Janus Henderson’s Global Sustainable Equity strategy, discusses recent developments affecting the world of Sustainable & Responsible Investment (SRI), and the strategy’s positioning, performance, and activity.
Global stock markets corrected sharply in the fourth quarter of 2018 with the MSCI World Index falling 11.2% in sterling terms to finish the year down 2.5%*.
Many rivers to cross – industrials and IT disappoint
Markets fell due to increasing concerns about the outlook for the global economy against a backdrop of rising US interest rates, trade war protectionism and difficult Brexit negotiations. The market declines coincided with a style rotation, with the MSCI World Value Index outperforming the MSCI World Growth Index by 3.9% during the quarter*. The outperforming sectors were utilities, real estate, consumer staples, communication services and healthcare. The underperforming sectors were finance, materials, consumer discretionary, industrials, information technology and energy.
Over the period, the strategy underperformed the MSCI World Index. Sector positioning was an important factor in the strategy’s performance last quarter. While performance benefited from the strategy’s underweight stance towards the energy sector, this was more than offset by the overweight stance towards stocks in information technology and industrials. From a stock perspective, companies exposed to global trade and tariff concerns detracted the most from performance in addition to which, several of our Japanese-listed investments underperformed.
*Source: Janus Henderson Investors, 31 December 2018
Key contributors to performance:
Getlink (Sustainable Transport), the manager and operator of the Channel Tunnel between Britain and France, rose. Despite uncertainty around the implications of Brexit, Getlink shares gained following the announcement that French engineering company Effiage had acquired a 5% stake, which served to highlight the value in this underutilised strategic infrastructure asset. The Channel Tunnel is the safest and most environmentally friendly way of crossing the English Channel: dug below the sea bed, the tunnel avoids any interaction with the marine ecosystem, and the choice of trains and electric power represents a major factor in reducing the carbon footprint produced by moving people and goods between Britain and France.
Tesla (Sustainable Transport), the manufacturer of electric vehicles, lithium-ion batteries and solar power systems rebounded in the fourth quarter after reporting a strong improvement in earnings and cash flow generation. The Model 3 production lines are now operating smoothly and the car has been well received by consumers. While we are optimistic that this solid set of results is the shape of things to come, we are cognisant that this is still one of the portfolio’s highest risk investments and the position is sized accordingly. We view Tesla as more than just a car manufacturer, with the potential to attack multiple profit pools while accelerating the world’s transition to sustainable energy.
Gildan Activewear (Quality of Life), the North American manufacturer of t-shirts and basic apparel, renowned for its high social and environmental standards, performed strongly in November. The company announced it is broadening its private label range at key customer Walmart and also benefited from investors rotating into more defensive areas of the market, such as consumer staples. Gildan is positioned to be one of the winners in the evolving apparel landscape. Its vertical integration enables it to produce high quality garments at very competitive price points and it has a dominant franchise in the print wear industry, where it is supplying blank t-shirts and sports garments to screen printers.
Key detractors from performance:
DS Smith (Environmental Services), a leading manufacturer and recycler of corrugated packaging products, performed poorly last quarter. Despite reporting good results, DS Smith has been caught up in weakness in the broader paper & packaging sector due to concerns over paper and containerboard oversupply and softening economic growth. DS Smith has a customer-centric strategy focused on providing sustainable packaging solutions to consumer goods companies. This strategy should insulate it somewhat from economic volatility, especially with a secular shift away from plastic towards paper and cardboard packaging. DS Smith aims to create a completely circular supply chain, thereby achieving zero waste and enabling customers to reduce the environmental impact of their products.
Evoqua Water Technologies (Water Management), a water technology company with a sole focus on water treatment, fell as management announced an organisational restructuring and reduced full year guidance. We have had several meetings with management over the last couple of months to better understand the issues and as a result we have decided to maintain our investment. Evoqua serves municipal and industrial customers and its solutions span the entire water life cycle from extraction and purification to waste treatment and reuse. Evoqua’s treatment systems and services enable customers to achieve lower costs from the more efficient use of water, as well as ensuring their ability to meet regulatory compliance requirements and environmental sustainability objectives.
Shimadzu (Safety), a Japanese manufacturer of analytical and measuring instruments, fell after reporting quarterly results that were below expectations. A pause in Chinese orders led to flat sales in the core liquid chromatograph and mass spectrometry segment. Despite this, management maintained full year guidance. Analytical instruments are being used in a wider range of applications, from new drug discovery, drug quality control and assurance, research into new high-performance materials, clinical healthcare and food and environmental safety testing. Shimadzu has one of the broadest technology portfolios, with a variety of instruments at differing price points. It has been developing new blood tests for early screening of Alzheimer’s disease and cancer.
Activity and positioning
Portfolio turnover was 5.7% in Q4 and 26.9% for the full year. This is line with our long term average of 20%-30%, and follows an elevated period in the latter part of 2017 and early 2018 (reflective of our collaboration with the Denver office following the completion of the Janus Henderson merger in 2017). We would expect portfolio turnover to continue in line with our long term average now that we have successfully integrated with the Denver-based investment teams.
Strategy positioning remains skewed towards our Knowledge & Technology and Efficiency themes, resulting in our continued overweight towards the information technology and industrial sectors versus the index. The strategy remains underweight energy and consumer staples and regional weighting remains in line with the MSCI World benchmark. The strategy is managed to maintain regional weightings in line with the MSCI World benchmark, while sector weightings are derived from the most compelling bottom-up stock ideas we find, while maintaining a balanced risk profile.
During the quarter, new positions were initiated in Costa Group, Knorr-Bremse, Intuit and Teladoc. Positions in Henry Schein, Kone, Leopalace21 and Mednax were divested.
Costa Group (Quality of Life) is Australia’s largest grower of fresh fruit and vegetables. Its portfolio consists solely of fresh healthy produce and its main products are berries, avocados, citrus, tomatoes and mushrooms. It supplies all the major Australian supermarket chains as well as independent grocers, and it exports to Asia, North America and Europe. It has adopted leading sustainability initiatives in its agricultural operations, including smart irrigation and vertical farms and is recognized for its high labour standards.
Knorr-Bremse (Sustainable Transport) is one of the top global manufacturers of subsystems and components for the rail and commercial vehicle industries. Its technology is focused on improving safety and efficiency, and reducing environmental impact. For example, it has leading capabilities in braking systems and driver assistance technology, which include lane departure warning and blind spot assistance.
Intuit (Sustainable Property & Finance) is a financial technology company that develops software for small businesses, accounting professionals and consumers, covering areas such as tax, payroll processing and personal finance. Its mission is to power prosperity around the world and it does this by providing the tools to help small businesses and consumers manage their financial resources more effectively. Its QuickBooks franchise also provides loans to further assist small business formation.
Teladoc (Health) is a virtual healthcare platform that provides telemedicine services in many countries around the world. Its mission is to transform how people access healthcare by offering an experience with greater convenience, outcomes, and value. Its network of healthcare professionals can prescribe medical treatment for a wide range of conditions across general medical, dermatology and behavioural health. Across the globe, healthcare services are under enormous strain, with millions of people not receiving care. Telemedicine enables more people to access healthcare services in a timely and convenient manner and at a lower cost.
Our outlook has not altered from the comments we made in our last quarterly update. 2018 was a difficult year for equity markets, with rising interest rates, US China trade tensions, signs of slowing economic growth, Brexit and political discord in Europe all weighing on investor sentiment. While we expect many of these uncertainties will continue in 2019, we also see many reasons to be constructive. Current signs are pointing to only a modest slowdown in global economic growth, not a recession, and equity market valuations now look more attractive. Despite recent rises, by historical standards interest rates remain at low absolute levels, and China is starting to enact economic stimulus policies. Meanwhile, technological change and innovation driven growth are not going to slow down. When we look at the portfolio we see some parallels with 2016, when we noted how many of our stocks had good growth prospects and were trading on attractive valuations.
The long term trends we analyse have not changed. Sustainability issues will continue to grow in importance, with active managers making a positive impact by consciously allocating capital towards companies that are contributing to a more sustainable planet, and away from those doing harm. The ‘great acceleration’ of the past few decades has led to a phenomenal increase in the demand for energy, land and water and now the concurrent climate change and environmental destruction is too obvious to ignore. To quote the chief executive of the World Wildlife Fund, “we are the first generation to know we are destroying our planet and the last one that can do anything about it”.
Sustainable investing for sustainable returns
When we think about sustainability we see a world of opportunity. We are seeing rapid increases in renewable energy, many more electric cars, and billions more connected devices, with semi-conductors and microchips capturing and generating vast amounts of data. All of this will be stored in the cloud, requiring memory and then analysed and made useful by software in order to create efficiencies, increase productivity and generate value. As well as holding many leading companies related to these areas, the portfolio also has exposure to consumer companies leading the way in the circular economy; and to companies in health and life insurance, healthcare services, water technology, electrical safety, architectural design, education and entertainment. We also believe that oil prices will remain under long-term pressure – in fact, that a high oil price is self-defeating, since it only serves to accelerate innovation and substitution.
Mean reversionary events are inevitable over shorter time periods and when they happen, it is important to remind ourselves of the difference between value and valuation. Many factors can cause fluctuations in near-term valuations, including interest rates. Over the long term however, we believe that growth will always generate the most value for investors. To our mind, creating long-term investment returns is, by its very nature, investing in sustainability.