Global Sustainable Equity: news and opportunities (January 2022)

Continuing US fiscal and monetary stimulus and strong corporate earnings made for a strong finale to 2021, which saw the most recorded rises for equity markets around the world. However, bouts of uncertainty persisted, with speculation over possible interest rate rises and inflationary pressures among the factors that kept investors’ enthusiasm in check. Other features included volatility in Asia caused by uncertainty in the Chinese property market, most notably the highly indebted company Evergrande, which defaulted on some of its debt payments. COVID-19 also continued to cast a shadow, with the Omicron strain of the virus causing a resurgence in positive cases globally. While this led to a significant equity market sell-off in November, early data indicated this variant appears to be less potent than predecessors, and global equity markets then recovered to finish the year on a strong note.

The long-term view on COP26 is promising

With regards to sustainability, the 26th United Nations Climate Change Conference (COP26) took place in November in Glasgow. While most of the countries attending the conference acknowledged that the steps being proposed are not strong enough to achieve the target of 1.5 degrees Celsius, which is viewed as essential to limit catastrophic environmental events in the coming years, important progress was made, and we take a positive view on the outcomes. The highlights included greater ambition on emissions reduction from important players including China and India, an agreement that all countries will review their nationally determined contributions annually rather than every five years, and greater clarity on carbon offsetting.

These factors are important for the stocks in the portfolio. We take a longer-term focus and believe that the direction and pace of travel is more important than any snapshot timed to coincide with a global conference. The crucial point is that COP26 achieved alignment on the need to accelerate decarbonisation.

Over 2021 as a whole, we saw significant progress in the low carbon transition, with electric vehicle (EV) sales markedly higher than the previous year. We expect this trend to continue, with higher oil prices and government initiatives further boosting demand for EVs. The progress at COP26 on carbon trading markets, and transparency for the accounting and reporting of targets and emissions should also be a powerful incentive for change.

Tech, but not all tech, leads the way

The technology sector led the way in the last quarter of 2021 with a double-digit increase over the period in US dollar terms. Given the strong performance of the technology sector in the quarter and the fund’s heavy weighting in that sector, we may have expected stronger overall fund performance. Despite this, several of our software holdings posted disappointing performance. Many of these companies have been among our stronger performers over the past few years, so there was scope for profit-taking after they reported operating results that were not quite as high as expected, notwithstanding the fact that they are still growing at a high rate and their fundamentals remain attractive.

A mixed bag of top performers

The leading contributor to performance last quarter was graphics processing units and chips designer Nvidia, which has performed well for the portfolio over the year. The company benefited from investor demand buoyed by growing evidence of the company’s technological lead and its applicability to unlocking the potential of the ‘metaverse’ across a various industries, which creates an additional large addressable market for the name.

The shares received another boost when the company announced strong earnings in November, and when it held its GPU Technology Conference, where it showcased its ‘Omniverse’ platform, which is designed to enhance 3D simulation capabilities and workplace collaboration. We remain confident in the long-term prospects for Nvidia, which has been successfully positioning itself as the platform for next-generation computing and has attractive levels of exposure to the secular trend of digitalisation. We also appreciate the sustainability aspect, which is illustrated by the company’s ability to provide strong efficiency gains in data centre markets and in the entertainment/gaming industry.

Real estate finance provider Walker and Dunlop was another significant contributor to performance. The share price maintained its recent upward trajectory, initially driven by the acquisition of Alliant Capital, an asset manager focused on the affordable housing sector, before reaching a new high after the company beat quarterly earnings and revenue expectations as a result of growing transaction volumes. Some of the strength was a result of the improved use of technology, rising multi-family sales and growth in the digital business. We are impressed by the way Walker and Dunlop has been positioning itself as a leader in the multi-family, green building and affordable housing lending areas, as well as its longer-term focus, which was outlined in the company’s 2020 environmental, social and governance (ESG) report.

Evoqua Water Technologies also delivered robust quarterly results, showing strong revenue growth in its services and aftermarket divisions, as well as an increased backlog of business. It is one of the leading providers of water technologies for the treatment and purification of water, and is exposed to trends around the circular economy and water re-use and re-circulation. The company will likely be a beneficiary of the recently passed US Infrastructure bill, which allocates $55 billion over the next five years to water infrastructure, including areas where Evoqua has extensive experience. The company is also well-placed to benefit as corporations focus on sustainability and minimising water usage in their operations.

Software disappoints

Apple is not held in our portfolio and, given the stock’s strong performance in the quarter, this was a drag on relative performance. We have not held any of the FAANG stocks, either because we don’t necessarily believe they currently make the world a better place, or because we feel they still have shortcomings in their operational ESG management. We do, however, always watch out for improvements and have certainly seen Apple improve the energy efficiency of its devices through its design approach.

Avalara fell despite a solid third quarter in which revenues and gross margins showed strong growth. The numbers were slightly lower than the previous quarter, with this marginal deceleration enough to see the stock punished. However, we see the decline in value as a short-term reaction, with our long-term thesis unchanged. As companies continue to digitalise their operations, Avalara’s products allow customers to manage their tax and compliance operations accurately. It is well-placed to benefit from higher levels of ecommerce, increasing tax and regulatory complexity, and cloud computing.

The shares of Encompass Health fell following weaker-than-expected results, largely because of disruptions associated with COVID-19 and rising labour costs. The company provided further clarity on its strategic review, deciding to spin off the home health business. We see the current issues as transitional. Encompass is exposed to the ageing population trend, which should make rehabilitation and treatment facilities more important. In addition, its use of technology is helping drive better patient outcomes while boosting profitability.

Looking ahead to 2022

During 2021, supply chain issues became a problem for many sectors including semiconductors, global energy and consumer goods. These difficulties revealed the fragility of the global ‘just-in-time’ supply chain architecture and highlighted the blind spot in supply chains from an environmental, social and governance (ESG) perspective in areas such as human rights and pollution. This is likely to remain a major theme in 2022, with implications for inflation, geopolitical tensions in areas such as China and Taiwan, human rights and energy security.

As was the case over the past 12 months, we expect the 2022 market environment to be characterised by ongoing tensions between secular growth companies and the post-pandemic ‘reopening’ of the global economy. We believe that the powerful secular growth trends of digitalisation, electrification and decarbonisation will play a huge part in the development of a more sustainable global economy and will drive myriad investment opportunities. While there may well be heightened volatility as the global economy contends with the rising inflationary pressures stemming from current economic and supply-chain dislocations we would urge investors not to be distracted by the inevitable flip-flopping of growth versus value. A period of inflation is likely to be beneficial to the growth of many of the companies in which we are invested, as it makes the economics of sustainable businesses more compelling and accelerates the level of investment into the low carbon energy transition.

We continue to look for companies that will have exciting growth opportunities as a result of this. We also seek those with cultures of innovation and built-in financial resilience. We are as excited as ever by the range of investment opportunities we see in 2022 and beyond.

Sustainability equity