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In the latest episode of our Global Perspectives podcast series, Head of Global Sustainable Equities Hamish Chamberlayne and Portfolio Manager Aaron Scully join Adam Hetts, Global Head of Portfolio Construction and Strategy. In this podcast, they discuss key environmental, social and governance (ESG) factors influencing sustainable investing, including Russia, energy price inflation and the rotation away from growth equities, alongside the longer-term structural opportunities generated during current market volatility.
Environmental, Social and Governance (ESG) or sustainable investing considers factors beyond traditional financial analysis. This may limit available investments and cause performance and exposures to differ from, and potentially be more concentrated in certain areas than, the broader market.
Commodities (such as oil, metals and agricultural products) and commodity-linked securities are subject to greater volatility and risk and may not be appropriate for all investors. Commodities are speculative and may be affected by factors including market movements, economic and political developments, supply and demand disruptions, weather, disease and embargoes.
Energy industries can be significantly affected by fluctuations in energy prices and supply and demand of fuels, conservation, the success of exploration projects, and tax and other government regulations.
Alpha compares risk-adjusted performance relative to an index. Positive alpha means outperformance on a risk-adjusted basis.
Volatility measures risk using the dispersion of returns for a given investment.
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Adam Hetts: Welcome to Global Perspectives, and welcome back to Hamish and Aaron. Thanks, guys, for doing your fourth episode here.
Aaron Sully: Great to join you.
Hamish Chamberlayne: Yes, great to be here.
Hetts: And of course, Hamish Chamberlayne is our Head of Global Sustainable Equities over in London and Aaron Scully is a Portfolio Manager on the Global Sustainable Equity Team here in the studio with me in Denver. So, Hamish, it’s early May, quite a few things have happened since our last episode in December. First, there’s Russia, so a simple question here, and maybe a dumb question, but what do you do about Russian ESG [environmental, social and governance] concerns? Like, what if there’s a Russian windmill factory? Do you not invest anymore because it’s Russia, or what do you do to support the “E” but mitigate the “S” there?
Chamberlayne: Yes, so it’s obviously a very topical question and we have had a lot of clients asking us about our exposure to Russia. And on one level, it’s a very simple answer. We have no exposure to Russian companies and in fact we’ve never invested in any Russian-listed companies. Quite simply, the corporate governance structures in Russia don’t pass our sort of ESG criteria and so we’ve never allocated capital there. Now, we obviously have investments in companies that do have exposure to Russian operations, and we were very quick to do a deep analysis on our portfolio to analyze the exposure of any potential Russian exposure of the companies that we invest in. And we, fortunately, have very little exposure. So, none of our companies that we invest in have more than 2% of sales exposure to Russia, and I think most of them have already written that off and are in the process of closing down their Russian sales operations.
We do have one U.S. company that does have a significant operational footprint in Russia. This is an advanced laser manufacturing company. It has operational facilities in the United States, in Europe and also in Russia, where it has some low-cost manufacturing. So, this has been the only company that’s had a significant impact I would say, in respect of its operations, and the company is in the process of shifting its operations to its European base. And fortunately, the company’s got a very strong financial profile, no debt on the balance sheet and a lot of cash, so it’s in a very strong position in order to be able to do that and navigate that.
Hetts: Then Aaron, so, another change in the last few months, energy and commodity prices [are] skyrocketing, obviously. And so the initial reaction seems that oil prices have been horrible for ESG returns, but what’s the bigger picture here as far as commodity prices and inflation and ESG returns?
Scully: Yes, very timely. So first off, not an earth-shattering conclusion that if you invest in our sustainable strategy, you’re not going to get exposure to oil and gas. Clearly, that’s a headwind for performance when oil and gas stocks are thriving. But with that said, actually, higher oil and gas prices only accelerate the adoption for a lot of our companies that we invest in and actually are very positive for these companies. An obvious example is the renewable energy sector. We invest in a number of renewable energy development platforms, and as the price of oil and gas goes up, the number of projects that can actually pencil acceptable returns increases. Not only that, but you see just greater demand for a lot of these renewable projects.
So the Russian war, that definitely has increased the spotlight on the geopolitical vulnerabilities of certain countries, and these countries will now be even more aggressive in transitioning towards renewable energy. I guess another example would be electric vehicles [EVs]. Higher oil and gas prices only make electric vehicles more attractive to consumers. There was that recent study by the University of Toronto that compared the lifetime [emissions] costs of owning a Tesla 3 [EV] versus a [gasoline/petrol powered Toyota] RAV4 and concluded that it was actually cheaper over the life of the vehicle if you owned the Tesla. So, while we no longer have direct exposure to EV manufacturers, we do have a great deal of exposure to companies that supply key technology that’s input into those electric vehicles. This can be connectors, the wiring of the car, semiconductor chips, electric motors, etc.
Hetts: OK, so what else is going on? How are you guys feeling right now about the broader ESG investing environment during what’s been a wild year so far, with rates and equity sell-offs and inflation? What does that mean for the broader landscape outside of just commodities and Russia like we just talked about?
Scully: Yes, I think that it’s important to really emphasize who we are as investors and where we generate alpha. And at the heart of our strategy is being long-term investors. And being long-term investors means not reacting to short-term trends of the sector rotation we’re seeing. No doubt growth is, at least for the time being, out of favor currently and, you know, the growth-tier sectors such as IT have definitely suffered over the last few months. But we look at the current volatility as an opportunity to take advantage of a market that is clearly short-term fearful right now and add to names [where] we have conviction in the long-term thesis. So we were fortunate to not get caught up in buying a lot of these more speculative business models over the last couple years that, you know, a lot of times were tied up in ESG such as hydrogen, renewable fuels, [and] some of these more speculative battery technologies.
A lot of these came out through SPACs [special purpose acquisition companies]. I’m sure a lot of our listeners have heard about these. So, our focus has always been in investing in proven business models with obvious competitive advantages that have a line of sight to profitability, if not right now, down the road. And, you know, a lot of these IPOs [initial public offerings] were actually bought by some of our competitors and we just felt that these were far too speculative for our investment lens. So we’re investing in companies with great compounding potential because they offer solutions to key societal environmental challenges. These are companies that should actually do really well in an inflationary environment. They have pricing power and they’re offering solutions in a lot of cases that are deflationary, such as software [and] low-cost energy via renewables.
It should also be pointed out that there’s this common media narrative that growth always suffers in a Fed [U.S. Federal Reserve] rising [interest rate] environment, which actually is not based on fact. If we go back to the early ’90s, there have been four Fed [interest rate] tightening cycles, and in three of those four, growth actually outperformed value. In addition, technology was often the best sector to invest in during those four periods. So, while we’re not saying that growth will outperform value this time, I do think it’s important to point out that this current media narrative is detached from recent history.
Hetts: Hamish, just maybe to close out here, how do you think we’ll transition out of the short-term environment and all these headwinds? And where do you think we go from here in the medium term?
Chamberlayne: Yes, and I think it’s really important, reinforcing Aaron’s comments, to distinguish between the short and the medium term. And there is no doubt we’re sailing through some pretty adverse weather conditions when it comes to growth and ESG in the short term. In fact, these are the most adverse market conditions that I’ve experienced in the last 10 years that I’ve been working on sustainable investment strategies. But everything that we see in the world today, via the current global economic and political climate, we believe is really only reinforcing the medium-term trends that we’re focused on.
When we look around the world, we see a lot of concerns around supply chain fragility, a lot of focus on economic resilience, on reshoring, on re-localizing supply chains, on energy independence. And these are all things that are playing into the sustainability trends that we’re focused on. It’s an interesting dynamic as well because when we look around the world and look at the sort of bottom-up [fundamental analysis] view of the companies that we follow, we see a lot of positive signs. A lot of the companies that we invest in so far this year, when we look at the results that the companies that we invest in, our companies have been reporting very strong fundamentals. There is good growth, good resilience in their business models and they’re providing constructive commentary on the outlook.
And we’re also seeing that at the country level, governments are increasing their focus on making investments in renewable energy, reshoring these supply chains. We’ve seen big announcements from some of the semiconductor companies around building fabs [factories] in the U.S. and in Europe. Some of the companies that supply the parts and equipment and technologies that go into these new factories have been telling us how they’ve been seeing increasing order books, rising demand and they can see a strong pipeline. And so we remain very, I’d say, very constructive. And as Aaron said, we actually welcome the market volatility because it’s throwing up opportunities. And we’d also like our clients and our investors to regard, you know, this is an opportunity as well. I always get excited talking about our investment strategy in terms of market volatility because really the opportunities only increase during these periods.
Hetts: Thanks, guys. I think that’s a good place to close it out then. You helped me on a couple of the near-term kind of concerns and questions around Russia and the commodity price movements that we’ve been seeing, and I think that really sets the table for what will be our fifth conversation coming up later about what’s going on as we transition out of this environment. So thanks again guys for joining again, and thanks to our listeners. Please don’t forget to like or comment, and if you’d like to hear more from Janus Henderson, you can find more Global Perspectives on Spotify or iTunes or wherever you listen. And of course, check out the Insights section of the Janus Henderson website. Thanks again. I’ll see you next time.