Hamish Chamberlayne, Portfolio Manager for the Janus Henderson Global Sustainable Equity Fund, discusses recent developments affecting the world of Sustainable & Responsible Investment (SRI), and the fund’s positioning, performance, and activity.
In the second quarter of 2019 global stock markets advanced to new highs for the year, with the MSCI World index rising 6.7% in sterling termsᴵ. There was another spike in volatility during the quarter as markets fell in May due to escalation in the US-China trade war and further evidence of a slowing global economy. The sell-off was short lived, however, with markets rallying sharply in June as the US Federal Reserve (Fed) gave a strong signal that it could soon cut interest rates.
Information technology again was one of the best performing sectors. While technology has been a key battleground in the US–China trade war, many companies are exposed to secular growth drivers that, to date, have not been derailed by the political environment. Perhaps counterintuitively, the political tension between the US and China could actually be supportive for technology companies, to the extent that it might precipitate an innovation ‘arms race’. The real estate sector also responded positively to the shift in direction in monetary policy. Underperforming sectors were healthcare and energy, the former remaining under pressure due to negative political rhetoric from Democratic Presidential candidates around large scale reforms, and the latter due to weak oil markets in the face of slowing economic growth.
It is too early to confirm but, six months into 2019, it appears that extreme weather events are on the rise. To highlight a few, there have been record summer temperatures in Australia, Alaska, and Europe, months of floods and tornadoes in the US Midwest and heavier than usual monsoons in India. Encouragingly, records are also being set in renewable energy. In the UK this year zero-carbon energy will overtake fossil fuels as the largest electricity source over a full calendar year. And in April, renewable energy overtook coal fired power generation for the first time in the US.
When considering greenhouse gases, most people think of transportation and power as being the largest polluters but, in fact, agriculture is a greater contributor. What we eat has the biggest impact on the environment, and this is why we include criteria on intensive farming, along with meat and dairy, in our investment principles. Reducing global meat consumption is an important factor in achieving environmental targets and, in this respect, it is interesting to see the growth in ‘fake’ meat. One of hottest initial public offerings (IPOs) this quarter was Beyond Meat, a manufacturer of plant based burgers and sausages, which has risen more than fourfold from its listing price. We have not invested because we find the valuation too high and we are not yet convinced of its sustainable competitive advantage.
In other news, there has been a step up in regulatory scrutiny of some of the big technology companies. The US Justice Department is preparing an anti-trust probe of Google and it has also been given jurisdiction over Apple as part of a broad review into potential anti-competitive behaviour. Meanwhile, the US Federal Trade Commission has assumed oversight of Amazon and Facebook, looking at how they could potentially be harming competition. Facebook also continues to be beset by controversies over the governance of its social media platform. Following its handling of the recent Christchurch attacks, New Zealand’s Privacy Commissioner branded the company "morally bankrupt pathological liars". We have never invested in Facebook because of its weak stewardship in respect of social concerns.
Over the second quarter of 2019, the Janus Henderson Global Sustainable Equity Fund returned 9.8%, outperforming the MSCI World index by 3.1%ᴵ. While the fund’s sector positioning was advantageous to performance (being overweight information technology and underweight energy), stock selection was the most important contributor to returns. Of the top five contributors to returns – Nintendo, Walt Disney, Adidas, Schneider Electric and TE Connectivity – only one was a technology company.
Key contributors to performance
Nintendo (Quality of Life) performed strongly in Q2 after announcing a partnership with Tencent and the intention to launch the Switch console in China, the world’s largest gaming market. The shares also benefitted from detail on future game releases given at the Electronic Entertainment Expo (E3) in Los Angeles in June. Nintendo is a Japanese consumer electronics and video game company with strong principles aligned with its mission to find unique ways to explore play with the aim of putting smiles on the faces of everyone it touches. We consider Nintendo to be different to other gaming companies in this respect and feel that any company that sees its purpose as bringing joy to as many people as possible, irrespective of age, gender or ethnicity, has a strong place in the portfolio.
Walt Disney (Quality of Life) rose following its analyst day in April, where management provided detail on the forthcoming Disney+ video streaming service. Investors applauded the extensive content offering at launch in addition to the international opportunity for the platform. Walt Disney is one of the best known media and entertainment companies and owns the rights to some of the most globally recognised characters, from Mickey Mouse to Luke Skywalker. Its mission is to inform and inspire people around the globe through the power of unparalleled storytelling, reflecting iconic brands, creative minds and innovative technologies.
Adidas (Quality of Life) gained after reporting strong quarterly earnings where margins came in ahead of expectations, suggesting a more benign competitive environment. Adidas is one of the world’s largest suppliers of shoes and clothing. In addition to its products supporting and encouraging active lifestyles, Adidas is a leader in sustainable manufacturing and, in particular, driving the circular economy. Examples include utilising ocean plastics in products and producing 100% recyclable shoes. The company’s sustainability approach spans from how sporting goods are made and sold, to where sport is played.
Key detractors from performance
Shimadzu (Safety) gave back the prior quarter’s gains as the company was impacted by broader healthcare sector weakness. The healthcare sector has been subject to profit taking, following concerns that US Democratic candidate, Bernie Sanders, could introduce a Medicare-for-all health insurance scheme that may, if approved, result in pricing pressure for pharmaceuticals and medical devices. Shimadzu is a Japanese manufacturer of analytical and measuring instruments that 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. It 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 and cancer.
AO Smith (Water Management) declined after reporting results that missed investor expectations, primarily due to challenges in China. While we like the long-term outlook for AO Smith, we sold our position given the difficult operating environment in China and concerns over management’s execution following a change in CEO. AO Smith is a leader in water technology, encompassing products ranging from energy efficient water heaters to water purifiers and commercial water treatment solutions.
Costa Group (Quality of Life) fell, following its AGM when management lowered full year earnings guidance. Costa is Australia’s largest grower of fresh fruit and vegetables and it experienced weaker-than-expected demand in some categories, which resulted in lower prices. Costa’s main products are berries, avocados, citrus, tomatoes and mushrooms, which it supplies to supermarkets and independent grocers worldwide. We have closely analysed these issues and consider them to be transitory and expect Costa’s growth to accelerate as the company expands its operations in China and Morocco. In addition to its produce supporting healthy diets, the company has adopted leading sustainability initiatives in its agricultural operations including smart irrigation and vertical farming.
Activity and positioning
Portfolio turnover was 4.9% in the second quarter of 2019 and 23.6% for the prior 12 months*. This is in line with our long term average of 20%-30%. Over the last six months, our trading activity has been focused on reducing exposure to global industrial production in favour of more defensive and idiosyncratic growth. We have trimmed back names that are more exposed to US-China trade. Much of our technology weighting is in software companies where we see strong growth, 'utility–like' business models with a high proportion of recurring revenues and minimal revenue contribution from China. Fund 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 fund remains underweight the energy and consumer staples sectors and regional weighting remains in line with the MSCI World benchmark. The fund is managed to keep regional weightings in line with the MSCI World benchmark, while sector weightings are an outcome of where we are able to find the most compelling bottom-up stock ideas, while maintaining a balanced risk profile.
*Source: Janus Henderson Investors as at 30 June 2019
During the quarter, we initiated new positions in Adidas and Nanosonics and divested our positions in PayPal and AO Smith.
Adidas (Quality of Life) is one of the world’s largest suppliers of shoes and clothing. In addition to its products supporting and encouraging active lifestyles, Adidas is a leader in sustainable manufacturing and, in particular, driving the circular economy (see key contributors).
Nanosonics (Safety) is a healthcare technology company specialising in infection control. Its mission is to improve the safety of patients, clinics, their staff and the environment by transforming the way infection prevention practices are understood and conducted, and introducing innovative technologies that deliver improved standards of care. Its solutions can be used at point of care and are proven to eliminate an extended range of infectious microbes and pathogens that have developed resistance to other disinfection methods.
With global stock markets having delivered strong returns, we are receiving lots of questions about valuation levels. There is also much nervousness around global politics and slowing economic growth. How could stock markets go higher from these levels?
Certainly, we are mindful of these risks and, for this reason, have been working hard to shift the risk balance in the portfolio. Our trading activity has been focused on reallocating capital away from stocks exposed to global industrial production towards more defensive growth. While it is true that valuations are less attractive than they were at the end of 2018, we still see reason to be constructive. With the Fed signalling a move towards looser monetary policy, we see the potential for significant valuation upside in companies that are growing.
We have a disciplined approach to portfolio construction and our position sizing is determined by the most attractive combination of growth, cash flow, returns and valuation. We are investing in companies where we see significant upside potential over the next several years. We are fortunate to have a world class risk team at Janus Henderson and we are closely monitoring our risk profile. Liquidity is an important element of risk control and we have a very strong liquidity profile despite our mid cap skew – we could liquidate 80% of the portfolio in one day using only 20% of the average daily volume*.
We always like to remind our investors of the need to differentiate between valuation and value. We still see value in companies that are growing. Our sustainability-focused investment framework is designed to help us identify companies exposed to long-term secular trends, and our multi-thematic approach enables us to construct a well-diversified portfolio.
*Source: Janus Henderson Investors as at 30 June 2019
Discover more about our favoured stocks in our Positive Impact Stocks document.
ᴵSource: All fund performance to 30 June 2019: @2019 Morningstar. All rights reserved. I (Acc) Class Shares, nav-nav, UK sterling net income reinvested. Souce for index performance: Refinitiv Datastream, to 30 June 2019, total returns, in UK sterling. Past performance is not a guide to future performance.
Index (comparator): MSCI World Index. Index description: The MSCI World Index is a measure of the combined performance of large and medium sized companies from developed stock markets around the world. It provides a useful comparison against which the fund's performance can be assessed over time.
Peer group benchmark (comparator): IA Global Equity. Peer group description: The Investment Association (IA) groups funds with similar geographic and/or investment remit into sectors. The fund's ranking within the sector (as calculated by a number of data providers) can be a useful performance comparison against other funds with similar aims.
Portfolio positioning as at 30 June 2019.