Daniel Roarty: Companies with strong ESG practices are just higher quality companies by definition. They tend to be more profitable, have less volatile earnings and are better at mitigating serious business risks that lead to major losses and bankruptcy. But something bigger is going on as well. Most sustainable-themed funds focus on companies with policies oriented to stakeholders—employees, customers and the larger community. A recent study that evaluated stakeholder-friendly actions by companies during the COVID-19 crisis found very clear evidence that portfolios’ positive practices had higher institutional money flows and less negative stock price returns through the downturn. So even shareholders are saying that a stakeholder approach is a form of competitive advantage and resilience.
3. The Fund’s three broad investment themes are climate, health and empowerment. How has COVID 19 changed the trends in these areas, and what are some implications for investors?
Daniel Roarty: Our view is that owning companies that embrace social challenges like poverty, water scarcity and clean energy has always been a great way to build powerful growth-oriented portfolios. The COVID-19 crisis makes these themes even more relevant. It’s changing behaviours among individuals, businesses and governments worldwide. In some cases, it’s creating new regulatory issues for companies. In other cases, it’s accelerating trends already underway. We think it’s crucial for investors to determine which behavioural changes are temporary, to get us through the immediate crisis, and which are here to stay. That’s a hard question to answer, but ultimately it will help separate winners from losers in the marketplace and in our fund.
4. Can you give some examples of the “winners”?
Daniel Roarty: One obvious one is what we might call “the virtualization of everything”. That’s part of our empowerment theme: information and communications technologies that provide knowledge sharing and connect communities. We’ve found many interesting ways to play the infrastructure side of this theme. Even though this category may not trade at some of the rich valuations of the more-talked-about virtualization players, these companies are positioned for very powerful growth. So, our fund holds SBA Communications, one of the largest telecommunication tower operators in the US and in Latin America. Then there’s the trend of “on-shoring” or “de-globalization”. This is the resource efficiency section of our climate theme. Companies around the world want to regain control of supply chains and bring production back home, in part because of the US-China trade war. Several industries will actually be deemed strategically important for national security in many countries. Companies that can facilitate the localization and the automation of supply chains can take advantage of this opportunity. In our fund, that would be a company like Rockwell Automation, a US maker of factory automation systems that help manufacturers improve product quality and the productivity of their asset utilization.
Another great theme is financial technology—part of our empowerment theme. “Fintech” companies support small- and medium-sized businesses that are really at the epicentre of the current economic crisis. They account for a substantial share of employment and economic growth and countries around the world, but they’re often underserved by traditional financial institutions. Fintech can expand the reach of those smaller firms and increase profitability. Our fund owns Square, a US-based merchant payment aggregator. The company has a very broad product platform that provides services like payment processing, payroll, HR and inventory software that’s tailored for micro and small businesses.
5. Given the market rally since late March, what’s your outlook, and how are you positioning your portfolio?
Daniel Roarty: Even though stocks have bounced back very strongly, there’s reason for caution. We expect a slow and volatile economic recovery. In terms of positioning, we think that this economic outlook should favour secular growth in the longer term despite us seeing a short-term rotation to cyclical value stocks post the recent news regarding a COVID vaccine.
Quality factors like high returns on capital and clean balance sheets should continue to command a premium in the longer term also, despite the uncertainty. We think that growing social unrest, and the greater awareness of social issues as we move through this crisis—like inequality and access to healthcare, for example—favour stakeholder-oriented companies.
6. Given that the pandemic is having a massive economic impact and so many companies are operating in the dark about profits, how do you evaluate companies differently over the next 12 months?
Daniel Roarty: Visibility is indeed extremely limited and many companies have pulled earnings guidance. Even so, we aren’t powerless. First in our investment process, we never produce a single-point estimate for any company that we look at. We know that we’re just not that smart. We’ve always forecasted a base case for financial outcomes, but also a bull and a bear case, because it’s always helpful to think about the full range of what can go right and what can go wrong for companies. The tails between the bull case and the bear case are probably a little wider than usual today.
You can also think about secular trends, and whether the current environment will reverse or accelerate them. For example: the migration of retail from stores to e-commerce has accelerated rapidly. And while the overall economy may not be headed for a V-shaped recovery, some industries are and haven’t slowed down at all. Finally, we can also evaluate the balance sheet strength of companies. So, our view is that structural winners with less cyclical business models, and stronger balance sheets should fare better in this environment—even if we can’t pin down the exact earnings numbers.
7. Finally, what are some of your takeaways of what the COVID 19 crisis means for sustainable investing?
Daniel Roarty: For one, I think 2020 has been the first real test of the era of stakeholder capitalism. Consumers, governments and investors are all watching very closely how businesses treat their stakeholders during the crisis. This is a trend I think will last, and it’s going to be more important than ever to evaluate that in your fund: if you have companies with poor practices in your portfolio, that’s going to be a risk. Of course, the opposite is true for companies that do it well. Finally, many of this year’s developments are likely to favour trends driving sustainable investing, such as healthcare innovation, broadening healthcare access, economic empowerment, knowledge sharing and communication, and even things like resource efficiency. Those are all things that were already important before the crisis, I think they’re only going to prove more important as we exit.
