Kames: Three ‘sustainable improvers’ to power returns
Environmental, Social and Governance (ESG) investing has become increasingly central to investors in recent years, but it remains a complex area with a variety of different approaches.
According to Craig Bonthron and Neil Goddin, co-managers of the Kames Global Sustainable Equity Fund, when it comes to investing, a concentrated and strictly bottom-up approach to sustainability, as opposed to one focused on themes or sectors, produces the best performance outcomes over the long term.
The managers, whose fund celebrated its one-year anniversary on 21st April, make portfolio decisions based on Kames’ in-depth research and sustainability analysis, which is integrated into their investment process via Ryan Smith’s ESG Research team. The managers avoid companies the analysis identifies as sustainability ‘Laggards’ to focus on ‘Leaders’ and, unlike many other ESG or Sustainability funds, ‘Improvers’ – those companies which are immature and developing or where sustainability issues have been identified and there is clear evidence of material improvements.
The duo, who firmly believe there is a performance benefit from sustainability integration, say capturing the tailwind of improvement is the key source of sustainability alpha as it is often an indicator or improving quality, sustainable growth and a consequent valuation re-rating.
Below, Bonthron highlights three global ‘Improvers’ the managers have recently added to the fund.
“Most global funds invest in large and mega cap companies which are perceived as safe due to sheer size but which we believe typically suffer from being too researched, too complex and too bureaucratic to deliver meaningful alpha. This large cap bias tends to be even more exaggerated in most Sustainability or ESG funds. These funds tend to rely too heavily on external ESG screens (which often don’t even cover smaller and mid cap stocks). As a result, such funds usually miss out on small or mid cap companies like Aumann, which came to market in an IPO recently. This is a very interesting German company that has automated the electric motor winding process within production lines. It has a technological lead and, importantly, strong relationships in an area which is hitting a tipping point in growth – electric and hybrid vehicle production.
“We see rapid adoption of these technologies with the mass-market Tesla Model 3 on the way and other interesting developments at major car manufacturers with electric vehicle platforms. We see this tipping point as driving non-linear growth in demand for electric motors, which will surprise the market.
“As its IPO was very recent Aumann’s disclosure is limited but we expect it to improve. The nature of its clients – largely major German car manufacturers – gives us reassurance on supply chain standards. Its corporate governance is good, its management is experienced and the pay is conservative. Aumann is a good example of an ‘Improver’ which provides a great product that enables efficient electric vehicle production.”
“Without lithium batteries, there would be no smartphones, tablets, laptops or electric vehicles. Albemarle operates lithium production operations – in Chile and the US – and has two further sites in development.
“In recent years it has acquired a number of lithium businesses while divesting other unrelated ones, and as such it has become almost a pure play on lithium.
“Albemarle will benefit from demand for lithium going up, which is not only a function of the adoption of electric vehicles, but also of electric bikes and other mobility vehicles. We do not expect supply to keep up with demand on a five-year view, not least since it takes a couple of years to get supply on stream.
“Albemarle had a big vote against it on pay at the 2015 AGM, but it has been very responsive to shareholder concerns and corporate governance performance is recovering. It also has a quality management team. Reducing water intensity of brine operations is key given their natural location but we like the stock and think it represents a strong ‘Improver’.”
“Acacia is a leading provider of high-speed coherent optical interconnect products – in other words, it allows fibre optic networks to run more efficiently and with lower energy demands. It is primarily a supplier to data centres, which use a lot of energy. This clearly a very positive product from a sustainability perspective.”
“Acacia’s product drives the case for inclusion as an ‘Improver’ since its disclosure is poor, but this is not uncommon as the company is again a relatively recent IPO. We have no issues with its social performance but better disclosure on the supply chain is needed. Governance is fairly standard for the US, but disclosure of performance targets attached to long-term remuneration is required. We expect to see improvement here and this is a stock we’re happy to own in this context.”