Ongoing fallout from Covid-19 and a number of flashpoints around social inequality have focused attention on sustainability and posed questions about the future role of ESG (environmental, social and governance) in investments.
While no one predicted the full impact of the pandemic, we have long recognised our current system is unsustainable and needs dramatic reform if it is to ‘meet the needs of the present without compromising the ability of future generations to meet their own needs’ (a 1987 quote from Gro Harlem Brundtland, who chaired a commission on sustainable development).
On a social level, the success of our economy at generating wealth has not fed through to all. We know the system is not working when in a country as wealthy as ours, those essential front-line nurses, carers and teachers cannot afford housing in the areas they work and particular groups are persistently disadvantaged. Meanwhile, the state of our natural world was summed up in a 2020 podcast by Inger Anderson, head of the United Nations Environment Programme (UNEP), in which she gave a dismal report on the effect of human impacts on land, sea and air. In each area, we have drastically decreased the resilience and abundance of the ecosystems upon which we ultimately rely.
And yet despite this, our belief on the Liontrust Sustainable Investment team is that the prevailing system of capital markets and competition between companies has to be a major part of the solution. People working together with businesses, putting capital to work towards a common purpose, has delivered immense good in many areas. Much of the progress towards higher quality of life has been driven by this, leading to the vaccines and cancer treatments, solar and wind generators, electric vehicles, LED lighting, internet, and countless other products and services that make our lives better and more sustainable.
Over 20 years, the key to performance on our Sustainable Future Funds has been investing in such companies, which have been successful because they help make our world cleaner, healthier and safer. This highlights the importance of identifying structural growth and we continue to believe investors underestimate the speed, scale and persistency of such trends.
As long-term sustainable investors, we have faced questions over the years on whether ESG would survive the next downturn and Covid-19 has brought renewed scrutiny on this. Our answer remains firmly in the affirmative but rather than debating sustainability itself, we address the question via our investment process and funds.
People working together with businesses, putting capital to work towards a common purpose, has delivered immense good in many areas.
We start by looking at the world through the prism of three mega trends, Better resource efficiency (cleaner), Improved health (healthier) and Greater safety and resilience (safer), and 21 themes within these, all focused on the shift towards a more sustainable economy. Building on this work, we also require excellence in ESG and our holdings tend to have processes in place to manage customer relationships, employees and supply chains; we believe outperformance on these issues will deliver more resilient businesses over the long term. We bring all this information into our forecast earnings, only selecting companies that can make money from their good work, and the final part is an attractive valuation.
Taking our process step by step, because of our thematic work, our funds came into the Coronavirus crisis with no exposure to airlines, casinos, pub chains, luxury shopping or cruise ships, all sectors that suffered the worst declines. Because of steps two and three, on ESG and business fundamentals, we are largely invested in companies making products the world genuinely needs, demonstrating close relationships with their customers, treating employees with respect, and understanding the complexities of modern supply chains. Our view remains that as we start to look past Covid-19, the tools companies have developed to outperform in the face of a climate emergency, an obesity epidemic or failing boards will be the making of sustainable investment.
Another point to note is that crises often accelerate changes in action for years and this is happening across many of our themes. Our Connecting People theme has seen a marked acceleration, for example, as millions of us work from home and stay connected with friends and family digitally. Rising demand for more digital communication, as we become more connected, increase our data consumption and become aware of the environmental impacts of travel, has been evident for years but lockdowns have supercharged this shift.
Companies such as Cellnex and TeamViewer – an operator of wireless telecoms infrastructure and a company specialising in remote desktop software – help towards more seamless digital connection and remote working and we believe the increased demand for their products over recent months is not transient but the beginning of a permanent shift in habits. Now so many of us have shown we can successfully work from home, it would be disappointing to see a return to widespread unnecessary travel.
While increased communication is important for the development of a sustainable economy, however, the challenge is to decouple this growth from its environmental impacts. Digital technology’s share of greenhouse gas (GHG) emissions is rising fast and we also see considerable opportunities coming from the trend towards outsourced storage and processing.
"We expect healthcare companies to continue to do well by doing good"
Meanwhile, with vaccines allowing the world to look past Covid-19, one thing the pandemic has hopefully done is open people’s eyes to the importance of getting healthcare right.
While pharmaceutical companies are currently in the headlines because of their efforts against Covid-19, we invest in healthcare because the sector’s innovation is vital for a more sustainable future. Over recent years, there have been significant advances across areas such as gene editing and DNA sequencing, and these are revolutionising how we think about treatment. The traditional model has a large element of trial and error, with people seeking help when they feel ill and hoping whatever drug or procedure prescribed is effective – but this often proves too late.
In contrast, we are moving towards a more personalised system where we can understand how someone’s genetic make-up makes them vulnerable to certain diseases. A recent addition across our funds is US healthcare business Illumina, a global leader in sequencing for genetic analysis. Illumina continues to lower the cost of sequencing, enabling broader adoption of these techniques and accelerating trends such as liquid biopsy, which allows doctors to detect cancerous cells from a blood draw rather than source tissue.
We expect healthcare companies to continue to do well by doing good; a company like Roche, for example, has seen significant demand for its diagnostic machines during the pandemic and we believe it will continue to expand its footprint. Even as Covid-19 testing falls, these machines will be put to work to scan for diseases where governments have been reluctant to invest, such as Tuberculosis or Hepatitis C.
Looking forward, with sustainable investing growing increasingly popular, there are inevitable questions about whether these stocks, and the concept overall, are in ‘bubble’ territory. While there has been a large increase in demand, we are still in the early stages and growth is coming from low levels; from our perspective, we would also highlight the diversification of our themes and the fact our long-term investment horizon and concentrated portfolios allow us to remain selective.
"We anticipate the next year being one of recovery and it seems the shape of this will be more aligned with better welfare and lower environmental impacts."
In contrast to identifying structural trends, we are also looking to avoid growth that is transient in nature as well as crowded and expensive trades such as the mega-cap FAANG names. We have seen bubbles emerge in certain parts of the market recently, including some IPOs in the technology space, SPACs and, to a degree, stocks where new entrants into ESG funds are buying without any regard for valuation, such as Tesla and Sunpower. The fourth pillar of our process, valuation, ensures we avoid companies trading at levels that have lost touch with underlying fundamentals.
Market moves over recent weeks have been indiscriminate but we feel fundamentals will ultimately drive the higher-quality names in our funds back up, leaving behind stocks buoyed by emerging bubbles; having a process that has been running for two decades helps when dealing with periods of rotation in the market.
We anticipate the next year being one of recovery and it seems the shape of this will be more aligned with better welfare and lower environmental impacts. The idea of a just energy transition, for example, has gained traction and, as stated, we expect many themes that have accelerated through Covid-induced lockdowns to persist: remote and paperless working, reduced travel, healthier lifestyles and greater focus on illness prevention, as well as a recovery in the social activities we have missed. Along with that, we hope to see a slight realignment of values so that, in future, wealth and welfare creation become two sides of the same sustainable coin.
Put simply, we cannot afford to go back to ‘normal’ when this crisis is over. The world should feel emboldened by efforts in response to the virus and go further to make our economy cleaner, healthier and safer, as well as striving to make it fairer. We will continue to invest in businesses at the vanguard of these changes.
For a comprehensive list of common financial words and terms, see our glossary at: liontrust.co.uk/benefits-of-investing/guide-financial-words-terms. This article should not be construed as advice for investment in any product or security mentioned. Before making an investment decision, you should familiarise yourself with the different types of specific risks associated with each of our Funds. This information can be found in the Prospectus and Key Investor Information Documents (KIIDs) available on our website: www.liontrust.co.uk.