03 Mar 2020
Due to the fires, travel disruptions were commonplace in Australia in January and a planned trip to New South Wales turned into a visit to fire-free Victoria. In late January, I visited Melbourne to see my strategist friend Paul Laband, returning to Sydney in early February to meet up with fund managers. Ironically, the city was hit with the worst storm in over 20 years, involving serious flooding and power outages!
The majority of the Stewart Investors Sustainability team are now located in Sydney and Singapore. As with other Stewart Investor portfolios, the Worldwide Sustainability fund looks to provide downside protection by focusing on businesses with stable, rather than economically sensitive earnings. The team focus on stocks on a bottom up basis, which they believe offer upside potential in absolute terms, rather than relative to an index. As a result of the strong performance of the US market and an increase in overall valuation levels in that market, only approximately 15% of the portfolio is invested in that region and the fund is overweight in Asia Pacific, especially India, where there is an 11% position, together with Europe and Japan.
With some stocks in the consumer staples space struggling, 2019 was a tough year for the fund. The portfolio also had exposure to drug stores in Japan, where returns to distributors of generic medicines were reduced by the regulator. Historically, businesses such as AIN have responded to this by requiring other drug dispensaries to grow market share, so the team continue to hold this name.
Traditional technology names don’t feature in the fund, but an interesting addition last year was Fortinet, a US listed global provider of network cyber security, which is growing at 20% p.a. A Canadian specialised software solutions company, Constellation Software, was also purchased in the fourth quarter. The team have looked to gain exposure to growth in the use of technology by holding some of the Indian IT outsource companies such as Tech Mahindra and TCS. A US listed name is Jack Henry, a provider of software for banking and payments.
In the fourth quarter Chr.Hansen, the Danish provider of microbes and enzymes for the food, pharmaceutical and agricultural industries, was added to the fund. 22% of Chr Hansen is owned by the Novo Nordisk Foundation. This business has a large and growing number of applications, its products are used to improve the taste, yield and shelf life of foods and to eliminate pesticides and antibiotics in farming. The fund has had low exposure to banks in Europe and the longstanding holding in the fund Handelsbanken was sold last year.
In 2019, Indian exposure was problematic, especially in the consumer space. Although 2019 was a disappointing year, the fund has shown defensive qualities at times of severe market selloffs and has matched the broad index over five years. The fund remains suitable for more cautious equity investors.
The Stewart Investors Asia Pacific Leaders fund is one of the lowest risk funds within this sector and whilst it lagged a rising market in 2019, it was one of the few funds in the sector to make positive gains in 2018. Over three years, the fund is ahead of its benchmark index but, with much lower levels of volatility, the best relative returns achieved are at times of market stress. The fund has low exposure to cyclicals, so did not benefit from the rebound in semi-conductor companies which occurred in 2019. The fund doesn’t hold Samsung due to governance concerns, but historically had a significant position in TSMC, which was reduced in the summer of 2018. For the next six months, this was a positive move, but the stock then rebounded strongly last year. The overweight to India was also painful with Mahindra & Mahindra hit with the downturn in both the global auto cycle and the rural Indian economy. Other consumer names in India suffered, although the high-quality financials held in the fund, such as Kotak Mahindra Bank, made positive returns.
After a strong year in the market, some longstanding names in the fund such as AIA and Doctor Reddy’s, were sold from the portfolio with the latter having rebounded around 50% from its 2018 lows.
The fund has exposure to a number of different healthcare names, including the hearing aid/implant business Cochlear in Australia and Fisher & Paykel Healthcare (respiratory products) in New Zealand. Hoya is one of several eye lens businesses held within the fund.
The team continue to believe that sustainability is a natural extension of the concept of quality, which has been used for this fund since its launch in 2003. If investing with a long-term horizon, this approach is essential and involves business model headwinds and tailwinds rather than negative screening. Sustainability is integrated into the assessment of franchise, management and financials and is very different to ethical investing.
This fund is focused on capital preservation, rather than delivering index matching growth in up years in the market. Overall, the fund remains managed by an experienced team of investors in Asian stock markets and should continue to give positive returns over rolling five year periods, with less than Index volatility.
Within First State, there are several different teams or fund management units operating with investment independence. The First State Global Listed Infrastructure team have been successfully investing in this asset class for over a decade and have a process that is mainly driven by bottom up factors. The team also look at politics and regulation, considered to be the biggest risks in the sector, along with macro factors. The importance of this was seen during the UK general election, when the re-nationalisation threat was removed from utility names, creating a strong bounce back in the fourth quarter.
In the US, state legislation is significant and individual states are promoting a strong move towards renewables. 2019 proved to be a strong year for globally listed infrastructure assets, helped by the favourable tailwind of lower bond yields in the first nine months. In this portfolio, some names that struggled in 2018 bounced back strongly, such as CCR in Brazil and in Europe, toll road company Atlantia. Mexico was also a strong performer for this fund last year as concerns over regulation of utilities under left wing President Amlo were dismissed and utilities have seen satisfactory regulatory reviews, resulting in strong rises in their share price, such as airport operator GAP with up to 45% increase in 2019.
In the mobile phone sector, towers were the strongest performer in 2019, not only benefitting from falling bond yields, but also from the secular trend of increased use of data and the move to 5G. US tower companies now have a growth outlook of around 6-8% p.a. Toll roads also performed strongly last year and pipelines benefitted from the simplification of their structures and less leverage. UK utilities gained ground, not just from the general election result, but also from satisfactory regulatory reviews. Even though rail volumes declined, a reduction in head count and other costs meant that railroads still delivered strong gains. The laggard area was satellites, where the move to watching media online left the sector struggling but this hasn’t been held in the fund.
On a regional basis, Latin America was a standout performer, with Brazil and Mexico bouncing back after a difficult 2018. Returns from US stocks were helped by currency strength, which was also the case for the UK in the fourth quarter. Asia lagged last year with Hong Kong utilities hit by trade concerns.
The team have a strong emphasis on looking at the sustainability of returns from utilities, factoring in climate change influences. The team believe that the weight of money going towards businesses with strong renewable product lines will increase further and that there will be a greater differential between good and bad ESG companies. Looking at these factors has always been part of the process and the team will now seek to engage more with companies that they invest in. NextEra, the largest holding in the fund, has a strong runway for growth in its renewables business, which should allow its valuation to run higher than in the past. Avoiding value traps with poor ESG or fossil fuel exposure will become increasingly important. Other names with strong renewable businesses include Dominion with offshore wind and Iberdrola and SSE in the UK, which has evolved its business to networks and renewables and shut down coal power generation.
Airports were one of the poor sector performers in 2019 as this business, which has delivered relatively strong growth over the last five years, has seen a significant run up in valuations at a time when airlines had started to reduce capacity, even before the Coronavirus issue. In some European countries, there has been a move towards rail travel over internal flights, due to concerns over carbon emissions. The team are watching airport stocks to see if the Coronavirus results in a significant selloff, which would provide a re-entry point. One element to consider is that the Chinese are not only a large driver of the increase in global travel, but are relatively big spenders, which means that airports such as Paris, Thailand and Sydney will be hit.
The investment proposition for this fund remains unchanged and looks to deliver inflation- protected income, together with capital growth, to investors. The team expect dividend growth of 6.5% p.a. over the next couple of years, supported by earnings growth in the range of 6-8% p.a. The fund holds a globally diversified portfolio of infrastructure securities, with varying degrees of economic sensitivity. There is a focus on infrastructure companies with barriers to entry often due to holding monopoly assets that have inflation-linked pricing power. In a global macro environment of slow growth/low inflation, infrastructure assets are likely to remain in favour in the market and in today’s world of zero to 2% interest rates, the sector can support higher valuations than in the past. This remains one of the best resourced and well-run infrastructure teams within the market and is a useful, lower risk equity solution for client portfolios.
I had hoped to visit Hong Kong but it was deemed inadvisable due to concerns over the Coronavirus so I returned home without my usual post-meetings adventure.
Graham O'Neill, Senior Investment Consultant, RSMR
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