The rising interest rate environment has punished bonds and equities, some more than others. Owing to the Russia-Ukraine war, the market is currently rewarding sectors largely excluded from sustainability-themed strategies, and is set to do so for some time, says Mirova’s chief investment officer Jens Peers.
This could mean the underperformance of funds associated with environmental, social and governance (ESG) themes is set to stay. “We know for oil and coal companies, and even weapon manufacturers [that] the next two, three years are going to be quite positive,” says Peers to The Edge Singapore.
What happens after this fallout settles? Unfortunately, the answer eludes most, and the market does not seem to care, Peers adds. “Many oil companies have invested more in fossil fuel exploration, and that’s fine for the next two to five years because they’re going to have a market for it. But what happens after that?”
Peers warns of stranded assets when market sentiment turns. “When interest rates stabilise, the fundamentals become much more important. When interest rates fall, the long duration becomes much more favourable from a valuation point of view; we’re in that period right now.”
Mirova is an affiliate of Natixis Investment Managers, the American-French global asset management company. Mirova and its affiliates manage EUR27.2 billion ($39.77 billion) as of Dec 31, 2022.
Peers joined Mirova in 2013 as chief investment officer of sustainable equities. He co-manages the Mirova Global Sustainable Equity Fund, a high conviction all-cap global equity strategy focused on integrating sustainability. The Fund, which aims to outperform the MSCI World Index, crossed EUR1 billion in assets under management in February 2020.
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According to the fund’s managers, they use a thematic approach in idea generation, investing in companies they believe offer solutions to four major global transitions: demographic, environmental, technological and governance. “We created a portfolio based on how we see the world evolving over the next 10 years,” says Peers.
As of Dec 31, 2022, returns from the fund’s Class A shares are down 27% for the year — after a maximum 5.75% sales charge — but up 4.33% over three years, 7.08% over five years and 9.28% over its lifetime.
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The fund indeed outperformed the MSCI World Index, but only over the long term; the wider index posted a shallower negative return of –18.14% over 2022 but a return of 4.94% over three years, 6.14% over five years and 8.88% from the share class’ March 2016 inception.
According to the fund managers, investment returns would be lower for Class A share investments, subject to higher fees and may include sales charges. Meanwhile, Class Y shares are only available to institutional investors with a minimum initial investment of US$100,000 through certain wrap-fee programs, retirement plans and investment advisory accounts.
As expected, the fund’s Class Y shares posted better returns, down 22.33% in 2022, up 6.68% over three years, up 8.63% over five years and up 10.51% over its lifetime.
By their nature, most sustainability-oriented portfolios tend to have a long-duration bias, says Peers. “It seems like renewable energy, digital payments, computing and Big Data have very good visibility of long-term value creation and long-term cashflow generation.”
As at the end of 2022, the fund held 46 stocks, with more than half (57.89%) from the US. Danish names represent nearly a tenth of the portfolio (9.3%), while Germany, Japan and the Netherlands round up the portfolio’s top five countries.
The managers tout a “high active share portfolio” of between 40 and 60 names. As at Feb 28, the top equity names in the portfolio are Nasdaq Copenhagen’s Novo Nordisk (4.69%), followed by the New York Stock Exchange’s Thermo Fisher Scientific (4.65%) and Mastercard (4.75%), as well as Nasdaq’s Microsoft (4.38%), eBay (4.38%) and Nvidia (4.30%).
Other large holdings in the portfolio include Irish-American automotive technology supplier Aptiv (3.36%), American software company Roper Technologies (3.23%) and Spanish multinational electric utility company Iberdrola (3.19%).
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Peers is optimistic about the fund’s performance in the coming years. “There will be room for falling interest rates in the next two, three years. So, in terms of positioning and a strategy like ours, for instance, that’s when we expect to outperform quite significantly.”
Transition costs
The energy transition is inevitable, and like any global trend, there will be winners and losers, says Peers. “The winners are typically the ones that help that trend happen or help others adapt. The ones that lose out are the ones that adapt too late or don’t adapt at all.”
He cites recent misses like Nokia (“They didn’t believe in the smartphone”), BlackBerry (“They didn’t believe in the touchscreen”), and Eastman Kodak (“Actually, they invented the digital camera but decided it would cannibalise their existing offer too much”).
What Peers does not believe in, however, are oil and gas companies that develop wind and solar projects on top of their pollutive core business. “They will do that with 2% or 3% of their activity, [but] utilities [companies] are better-placed to do that. They may become a utility company, [but] that will be rare. I think you’re better off investing in pure-play companies.”
The energy transition, while commendable, comes with its costs. “Nothing is ever black or white; it’s always a bit more balanced,” says Peers.
For example, turning the economy from fossil fuel reliance to electrification will require a lot of metals. “Shifting from fossil fuels will potentially push the price of some metals up.”
The most common form of batteries today are lithium-ion batteries, which rely on a combination of lithium, nickel, manganese and cobalt. However, mining for such materials has been mired in reports of child labour in cobalt mines in the Democratic Republic of Congo and human rights abuses around lithium mining projects in South America, to name a few. “[We are] maybe trading an environmental problem for a social problem, at least temporarily,” says Peers.
For these reasons, Mirova’s sustainable fund excludes mining companies “as of today”, says Peers. He believes the situation will improve, but it will take some time. “There’s going to be a lot more political pressure on those countries to do better; the pressure also has to come from the companies themselves … Companies are becoming more aware of those problems and taking small action. It’s slow, however.”
Finally, how should investors take action, whether for profit or the planet? “Divest from the most polluting sectors, of course, and invest in technologies that will help create a greener world,” says Peers. “So, that ranges from water filtration to renewable energy, [from] energy efficiency to precision agriculture; the best way is to think about the types of companies that offer solutions and have a bigger allocation to those.”
