What are your investment aims?
We aim to generate strong long-term risk-adjusted returns by investing globally in the shares of high- quality companies that are particularly well positioned to contribute to and benefit from sustainable development. Sustainability is fully integrated into the management of risk and return. The team seeks to improve sustainable outcomes by avoiding businesses linked to harmful activities, investing in companies contributing to solutions, and engaging and voting for positive change.
What is your investment philosophy?
The foundations of Stewart Investors’ investment philosophy and approach remains largely unchanged since 1988 and since our first dedicated sustainability strategy was launched in 2005.
The Sustainable Funds Group investment philosophy is summarised below:
- We are stewards.
Our role is to allocate society’s capital to productive uses, in accordance with our Hippocratic Oath.
- We are long term.
Our time horizon is measured in years, not weeks, and we value companies accordingly.
- We invest only in companies contributing to a more sustainable future.
We engage constructively as owners to help companies on their sustainability journeys.
- We invest only in high-quality companies.
We invest in companies with exceptional cultures, strong franchises and resilient financials.
- We believe capital preservation is important for capital growth.
We define risk as the possibility of the permanent loss of client capital.
What is your investment process?
We take a long-term horizon and invest in quality companies that contribute to and benefit from sustainable development.
The team’s starting point is a blank sheet of paper, not the index. Investee companies have to meet stringent quality, sustainability and valuation criteria. We do not own shares in the vast majority of the largest companies in the benchmark because they do not meet our investment criteria. Consequently, our active share tends to be very high.
Idea generation is bottom-up and our most significant source of new ideas is meeting with senior management. Our annual portfolio turnover tends to sit between 20% and 30%, and our typical holding period is in excess of five years. There are some companies we have held for over 25 years. We believe that over extended time frames of investment, quality becomes increasingly important to risk and returns. Our investment philosophy is centred on the idea that protecting client capital in market downturns enables us to compound it faster over extended periods of time.
Fundamental bottom-up approach
Our research process is focused on the assessment of quality, which we define in three ways:
- Management: competence and integrity, alignment with all stakeholders, track records over extended periods, stewardship and time horizon.
- Franchise: necessary and responsible products and services and business practices, pricing power, barriers to entry, sustainable and profitable growth opportunities, return on invested capital.
- Financials: resilient cash flows and profit margins, appropriate payment of taxes, strong balance sheets, conservative accounting.
The positioning of a company with regards to sustainable development is embedded throughout the research process.
Perhaps the most important aspect of quality for us is quality of management. We believe that compromising on quality of management is one of the fastest ways to lose money. Ultimately, it is the owners and managers of the businesses to whom we are entrusting clients’ capital who will, over the long-term, determine the fate of the companies in which we invest. Therefore, while our analysts spend a lot of time reading accounts and industry reports, we are also historians and investigative journalists. We use various sources – reputation checks, conversations with independent directors, interactions with journalists, studies of past behaviour, as well as direct meetings – to build a picture of the integrity, competence and alignment of management teams and company owners. We rule out the vast majority of potential investments because the quality of management falls short of our standards.
Team members select the most promising bottom-up ideas that we collectively discover in our meetings with companies, our reading and our interaction with other market participants. We then conduct in-depth research and write detailed reports on these companies. We regularly supplement proprietary research with third-party information. This can come from forensic accountants, macroeconomists, consultants, academics, and environmental groups, as well as more traditional analysts at investment banks. We commission independent third-party research, often focused on a particular industry (semiconductor equipment and medical diagnostics have been recent examples) or a particular issue (such as lead content in paint in emerging markets or the deforestation risks within soy supply chains).
Portfolio construction and position sizing is a function of conviction in both quality and valuation. Our largest positions tend to be in companies which we view as highly resilient. Our top ten holdings typically account for around 40% of the total portfolio weighting. These tend to have very stable cash flows, strong balance sheets and reasonable valuations.
We do not maintain rolling price targets, nor do we construct complex financial models and discounted cash flow valuations. We believe that the risk with such approaches is that they can sometimes obscure the key investment points and create a false sense of certainty. We accept that we cannot value a company’s shares with great accuracy. Instead, we focus on trying to assess valuation holistically, using a range of methods, and on a ten-year time frame. This reflects our view that valuation is more of an art than a science. We believe that, over the long term, earnings growth matters much more than valuations. Starting valuations can be an important headwind or tailwind to investment returns and thus cannot be ignored – but at the same time, short-term multiples can often be misleading and in the long-run it is often rewarding to pay up for quality.
How do you manage risk?
Portfolio risk controls are driven by absolute rather than benchmark relative risk. Risk management is focussed on stock selection and investing in high-quality and sustainable companies that are priced reasonably for risk-adjusted return requirements over a long-term investment horizon.
Key risk controls:
- Investing in high-quality businesses and managers: the biggest risk arises from compromising on quality
- Focusing on reasonably priced companies with a > 10 year view
- Aligning the investment time horizon with clients and family owners
- Building long-term relationships with company stewards/family owners
- Investing alongside our clients
- Diversifying sensibly
- Fully integrating sustainability analysis and investing only in companies where sustainability is core to the business model
- Avoiding harmful products and services and controversies
- Being benchmark agnostic
- Engaging on ESG issues
- Encouraging diversity and inclusion of opinion
- Meeting bi-annually with the risk oversight team
- Setting formal company, geographic and sector exposure limits
- Liquidity monitoring and controls (days to trade, % of company ownership/free float)
Each strategy has a Lead Portfolio Manager that is responsible for managing portfolio risk and adhering to the strategy and risk parameters. The Lead Portfolio Managers are supported by a Co-Portfolio Manager, the Deputy-Portfolio Manager and the team of analysts.
The trade order management system, Charles River Investment Management System, has a pre- and post-trade compliance engine designed to prevent active breaches of regulatory parameters, internal guidelines and client-imposed restrictions. In addition, there is an overnight batch process for all portfolios that monitors actual positions against restrictions and guidelines. The process accounts for the previous day’s trading activity and price movements.
While the Sustainable Funds Group retains control of the investment philosophy, process and all investment decisions including risk monitoring, additional independent oversight and support is provided by relevant teams at First Sentier Investors (FSI) which is the parent brand of Stewart Investors. This includes the FSI Investment Product Research & Assurance function who report to the FSI Global Head of Product. The team are responsible for overseeing investment risks within all portfolios. They review and interpret risk and performance reports, prepared by the FSI Performance teams, and are responsible for implementing stress testing and liquidity monitoring on portfolios, where appropriate. They also provide independent challenge to the investment team and provide reporting and commentary on performance and risk into the FSI Global Investment Committee and regional committees and boards. The Sustainable Funds Group attends regular risk assurance review meetings which include representatives from risk assurance and performance reporting.
While operationally some of our funds may be permitted to do so, we are philosophically opposed to leverage and stock lending and do not use it in any of our strategies.
How do you approach sustainable investing / E, S & G?
Sustainability is core to our investment philosophy and integrated into our investment process. We do not have a separate team that looks at sustainability – every investment analyst in the Sustainable Funds Group analyses the sustainability positioning of a business, and is also responsible for engaging with companies.
We only invest in high-quality companies that contribute to and benefit from sustainable development. We define development as sustainable if it furthers human development and has an ecological footprint that respects planetary boundaries. All members of the investment team sign our Hippocratic Oath, pledging to uphold the principles of stewardship.
We approach sustainability as a means to mitigate risks and as a driver of investment returns. Integrating sustainability into our analysis is a natural extension of having a long-term investment horizon; the sustainability headwinds and tailwinds that affect companies are different to the shorter-term risks that businesses face.
Our consideration of sustainability is holistic; it includes ESG but is more than ESG. We consider financial sustainability – conservatism around the balance sheet, for example – and stewardship by management – the treatment of all stakeholders through a crisis, for example – to be as essential to the sustainability positioning of a company as the product or service the company sells.
When assessing a company’s sustainability we ask ourselves the following questions:
- Commercial proposition
Do the products and services make a valuable contribution to sustainable development?
- Operational impact
Is the company trying to reduce impacts from its operations?
- Company ethos
Do the culture and values embody sustainability and continuous improvement?
Can the company benefit from sustainability tailwinds and negative headwinds?
We have established a materiality threshold for harmful or controversial activities at 5% of revenues – 0% for tobacco production and controversial weapons. Within the Sustainable Funds Group, we explicitly seek to invest in companies that are making a positive contribution to society. Click here to read our position statement in full.
We supplement our internal research around sustainability using Sustainalytics. At the end of each quarter, portfolios are checked to ensure companies meet global norms for best practices and raise no red flags against our thresholds for harmful activities. We also receive controversy reporting from RepRisk.
What’s your approach to engagement and voting?
We believe that no company is perfect and engagement and voting are key responsibilities for us as long-term shareholders. Engagement is a means to mitigate business risks, protect against potential headwinds and improve sustainability outcomes.
Our engagement activity is prioritised from a bottom-up perspective by the investment analysts. The way each company responds to engagement is integrated into the analysts’ conviction level in the company. Engagements are on issues such as:
- Pollution, natural resource degradation, biodiversity and climate change – packaging, plastic pellets, deforestation, sustainability of supply chains (soy, palm oil and coffee), fossil fuel versus renewables, water, waste and energy efficiency.
- Aligned remuneration and incentives – living wage, gender pay-gap and complexity of incentives.
- Diversity, equity and inclusion – diversity, particularly gender, in senior management and on boards.
- Addictive products – indirect exposure to tobacco and sugar content in food.
- Governance – corporate strategy and legal structure.
In addition to direct engagement with companies, we take part in collaborative engagements as both a participant and a leader. Recent examples have included deforestation, plastic pellets, micro insurance and access to medicine. The team uses the PRI Collaboration Platform to work with other investment firms and asset owners to collectively encourage companies to improve their approaches to ESG issues.
We consider each proxy vote individually and on its own merits in the context of our knowledge about that particular company. This process is not outsourced to an external provider or separate proxy voting / engagement team. The investment analysts use proxy voting as an extension of their engagement activities and are guided by the principle that, where possible, voting should be used to improve sustainability outcomes.
We vote against management to influence companies to improve E, S and G issues, particularly when engagement has been unproductive. A contrary vote is an important part of the engagement process. We aim to explain our rationale for voting against management before voting and will continue to engage following the vote if appropriate. Contrary votes most frequently relate to overly complex management remuneration packages, a curtailment of minority shareholder rights, and director appointments. Given our focus on investing in companies contributing to sustainable development, votes on environmental and social issues are less common than they would be for more index-constrained strategies, but where relevant, we support votes against management to improve social and environmental outcomes.