The strategy was launched in November 2013 and transitioned to the Sustainable Funds Group in October 2016. The strategy invests in global companies which generally have a stock market value of at least USD 3 billion, and are positioned to contribute to, and benefit from sustainable development.
1 January - 31 March 2022
The strategy's performance during the quarter was disappointing but not surprising. The conflict in Ukraine is adding fuel to the inflationary pressures that had already been building up.
Prices of commodities, particularly those of crude oil have been very strong in the last few months. Our limited exposure to commodity businesses and avoidance of fossil-fuel companies means our portfolios will underperform in such markets.
Our portfolio companies tend to be consumers of commodities. As category leaders with structural growth opportunities, they are well placed to manage inflation. This has given us some great opportunities to add to some of our favourite holdings such as bioMérieux (France), Deutsche Post DHL Group (Germany), Expeditors (United States), HDFC (India) and Natura (Brazil). Deutsche Post, which owns DHL, the world’s leading express-logistics business is on a price/earnings ratio (PE) of 11x. While the pandemic played a part in boosting near-term earnings, the business has gone from strength to strength, with cash flows compounding at 15% over the last decade1. HDFC is trading at its cheapest valuations in the last three decades, as measured by its price to book.
Over the course of this quarter, we also initiated a position in KLA-Tencor (United States), a leading supplier of process control and yield management equipment to the semiconductor supply chain. KLA have, since 1976, consistently reinvested in innovation and improving research and development (R&D). This investment, combined with working closely with their customers over decades, has meant that KLA is one of the most trusted equipment suppliers in this ecosystem, with dominant market share in process control. Whilst the business is fully free float, the long-tenured managers have stewarded the company through cycles, maintaining steady growth and profitability, as well as a robust balance sheet. As an indicator, the top three managers have between them 92 years at KLA. The equipment the company produces enables semiconductor foundries to reduce waste and improve yields, thereby making KLA well positioned to continue growing with the demand for more chips.
During the quarter, we sold out of Schindler (Switzerland). While we still like the franchise and ownership, there were better opportunities given its valuation and growth outlook. We also exited Shopify (Canada) and Masimo (United States) as we were unable to build conviction. In the case of Shopify, valuations remain expensive despite a deterioration in the outlook for future capital expenditure (CapEx). While in Masimo, a significant unrelated diversification broke the investment case. We continued to trim our holdings in Ansys (United States), Fortinet (United States) and Arista Networks (United States) due to expensive valuations.
A notable feature of some of our companies is the use of non-GAAP (Generally Accepted Accounting Principles) earnings. For instance, Ansys and Fortinet trade on a PE multiples of 40x and 70x respectively2. However, using a more conservative GAAP accounting approach, these jump to 57x and 87x. One of the main drivers of this difference is the treatment of stock compensation. Non-GAAP earnings usually exclude stock compensation in income statements and operating cash flows, significantly overstating earnings. Strong stock market returns and poor accounting and performance assessment choices are leading to higher stock issuances to employees. Attracting and retaining talent in such markets is a challenge, but simply paying more stock to employees may not prove to be a sustainable long-term solution. One only has to go back to the tech bubble in 2000 to understand the risks of poor stock market performance on employee morale.
In the last decade, the S&P 500 has returned roughly 16% p.a3. A very strong period considering equity returns over the last century are closer to 10%. Low interest rates have provided immense tailwinds to these returns. However, the coming decade may not be as accommodative given rising inflationary pressures. We continue to look for stewards who are mindful of the easy monetary, fiscal and global trading conditions. One of the reasons why we have preferred net cash balance sheets, even during a period of low interest rates. Such businesses will have the financial flexibility to capitalize on opportunities that might arise from a more challenging macro-environment. We remain excited by the sustainability positioning, balance sheet strength and growth prospects of our portfolio companies. We were lucky to add to some of them at cheaper valuations last quarter.
1 Source: FactSet
2 Source: FactSet
3 S&P 500 Returns since 2012, https://www.officialdata.org/us/stocks/s-p-500/2012?amount=100&endYear=2022
1 October - 31 December 2021
We initiated one new position in the strategy – Old Dominion Freight Lines.
The company focuses on less-than-truckload freight services, moving small items across the United States quickly, using a complex network of their own trucks and warehouses. They have focused on doing one thing, and doing it well. This concentration of ambition comes from the Congdon family who started the business in the 1930s. The long termism of these stewards is evidenced by steady investments in building out a wide network of warehouses across the country. The ability to control these physical assets combined with a culture obsessed with customer satisfaction has resulted in incremental gains in market share over time. Holding themselves to higher standards on speed and quality of delivery also results in a better ability to control prices, and results in best-in-class margins. Old Dominion continues to benefit from structural tailwinds around more efficient logistics and increased consolidation across the industry.
We also continued adding to Jack Henry and Natura. Jack Henry provides core banking software to credit unions and mid-sized financial institutions across the US. The business remains well managed by a strong and stable management team who have consistently invested in improving the franchise. A beneficiary of the increasing requirements of digital banking infrastructure, 80% of Jack Henry’s sales are now recurring in nature. We continued building our position in the company through this quarter. At Natura, a Brazilian personal care products company, we have seen the stewards build an ethos of sustainability in everything from sourcing and packaging to distribution. The turmoil caused by the pandemic as well as the integration of an acquisition have given us the opportunity to further build a position here as well.
This quarter, we also exited our positions in Taiwan Semiconductor (TSMC) and Alcon. TSMC remains a solid franchise and the leading semiconductor foundry consistently at the cutting-edge of technology. We decided however to increase our holdings in other companies benefiting from similar tailwinds, more focused on software and where the business models had a greater source of recurring revenues. We also sold out of our position in Alcon, an eye care and surgical instruments franchise. Alcon has been looking to steadily improve the profitability of the franchise, but we decided to exit as valuations became increasingly full for the quality of the growth ahead.
1 July - 30 September 2021
During the quarter we had an opportunity to initiate a position in two companies we have long admired; Natura in Brazil and MonotaRO in Japan.
Natura is a Brazilian beauty and personal care group with operations across the world. We have been lucky to have known Natura since it listed and have held it in various client portfolios over the years. The company was founded with an ethos of sustainability and is an exemplar of balancing profitability with looking after other stakeholders. Natura is a world leader in its approach to a whole range of sustainability issues ranging from biodiversity in sourcing, fair treatment of staff and environmental design of products and packaging.
In 2014, Natura became the world's first publicly listed B-Corp, joining a select group of companies legally committed to driving positive change in society through sustainable business practices. Recent share price weakness gave us an opportunity to make an investment. Veeva Systems is our other B-Corp investment.
MonotaRO is a business-to-business online platform which sells maintenance, repair and operations products such as cutting tools, safety kit, bearings and fasteners as well as office equipment and medical products, mainly to small and medium sized enterprises. It has been growing at over 25% compound annual growth rate over the last decade with a very low capital intensity. Once again, a bout of share price weakness helped us to make an initial investment although it remains an expensively valued company.
We have continued to increase our investments into Ansys, bioMérieux and Deutsche Post DHL Group where valuations seem acceptable.
After seven years of an investment in Nestlé, we completely sold out of the company. In many ways, the company is an imperfect giant and it is hard to tell whether enough has changed in the sustainability thinking at this huge food behemoth. The product portfolio has certainly improved vastly and the commitment to tackle plastic packaging is also commendable. Ultimately, we were concerned about the level of growth that it offered on valuations that were expensive.
We also sold out of Microsoft. Although there are no imminent threats, we cannot help but worry about regulatory risks in this giant.
Finally, we trimmed some of our semiconductor related holdings.
1 April - 30 June 2021
In a quarter that continued to set new market highs, we remained wary of valuations that are even more stretched.
We sold out of Tokyo Electron Limited and Novozymes on valuation grounds. The quality of these companies remains good and we would be happy to own them again at more reasonable valuations. We also sold out of Tech Mahindra. Although not particularly expensive, its performance is more volatile in comparison to our other top holding Tata Consultancy Services.
Two new companies were added to the portfolio this quarter. The first, Techtronic, is a company we have known and admired for a long time through our Asian portfolios. Well stewarded by the Pudwill family, the company has an excellent position in its power tools and appliances business. The company leads the industry in replacing high-polluting, fossil-fuelled products with environmentally-friendly, clean, cordless powered technology. Their early investment in battery technology, as well as strong brands in consolidated areas has meant they enjoy pricing power too. The company is also a leader in making its batteries compatible across tools and the batteries are compatible with products up to 12 years old.
Another company we added to the portfolio was Cognex, a research and development driven franchise that should continue to benefit from the growth tailwinds of automation and inspection across a variety of industries. The company has a very sound financial foundation to endure the cyclicality of end customers and remains expensive. As their products and services help improve manufacturing quality and reducewaste, we expect plenty of growth in the years ahead. Although founder-chairman and chief culture officer, Bob Shillman has now retired and stepped down from the board, the company continues to be well stewarded by long tenured Cognoids (employees and management of Cognex are known as Cognoids). The company also produces the most original annual reports that we have come across.
We continued to add to other significant holdings in bioMérieux, Deutsche Post and Philips as valuations remain very attractive.
1 January - 31 March 2022
Worldwide Leaders Sustainability
During the quarter there were 57 resolutions from six companies to vote on. On behalf of clients, we voted against three resolutions.
Voting with management, we voted against the approval of two proposals put forward by shareholders of Costco. We voted against the request for the company to disclose charitable contributions of US$5,000 or more, as we find the company's current disclosure regarding its charitable activities to be adequate. We also voted against the request for the company to report on its sustainability commitment to address structural racism, nutrition insecurity, and health disparities. We are not convinced that this proposal would be a productive use of company resources, particularly given its existing disclosures on its efforts to improve access to affordable, healthy food and to address food insecurity through philanthropic efforts. (two resolutions)
We supported one shareholder proposal requesting Costco adopt short-, medium-, and long-term science-based greenhouse gas (GHG) emissions reduction targets to achieve net-zero emissions by 2050. Although the Company has provided detailed disclosures concerning its Climate Action Plan and has committed to setting a Scope 1 and 2 emissions reduction target, we believe supporting this resolution will further encourage the development of these goals.
We voted against the appointment of the auditor at Infineon Technologies, as they have been in place for over 20 years and the company has given no information on intended rotation. (one resolution)
1 October - 31 December 2021
Worldwide Leaders Sustainability
During the quarter there were 37 resolutions from five companies to vote on. On behalf of clients, we voted against three resolutions.
We voted against the approval of CSL's remuneration report and the equity-based remuneration of the CEO. We have engaged with CSL over a number of years on remuneration and whilst we appreciate and acknowledge the changes they have made to their remuneration structure, our concerns remain that their remuneration focuses on the shorter term over the longer term, and the absolute level of CEO pay and the gap between median pay. (two resolutions)
We voted against the appointment of the Auditor at Coloplast, as the Auditor has been in place for over 10 years and the company has given no information on intended rotation. (one resolution)
1 July - 30 September 2021
Worldwide Leaders Sustainability
During the quarter there were 56 resolutions from four companies to vote on. On behalf of clients, we did not vote against any resolutions.
1 April - 30 June 2021
Worldwide Leaders Sustainability
During the quarter there were 317 resolutions from 23 companies to vote on. On behalf of clients, we voted against 16 resolutions.
We voted against Adobe’s equity compensation plan and executive compensation as we believe the CEO’s median pay ratio is too high and the plan is unnecessarily complex, and we do not have enough information to determine whether the plan will benefit solely employees or will be very top heavy. (two resolutions)
We voted against the approval of Texas Instruments’ executive compensation as we believe the CEO’s median pay ratio is excessive. (one resolution)
We voted against the approval of Alcon’s executive compensation and their compensation report as we believe the CEO’s pay is excessive and we have reservations on the company awarding bonuses for the year despite all financial targets being missed. (two resolutions)
We voted against the approval of Edward Lifesciences’ executive compensation because they changed the goalposts of their plan in light of COVID-19 and the company was not achieving the threshold performance level for any of the corporate financial metrics. (one resolution)
We voted against Ansys’ equity compensation plan and executive compensation as we believe they do not reflect long-term thinking and are unnecessarily complex. (two resolutions)
We voted against Illumina’s executive compensation because they changed the goalposts of their long-term incentive plan in light of COVID-19. (one resolution)
We voted against Constellation Software’s request to appoint KPMG as their auditor for the 26th year, and their ability to set the auditor fees. We believe the non-audit fees are excessive, given they exceed those paid for audit related services, and a change in the auditor would be in shareholders’ best interests. (one resolution)
We voted against a shareholder proposal relating to Synopsys where shareholders were requesting the company lower the recently introduced provision for shareholders with a 20% holding for over one year to be able to a call a special meeting, to a 10% holding and no minimum holding period. We do not want to encourage any activist-driven change in the company’s culture to a more short-term focus. (one resolution)
We voted against two shareholder proposals relating to Texas Instruments and Edwards Lifesciences which would have enabled shareholders to take action with written consent on important issues that arise between annual meetings. We consider ourselves active shareholders and voting an important responsibility in our investment management duties. (two resolutions)
We voted against a shareholder proposal relating to Nestlé where shareholders were requesting the use of an independent proxy to vote on additional or amended proposals from shareholders at annual general meetings (AGMs). We consider ourselves active shareholders and voting an important responsibility in our investment management duties, as such we do not wish for any other business to be transacted at the AGM. (one resolution)
We voted against a shareholder proposal relating to Ansys where shareholders were requesting the company eliminate the super majority vote they have in some circumstances and replace it with a simple majority vote. We believe the current arrangement better protects the company’s independence and growth over the long term. (one resolution)
We voted against a shareholder proposal relating to Veeva where shareholders with 15% of the company’s outstanding shares would be able to call a special meeting. We do not want to encourage any activist-driven change in the company’s culture to a more short-term focus, and believe the company’s proposal of 25% and one year holding requirement is better for long- term stewardship. (one resolution)
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