This week’s Investment Q&A is with Elite Rated manager Will Lough who tells us more about the newly-launched R&M Global Sustainable Opportunities fund, and how broadening the definitions of value investing and sustainability opens up the opportunity set for the fund. In the second half of the interview, he covers Japanese equities and how the fund has been engaging with Japanese companies for positive change.
(Recorded 19 September 2023)
[00:29] The fund launched in July 2022, tell us about its key features.
The R&M Global Sustainability Opportunities fund is a multi-cap, multi-sector, benchmark agnostic, sustainable equity strategy, and it has a value tilt, which we think is a bit of a differentiator. It’s a high conviction portfolio with around 50 holdings at any time, which we build via fundamental bottom-up research. And we use a proprietary quantitative tool for idea generation. The key features are strong quality characteristics, for example high returns on capital overall, attractive valuations on measures such as free cashflow yield, and a skew to smaller companies throughout which may change from time to time but we will always have more than the benchmark.
From a sustainability point of view, we look at companies which might have improving characteristics in terms of their sustainability credentials, or those companies which are enabling others to improve theirs. Finally, we engage with companies to either support positive change where it’s already happening or to accelerate that change where it’s necessary. We’ll have around a third of the fund at any one time where we’re doing direct engagement with the companies, setting them goals and targets to deliver against.
[02:33] It’s unusual to have a sustainable fund with a value bias. Tell us a more about the R&M PVT (Potential, Value & Timing) philosophy and process?
For several years, this concept of value investing and sustainability have appeared at odds with each other, and our view is that that idea rests on defining those two concepts, value investing and sustainability, in very narrow terms. But you don’t just choose stocks which are undervalued because they’re low price to book; that’s just one measure of doing it, for example. Similarly on the sustainability side; just excluding companies which have high emissions, for example, is not necessarily going to deliver you good sustainability outcomes. So, we try and define things a little bit more broadly. We’re not trying to reinvent the wheel.
[03:55] We have four defining principles behind our approach. The first is that we are looking to own companies with very clear drivers for future shareholder value creation. We think there are three phases of a company’s lifecycle where that can be delivered; growth, quality and recovery. And the drivers of successful value creation will differ depending on that phase.
In the growth phase, you want your companies to be reinvesting heavily. If they’re in a recovery phase of the lifecycle, actually to deliver value, you want them probably to be cutting costs or to be doing things like selling non-core assets, so not really reinvesting, it’s kind of the opposite. That’s how we define potential.
The second point is we want to identify mispricings between the current stock market valuation and the long-term fair value that we determine. We think that increases the probability of generating attractive returns if we’re right about finding companies with the value creation opportunities. And it manages our downside if we’re wrong about those things, which does happen more than most managers would care to admit!
The third defining aspect of our approach is to take behavioural factors into account in determining the best time to buy and sell. You might think that something’s cheap relative to fair value, but is it the best time to buy it or could it get cheaper? We’re just trying to minimise the risk of buying too early or leaving too much on the table. We want to consider catalysts that will make other market participants reassess the value of the business. So, that’s timing.
[05:52] And into all of this, the fourth key principle is that we integrate the analysis of material risks and opportunities relating to sustainability. How does sustainability impact the business fundamentals and the valuation — is it a headwind for the business? Is it a tailwind for the business? If it’s a headwind today, is it one that could shift over time and therefore create a re-rating because those sustainability characteristics have improved?
And we look at that sustainability lens through three pillars: people, innovation, and environment. People represents the stakeholders — ie. suppliers, customers, employees and also the governance of the business. Innovation covers R&D, but also business model adaptability. And environment is quite self-explanatory.
The importance that we place on those different pillars will vary depending on the business model that we’re looking at. If you think about a software business, you’ll probably place more influence on the people and the innovation than, maybe, the environment. And if you were looking at an energy or a materials business, it would be the other way around; you’d definitely be thinking about the environmental factors and you’d be thinking about things like health and safety for employees.
Overall, this allows us to take an holistic view and is about proper integration into the investment case so, we’re not only thinking about the sustainability characteristics of the business or whether something’s got a very low valuations or not.
[07:44] Does this fund have exclusions?
We do operate exclusions, probably lighter ones than many sustainable investing funds. We exclude tobacco, for example and we exclude certain activities within fossil fuels, like oil sands. We also exclude thermal coal exposure, and companies which fail the UN Global Compact* measures. Philosophically we prefer to have a wider net and to then assess businesses on their merit. That enables us to look at a wider set of opportunities in terms of those companies which can improve their outcomes. And we think that actually delivers a more significant real-world impact for our investors.
[09:00] You wrote recently that you’re particularly excited about global smaller companies — is this still the case?
It certainly is. At the moment, we have around 30% of the fund invested in companies which are below $10 billion in market cap. And that will compare to around 6% in the main global benchmark, the MSCI ACWI.
What that reflects is going company by company, and just the opportunities that we find. I mentioned that we will typically have a skew towards smaller companies relative to the benchmark; that will be a common feature for the fund. But we are at the maximum that probably I’ve ever managed at the moment in terms of accessing that.
And I think if you were to zoom out to 30,000 feet and try and describe what the opportunity is, over the last 15-20 years global smaller companies have typically traded at a 20-25% premium on a price to earnings basis vs the headline MSCI ACWI. At the moment, they trade at a 5-10% discount, so that’s over two standard deviations below the long-term average. And we think that reflects for us an opportunity.
It embeds a lot of concern about the outlook, which perhaps you’re not getting in some of the large caps. So, we’re just trying to say really that the risk / reward in small caps is really attractive. It’s a global feature, so you’re not having to take huge regional bets with that smaller companies’ exposure. It’s multi-sector, so again, you’re not having to take huge sector bets to achieve it. Ultimately, we just really like the breadth of the opportunity.
*The UN Global Compact is a voluntary initiative that seeks to advance universal principles on human rights, labour, environment and anti-corruption through the active engagement of the corporate community, in cooperation with civil society and representatives of organised labour.
This only scratches the surface of the interview. Will also discusses their growing interest in Japanese equities, the investment case for Nikon, and the sustainability case for energy company Baker Hughes. Listen to the full interview in Episode 282 — How value investing and sustainability can be good bedfellows — of the ‘Investing on the Go’ podcast to explore how value investing and sustainability make an intriguing match.
• [11:21] Why the fund has a growing interest in Japanese equities
• [11:51] How the fund has been engaging with Japanese companies for positive change
• [13:20] Why board structures in Japanese companies are changing
• [15:21] The investment case for Nikon
• [18:41] The sustainability case for energy company Baker Hughes
Listen here:
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