Responsible Investing

Sustainable Opportunities in a Post-Pandemic World

As the coronavirus pandemic reshapes markets and underlying economies, how should investors manage catastrophic risk with the need for upside growth?
July 2020

Nick Henderson

Director, Portfolio Manager, Responsible Global Equities

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As the coronavirus pandemic reshapes markets and underlying economies, how should investors manage catastrophic risk with the need for upside growth? According to veteran portfolio manager Nick Henderson, the answer is grounded in sustainability – an approach rapidly gaining popularity for its inherent tilt toward quality, resilience and long-term capital appreciation.  

A silver lining in chaos

For decades, advocates of responsible investing struggled against misperceptions of a performance penalty associated with their strategies. Ample research existed to the contrary; in fact, the data showed that firms with higher ESG scores tended to deliver better risk-adjusted returns over the long term. Yet despite the mounting evidence, some investors continued to believe that there was an unavoidable cost to prioritizing sustainability issues.

The market reaction to COVID-19 shone a spotlight on this myth. At the end of March, the MSCI World Index was down 4% over a 12-month rolling period, while the BMO Sustainable Opportunities Global Equity Strategy was positive at 2.5%.1 The strategy outperformed during the drawdown – and beat the benchmark over the longer term as well.

What a growing number of investors are beginning to recognize is that “sustainable opportunities” is really shorthand for a certain type of company: High-quality, growing businesses that are positioned to benefit from long-term, structural changes in the economy. As its portfolio manager, I fundamentally believe the strategy can go toe-to-toe against any other global equity fund, which is why we measure our performance against the broad world index rather than an ESG-specific composite. 

Annualized strategy performance vs. benchmark (CAD, gross of fees)

Annualized strategy performance vs. benchmark (CAD, gross of fees)

Source: BMO Global Asset Management as at 31-Mar-20. Benchmark: MSCI World. BMO Sustainable Opportunities Global Equity Strategy inception date: 28-04-16.

What we include, and what we don’t

That said, the strategy exists to identify and invest in businesses that are addressing – or can be persuaded to address – any number of the numerous sustainability challenges facing the world. While our approach is generally positive, we do begin with acts of omission. Our first step in narrowing the investment universe is to avoid companies with damaging or unsustainable business practices such as tobacco, alcohol and weapons manufacturers, as well as avoiding businesses that:

  • Explore for, process, refine, and/or distribute coal, oil and/or gas
  • Produce and/or transmit electricity derived from fossil fuels
  • Transmit natural gas

Once we’re past exclusions, we operate on a philosophy of invest and improve. Companies that make a positive contribution to society and the environment, and do so while maintaining a strong financial position, are chosen through a highly robust, disciplined investment process. We work hand-in-hand with BMO’s Responsible Investing team, looking for competitive advantages, long-term growth drivers, sustainability characteristics and a proven management team that’s capable of execution. From a field of approximately 5,000 equities, we create a watch list of 80 to 100, and invest only in a carefully risk-weighted balance of 30 to 50 names. 

Part of our philosophy is to hold these investments for the long term, trusting their compound earnings growth to provide a more attractive return profile over time. Even through extreme volatility, we stay disciplined. Whilst the recent market weakness has created opportunities that we have taken to initiate positions in high quality businesses at more attractive valuations, we do so in a discipline way, and expect our portfolio turnover to remain in the 20-30% per year range.

In recent months, the market has rebalanced toward areas in which our strategy was already overweight, such as health care. Many of our securities have benefitted from this rotation, though it’s important to note that our rationale goes beyond the short-term coronavirus bump. When we look at health care, we see a sector supported by secular tailwinds such as aging demographics, obesity and insufficient public sector finances. We see an opportunity to invest in those trends and, most of all, we see room for the private sector to bring innovation within the space.

Consider Thermo Fisher Scientific, a manufacturer of medical instrumentation for laboratories across North America, which began working on diagnostic tools to reduce coronavirus testing times. Or CSL, another business in the portfolio, that’s collecting blood plasma samples from recovered COVID-19 patients to help develop treatments, or perhaps a vaccine. Even one of our industrial gas holdings, Linde, is finding ways to help, by continuing to provide oxygen used by hospitals for treating infected patients. Across the strategy, we’ve seen positive results from an overweight exposure to health care and high conviction stock picking.  

A closer look at the “G” in ESG

The improvement side of the equation is based on our belief in active ownership. We feel strongly about our responsibility to engage with the companies in which we invest to drive positive change. As shareholders, we proactively discuss emerging risks related to climate change, urbanization, infrastructure, agriculture, gender equality – whichever sustainability challenges they can engage with to enhance their governance structure.

For example, we have had some excellent traction with Hoya Corp, a Japanese glass manufacturer that we’ve been in discussions with since early 2019. After speaking with the company at length, they eventually recognized that their third-party supply chain was something of a blind spot to them. Within months, they launched an ESG committee to provide better visibility on labour conditions and other sustainability issues within their organization. It was a truly collaborative experience that fulfilled the firm’s social responsibility while also managing their downside risks related to workplace safety and any remedial action that might have been required.

If we look at the past four months specifically, I would say Microsoft is a standout performer. It has good visibility of earnings from recurring revenue products, the management team is battle-tested, and there’s plenty of cash in their rainy day fund. With investors craving reassurance at the moment, companies like Microsoft bring a certain level of peace of mind. A lesser known example is Descartes Systems, a Canadian technology company with immense growth potential. They work with logistics companies to optimize the routes of delivery vehicles, cutting time spent on the road, saving fuel – and reducing carbon emissions. It’s a well-run business that we can have confidence in during these extremely tumultuous times.

As a counterweight to our investment process though, we remain wary of potential “sustainability traps.” It’s not our policy to pursue environmental, social or governance goals at any cost, irrespective of the competitive dynamics within the industry, barriers to entry and other such factors. Instead, we try to be discerning about companies which have destiny in their own hands, which is perhaps why the strategy outperformed both during the drawdown in March and also since then as well.

A sea change in corporate attitudes

Within corporates, there’s a growing awareness and familiarity with the tail financial risks associated with climate change. Firms are waking up to the potential fallout, and we’re starting to see more dramatic action taken by blue chip companies across a spectrum of industries and geographies.

In Germany, SAP has committed to aligning their business strategy with a maximum global temperature rise of 1.5 degrees Celsius. Meanwhile, VF Corp., the owner of Timberland, The North Face and other brands, announced it will adopt science-based emission targets in accordance with the Paris Climate Agreement, and Microsoft declared it would achieve carbon neutrality by 2030. More ambitious still, Microsoft announced its intention to eliminate lifetime carbon emissions by 2050, compensating for its footprint dating back to the firm’s founding in 1975. Knowing that the technology required to accomplish this goal does not currently exist, the company also pledged a portion of its research and development efforts to the task.  

We’re also seeing interesting new challenges as a result of COVID-19. Whilst we have seen the consumer move away from plastic-based packaging, sales of pre-packed bread, deli meats and cheeses increased 54% in April compared with the previous year, as fear of transmission led to a reversal in consumer behavior. Shoppers understandably felt safer buying food items off the shelf rather than over the counter, just as they were right to purchase greater numbers of disposable personal protective equipment. However, there are obvious downsides. Eight million tonnes of single-use plastics annually find their way into our oceans, and by 2050 it’s estimated there could be more plastic in the ocean than fish.

Smurfit Kappa Group, an Irish business that deals in paper-based packaging solutions, is trying to address this issue with viable alternatives. Despite the backward shift we’re seeing now because of fear of transmission, we think their long-term outlook for growth is very good. Customers have demonstrated interest in moving away from plastics, which qualifies as a secular benefitting not only the health of marine life but also shareholders of Smurfit Kappa.

A word to the wise

Another factor that’s driving sustainable opportunities is the composition of the investment community – it has fundamentally changed. Younger shareholders want to align their financial commitments with personal values, and that’s led to significant growth in the volume and variety of strategies available along the institutional and retail channels. 

Although we’re naturally very supportive of this rise in responsible investing, there needs to be an element of caution as well. Institutional investors should be wary of greenwashing, a phenomenon where fund managers rebrand themselves as ESG-friendly without necessarily matching the best practices within the industry. For genuine impact, you need a trusted party with the experience and intellectual resources to properly assess their holdings.

My colleagues and I are lucky to have access to BMO’s Responsible Investment team, a collection of 19 professionals with specialty knowledge across ESG issues. Leaning on their expertise, in addition to our own robust company analysis, we can have extraordinary confidence that our portfolio is a diversified 30 to 50 stock portfolio containing some of the best companies in the world addressing long term sustainability challenges, and we are delighted with 5 sustainability ‘globes’ awarded to the fund by Morningstar. We can know our upside participation will be high in good times, and we also know that in periods of uncertainty, such as the one which dawned in March, our holdings are positioned to win the future.

 

To learn more about BMO Global Asset Management’s steadfast commitment to ESG investing – including its dedicated RI approach and breadth of active ESG funds – please contact your Regional BMO Asset Management Institutional Sales & Service Representative.

Disclosures

1 Morningstar, BMO Sustainable Opportunities Global Equity.

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This communication is intended for informational purposes only and is not, and should not be construed as, investment, legal or tax advice to any individual. Particular investments and/or trading strategies should be evaluated relative to each individual’s circumstances. Individuals should seek the advice of professionals, as appropriate, regarding any particular investment. Past performance does not guarantee future results.

Any statement that necessarily depends on future events may be a forward-looking statement. Forward-looking statements are not guarantees of performance. They involve risks, uncertainties and assumptions. Although such statements are based on assumptions that are believed to be reasonable, there can be no assurance that actual results will not differ materially from expectations. Investors are cautioned not to rely unduly on any forward-looking statements. In connection with any forward-looking statements, investors should carefully consider the areas of risk described in the most recent simplified prospectus.

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