Global Perspectives: investing in the transformation of a sustainable economy

Matthew Bullock: Hello and welcome to the latest recording in the Global Perspectives podcast series. My name is Matthew Bullock, I’m the EMEA Head of Portfolio Construction and Strategy. And today we’re fortunate to be joined by Hamish Chamberlayne, Portfolio Manager and Head of Global Sustainable Equities here at Janus Henderson. So, great to have you here.

Hamish Chamberlayne: Good to be here.

Bullock: So Hamish, I spend most of my time working with clients around the world and I talk about building portfolios and talking about some of the key themes that are in the marketplace.

And the area of sustainability comes up all the time, but it really sort of splits the audience. Sustainable investing is getting plenty of headlines right now, especially around the impact that interest rates could have, but also the return outlook as a result of that. And then at the same time, we’re seeing lots of press, particularly in the US, where it’s really questioning investments into sustainable assets and whether that means accepting lower returns.

So, as we’re seeing this impact of higher rates flow through to many of the sectors associated with sustainability, what gives you cause to be optimistic?

Chamberlayne: Yes. So, certainly the financial environment has changed and that has definitely had an impact on many of the companies that we’re looking at. I think what I’d start by saying is that sustainable investing is obviously a very broad church still and it covers many different sectors and parts of the economy.

And we’ve always had a very clear definition of what sustainable investing means to us. And for us, it’s all about alignment. This alignment between investing in the transformation to a more sustainable global economy and that being highly aligned with finding attractive investment opportunities and a namely, so the idea of secular growth, you know, we think the companies that can have the best secular growth prospects are those that are aligned with that transition to a more sustainable global economy.

Now, with higher interest rates, obviously that is a headwind to investment. And I think, you know, the transition to a sustainable global economy does require investment. Obviously, you know, we’re thinking about the greening of buildings, the electrification of transport, decarbonizing our electricity systems, digitalization. There’s a lot of areas that require investment and investment is obviously facilitated or made easier with lower interest rates.

I think in terms of the market perception, what we’ve seen this year is quite a mechanical reaction to higher interest rates and that being applied to discount rates and certainly you’ve seen valuation compression across many of the sectors that we look at across many of the companies that we follow, you know, really outside of the sort of areas of high performance computing and artificial intelligence, it’s been quite a challenging market environment this year across all sectors.

And that certainly includes sustainability. The thing that gives us cause for optimism, though, is that when we look at the underlying growth, it’s still there. So the share prices are telling us that there’s been a bit of a lull, however when we look at the underlying statistics we can see there’s still growth very much in evidence. So just a statistic is that in the US, more than 250 clean energy and manufacturing type projects have been announced so far this year, and that’s across places like electric vehicle manufacturing, battery investment, renewable energy projects, real estate.

So the stuff that’s still happening underlying this and the financial performance, the underlying cash flow generation of many of these companies has remained very strong.

Bullock: And just on the 250 energy projects mentioned in the US, and I don’t want to go too deep into politics, but what influence does politics in this example the US have upon the sort of future success of those 250 plus projects?

Chamberlayne: So I’ve been doing sustainable investing for quite a long time now, and I’ve seen quite a few political cycles over that time. I still remember very clearly 2016 when we had Brexit in that year, and that was also the year that Donald Trump was elected.

And we had a lot of concerns that were voiced at the time was what was the prospect for cleaner energy projects with the election of Donald Trump? And at the time I remember very clearly saying that we didn’t expect there to be a negative impact at all. And there are a few reasons for that. One is that the economics continue to get more and more compelling. And when we look at the sort of the cost parity with cleaner energy, whether that be solar and wind with traditional sources of generation, where that called a natural gas, whether we look at sort of the trajectory of the cost of electric cars and that parity in terms of total cost of ownership with gasoline cars, those economics are becoming much, much more favourable over time. And we thought and we expected the investment to carry on regardless. And the other dynamic as well, which I think is an interesting one, is that a lot of the investment, a lot of the job creation that’s happening in the United States is happening in Red States. So it’s actually the Red States which tend to be benefiting more than the Blue States from a lot of this clean technology and clean energy type of investment.

And so there is actually quite strong bipartisan support for things such as the Inflation Reduction Act and these government incentives.

Bullock: Okay. I didn’t know that. And yeah, let’s move on from politics, but I want to go into something else that’s in some ways equally as exciting, talking about regulation. Now regulation, especially around sustainable investing, it feels like almost every day there’s something in the paper talking about, you know, more regulation, a focus on asset management in particular.

So how are you feeling about the regulatory environment for sustainable investing? And, you know, very importantly, where the industry is going to be heading?

Chamberlayne: So that’s quite a loaded question in some ways. You know, I think, you know, the regulation that’s happening across sustainable investing and across ESG, it’s well-intentioned. And, you know, it is a very complex area.

And, you know, investors are struggling to understand the differing products that are available and obviously we hear a lot about greenwashing. And so there’s also, you know, the other aspect of regulation is it’s not only aiming to help investors understand or navigate their way around the space better, but there’s also an aspect to the companies and making sure that companies are allocating capital and changing in a positive direction.

In the near term, I mean, I regard it as a journey ultimately. And I think we’re at the very beginning of the journey. And at the beginning of the journey, there’s a high degree of complexity. And the reality is, is that if anything, I think it’s leading to more confusion rather than less confusion as we look at the world, as we look around the world today, you know, every single region has got a slightly different approach.

You know, the SEC, the FCA, the European Union have all got different regulatory frameworks or pathways with regards to sustainability and ESG. And as a global manager, that is creating a lot of complexity for me and I see my clients and it’s creating a huge amount of confusion, complexity for my clients. However, when we look out over the next ten years where we’re traveling towards, you know, we’re going to be going towards a scenario where companies are I mean, this is actually another key point.

It’s just the consistency of the data that’s being reported by companies. In some ways, we’re putting the cart before the horse, regulating the asset managers, before the companies are all reporting data in a consistent format across the world. Now, I sort of draw the analogy to international, you know, accounting standards. Until there is sort of a common basis of data that’s consistently reported by companies across the world and common standards with regards to sustainability, it then makes it very difficult for portfolio managers or investment managers to produce consistent data on their portfolios. However, that’s the world I think we’re going to travel towards over the next ten years. I don’t think is going to be a smooth ten years, but I think we’ll get there.

Bullock: So a bit early on I think it was the first question that I asked, you threw out a few different sectors that were interesting and I wrote some of these down as quickly as I could. You talked about buildings, electrification, transportation, digitalization, and then the list goes on. But out of all of this, where are you focusing your time? Where is the sort of the real winners that you’re expecting to see in the coming, let’s say, sort of five, ten years.

Chamberlayne: Sure. So, I mean, you know, the companies that are aligned with those sectors that you’ve just mentioned, I think one of the big trends that we’re really focused on is that we see cutting across really all parts of the economy, all sectors in the markets is something that we call the DED nexus, the digitalization, electrification and decarbonization.

Bullock: DED nexus?

Chamberlayne: Yeah, the D-E-D nexus.

Bullock: Okay.

Chamberlayne: So, this idea that digitalization and electrification, we see as, you know, very powerful secular trends that are happening across all parts of the economy. We need to electrify and we need to digitalize in order to decarbonize. You know, they are very important vectors of decarbonization. If we break that down and then go into sort of the different sectors, you know, I’ve talked about the greening of buildings.

There’s a lot of investment that’s required to improve the efficiency of buildings and improve the I suppose, the infrastructure and technology embedded within buildings. So, we see a lot of opportunities in companies exposed to that sector, whether they be the low voltage electrical space, whether they be in building materials space or whether they be in the sort of higher tech sort of, you know, Internet of Things or connected technology space.

Then you’ve got things like the electrification of transport. Again, you know, here we are talking about electrification. And as and as we electrify transport, we can digitalize it and there’s a lot of sort of there’s a strong software element to the electrification of transport. And again we see lots of opportunities along that value chain as well. We haven’t really invested in many electric car manufacturers themselves and we see that as being quite a crowded space and a lot of competition.

You’ve got all the incumbents alongside a lot of new entrants, but where we do see quite interesting opportunities is in the value chain and the companies making the enabling technologies for this, the sensors and connectors, the semiconductors, the electrical harnesses. So there’s quite a lot of interesting the passive electronic components, a lot of interesting companies in the supply chain there.

Bullock: And actually you sort of pre-empted the question I was going to ask you, which is about crowding, because a lot of people are talking about sustainability and you focus on electrification of transport. Do you see the same value in other supply chains that you cover? So is this a broader story? Are there opportunities or is there a crowd out effect which means that the opportunities to outperform in sustainable investing get harder?

Chamberlayne: So, it certainly is certainly a very valid question. I think that was very relevant a couple of years ago. When we think back to 2020 and 2021, when arguably there was a bit of an ESG bubble closely linked to the growth bubble that was happening in markets where valuations were really, really high and we saw a lot of capital market activity, a lot of companies coming to market IPOing, maybe coming out of private equity, and a lot of them were associated with, shall we say, ESG story stocks.

And they came at very high valuations. They didn’t have strong fundamentals. There are also other parts of the space where you get what we call ESG story stocks. They’ve got a good headline story and you do sometimes get crowding. So we’re very disciplined around how we look at valuation and the companies we choose look at. We think there’s definitely enough opportunities out there to find attractively valued investment opportunities. And especially when it comes to things like the I think, you know, a key focus of ours has been enablers. So generally companies which are a bit less, shall we say, exciting on the outset, companies making sensors, companies making connectors, companies making analog semiconductors, microcontrollers. And these are all, or passive electronic components, and these are all essential building blocks to enable the electrification of transport or the digitalization of industry or the making buildings greener and smarter. And that’s where we see some really interesting ideas.

Bullock: So just on the crowding piece, are there any areas you see that you actually would caution against? So are there areas that investors should sort of steer away from that are more prone to crowding or could be on the other side of the coin that you talked about the winners, but could be the losers as we see this sort of evolution in sustainability?

Chamberlayne: Well, I think since 2021, it’s been quite a challenging market for sustainability, you know, growth and sustainability have been quite challenged areas. So I would say since September 2021, there’s almost been a bit of a bear market in some of the sectors that we look at. Certainly, this year we’ve had very narrow markets and it’s all been about the Magnificent Seven, you know, Apple, Amazon, Meta, Alphabet, etc. And a lot of the names that we follow have had quite a rough ride, and that’s been in response to the higher interest rates and the market sentiment around higher interest rates and higher discount rates and just lower valuations.

So we see much less crowding now and valuations have come down to what we think are much more interesting levels across many of the areas that we’re looking at. So for investors who don’t work in sustainable investing every day, so it is a minefield as far as the different terms and interpretations, what’s meant by sustainable. You see some very pure approaches, some less pure approaches, active passive.

So what advice would you give investors and what questions should they be asking all fund managers, including yourself, of course, so that they truly understand whether a strategy is right for them? Yes, it’s I mean, it’s a really important question because I think the intent of a lot of this regulation has been to try to make that easier for clients, for investors to understand the products they’re investing in.

But that’s not necessarily what we see. We see actually a lot of confusion and it’s actually led to more questions coming from clients. So really, you know, I would say our advice is the same as it’s always been even before the advent of regulation, is that you really need to still do your due diligence and understand your investment managers philosophy.

And one of the things I always really like to say to clients is that when I sit down to speak to a new client for the first time, or even, you know, an existing client, and I say, let’s just take all sustainability language out of the conversation to start with, and I want to give you our portfolio with no name above it, no text around it, and just a list of names that we invest in.

And what I want you to see is a portfolio of really interesting global businesses, the leaders that are leaders in their respective industries or sectors and that are exposed to powerful secular trends. And ultimately that’s what we think clients should be looking at, is that this is all about, to our mind, it’s all about at the end of the day, generating wealth, compounding wealth for our clients.

And the logic of sustainable investing ultimately sits behind that. So we’re almost out of time, and I’m going to ask you an unfair question to finish off with, which is something that I usually do when I do these podcasts, which is we’re talking about equity strategies, which are usually longer term in focus. But I’m going to ask you to sort of get the crystal ball up, talk about the next 12 months, which, you know, a lot of investors will be thinking about and ask you the question about whether you’re optimistic for the next 12 months for sustainable equities, or is this a time really for someone to be standing on the sidelines and waiting

for some of this noise to die down to see what happens with rates going forward? So I’m generally cautiously optimistic, I think and that may sound like a bit of a cop out. So, we are long term investors. So we’re definitely thinking about that longer term secular growth. And I tend to shy away from talking about the immediate term and I find, you know, the near-term market prognostic very, very challenging. And that’s the thing that gives us confidence to investors that we can see these very powerful secular trends.

And that feels like, you know, a much easier thing for us to latch on to and to have confidence in, sort of the returns that we are going to generate over the next 3 to 5 years. In terms of our nearer-term outlook, it is linked to that medium term outlook, you know, valuation is an important starting point.

And I think about where we are today compared to where we were two years ago. I think I’ve already mentioned it, market conditions have been challenging over the last 18 months, 24 months. Valuations have come down quite significantly in some of the areas that we’re looking at. I’m talking outside of high-performance computing and artificial intelligence.

Yeah, we have got some exposure, we are really excited about ongoing growth there, we think it is going be very transformative to many industries and a really empowering sort of R&D and innovation across many sectors. But outside of that, there’s been a bit of a bear market in things like electrification, the automotive sector, utilities and renewable energy.

So valuations we think are more attractive. Interest rates, you know, we see many people are talking about the cycle topping out and that’s generally going to be a better backdrop if we can get confidence at the pace of interest rate rises or the outlook for interest rates is going to moderate, then that’s going to provide a more supportive backdrop for growth and yes, I think, you know, hopefully we’ll be able to navigate in a period of, you know, even if rates stay a little bit higher for longer, you know, the things that were concentrating on is the productivity, the underlying cash flows of the companies we invest in remain strong.

And I should hopefully see them, you know, see them through any sort of, you know, any challenging period. So cautiously optimistic, cautiously optimistic about the near-term.

Thanks, Hamish. So, we’re unfortunately out of time, but I just want to thank you very much for all your thoughts and to thank our audience for listening as well. And so, of course, if any of our listeners wish to learn more about Janus Henderson’s investment views or if you have any other questions, then please don’t hesitate to contact your client, relationship manager or visit our website.

So with that, thank you and goodbye.

Cash flow refers to the net balance of cash moving into and out of a business at a specific point in time.

Discount rates determine the present value of future earnings, which allows an investor to have a better idea of the value of a business today.

Environmental, Social and Governance (ESG), also known as sustainable investing, considers ethical factors beyond traditional financial analysis.

A company’s fundamentals are the information that contributes to the valuation of a security, such as a company’s earnings or the evaluation of its management team, as well as wider economic factors.

An initial public offering (IPO) is the process of issuing shares in a private company to the public for the first time.

An interest rate is the price paid to borrow debt capital, in other words it is the cost of money, and is determined by the central bank rate. The interest rate cycle ‘topping out’ implies that a central bank has finished its path of raising rates i.e. that the bank rate has peaked.

The SEC and FCA are oversight agencies, in the US and UK respectively, responsible for regulating the securities markets and protecting investors.

Secular growth trends are long-term investment themes that are ubiquitous and have strong growth potential. Examples include climate change, artificial intelligence, or changing demographics. Can also be referred to as a long duration trend.

Valuation metrics are used to gauge a company’s performance, financial health and expectations for future earnings, eg. price to earnings (P/E) ratio and return on equity (ROE).