The term ‘sustainable’ can mean many things, in particular in the context of investing where each fund manager implements their own interpretation of it. These various interpretations can include finding what most investors are yet to see – an approach favoured by Peter Michaelis who has run the Liontrust Sustainable Future fund range since 2001. This range includes UK, European and global equity funds.
Mr Michaelis and co-managers Neil Brown and Simon Clements look for economic changes they believe will have a lasting impact, and then seek companies that should profit from them.
“Our themes focus on what’s going to change in the economy over the next decade,” explains Mr Michaelis. “We then find companies aligned with those themes, and carry out company valuation analysis based on our view of the future. If the market anticipates what we anticipate then there isn’t an investment case. Where there is a gap and we see returns of 30 per cent over the next three years, that company becomes a buy for our funds.”
The themes they invest in relate to creating a more sustainable world, for example, better resource efficiency, improved health, and greater safety and resilience. These are then then broken down into specific and evolving trends that will require input from high-growth companies.
“It’s not just about screening out companies but investing in companies that have great stories, and which are having a positive impact on people and the planet," he says.
Mr Michaelis and his team have recently updated the themes in which they invest the Liontrust Sustainable Future UK Growth (GB0030028764), Liontrust Sustainable Future European Growth (GB0030029390) and Liontrust Sustainable Future Global Growth (GB0030030067) funds. This is because Mr Michaelis believes that some of these have run their course, for example, renewable energy and the transition to lower carbon fuels. He and his team had considered this an area of growth, but following the success of solar and wind energy production, and the Paris Climate Accord, valuations of companies in this area no longer meet their criteria.
"There are areas of previous excitement where things have moved a lot faster than we expected, such as renewable energy, where the cost of power generation is falling year on year,” he explains.
One of their new themes is safety via increasing financial resilience which includes countries developing sustainable economies and saving for the future. He and his colleagues get exposure to this theme in Liontrust Sustainable Future UK Growth via Prudential (PRU), the fund’s third-largest holding.
“The financial sector has a very important role to play, so we look at what that is and how a well-run financial company will benefit from these trends,” he says. “Life insurance and savings products are essential to a prosperous society – when they are done well. With Prudential, there’s a very strong correlation between insurance penetration and economic development. And in a lot of Asian countries, there is a low degree of penetration. As they develop, part of that enhancement will come through insurance.”
Another stock held by the funds Mr Michaelis and his team run is Japan-listed Daikin Industries (Jap:6367) which provides more efficient air-conditioning systems. Air conditioning accounts for 6 per cent of energy use in residential buildings and around 19 per cent in commercial buildings. Daikin’s products can help reduce energy usage by between 60 and 65 per cent.
“In the next 20 years Asian energy consumption is going to grow by 66 per cent," says Mr Clements. "Daikin has a huge lead in Asia - the area that is growing fastest. It’s a high-quality company producing products that cut energy usage significantly, and it’s growing its top-line revenue at about 8 per cent which converts into double-digit earnings per share (EPS). It’s trading at 21 times price/earnings (PE), but we see valuation upside and don’t mind paying for it.”
Valuations are a key aspect of the team’s approach and they have a strong sell discipline.
“We come up with models forecasting revenue growth for five years, and earnings and free cash flow from that revenue growth," explains Mr Clements. "We then decide what PE multiple is right for that level. We are long-term investors and try to be patient. Sometimes a multiple may go up in the short term but we think compounding earnings will bring it down over time. We have one-, three- and five-year price targets. If a stock does well and goes through the one-year target, we will have a look at it and may reduce the position. Our three- and five-year targets are based more on inherent value. If they go through that the stock in question will be fully reviewed. There has to be upside to that price and if there isn’t we have to sell.”
Mr Michaelis adds that having a strong sell discipline helps to tackle a common misconception about sustainable funds – that non-financial considerations determine which they stocks they hold. “Valuation is at the heart of our offering," he adds. "We are aiming to deliver superior investment performance by investing in more sustainable companies. If there is no valuation upside and the market recognises the potential, then it is not worth us investing.”
Peter Michaelis and Simon Clements CV
Peter Michaelis and Simon Clements are co-lead managers of the Liontrust Sustainable Futures equity fund range. The funds were bought by Liontrust from Alliance Trust Investments in April 2017, before which the funds were owned by Aviva Investors, where Mr Michaelis was head of socially responsible investing.
Mr Clements was previously head of global equities at Aviva Investors.
