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Green machines: The ESG funds and trusts best placed to thrive
In late September 2021, when the UK market had its most recent wobble, many ESG or ‘sustainable’ stocks and funds experienced a sharper sell-off than the FTSE All-Share index, prompting some to wonder if the boom in ethical investing had run its course.
Fast forward to today and the best of those ethical stocks and funds are trading at even higher levels than the start of September. Sustainable investing looks like it’s not only here to stay, but it has the potential to deliver better returns than the index.
BUY ON WEAKNESS
When the market sold off, Impax Environmental Markets (IEM), one of the oldest and most successful sustainable trusts, saw its shares drop nearly 10% from 544p to 491p in less than 10 trading days while the FTSE 100 and the All Share were down less than 2% over the same period.
Today the stock is trading back above 550p, meaning investors who stepped in and bought on the basis that the business hadn’t changed but the shares were trading at a smaller than usual premium to net asset value have done rather nicely.
Similarly, shares in hydrogen economy company ITM Power (ITM:AIM) fell nearly 14% from 430p to 372p in less than 10 days yet they have not only recovered their prior levels, they recently closed above 509p.
NOT EVERYTHING GREEN GLITTERS
It’s tempting to assume that everything ‘green’ and sustainable will have benefitted from the build-up to the COP26 climate conference, as a rising tide lifts all boats after all.
However, not everything has enjoyed the same degree of investor enthusiasm. After a good performance last year, most solar assets have failed to deliver in 2021, with the Invesco Solar ETF (TAN) posting a -3.5% net asset value and -3.9% share price return year to date.
Even worse, the iShares Clean Energy ETF (INRG) has registered a 13.5% drop in NAV total return this year. Some clean energy trusts have performed better, with Foresight Solar Fund (FSFL) generating a 7.7% return over the last 12 months and Greencoat UK Wind (UKW) breezing to a 10.5% gain, yet both pale by comparison with the less sectorially-constrained Impax Environmental Assets which has returned 43% over the past year.
WAS COP26 JUST A LOT OF HOT AIR?
Studies have shown that if global warming leads to a two degree rise in temperatures there could be a 15-fold increase in the number of people suffering from heat stress, a potentially fatal combination of heat and humidity. That’s why one of the most significant developments from COP26 is the global agreement to try and limit global warming to only 1.5 degrees.
Another coup for the climate summit was the agreement by more than 400 banks, asset managers and insurance companies to align $130 trillion of private finance with science-based net zero targets and near-term goals through the Glasgow Financial Alliance, led by former Bank of England governor Mark Carney.
This means a phenomenal amount of money is going to be reallocated to green initiatives, both public and private, and is likely to mean an even greater focus by financial institutions on ESG and sustainability.
Other milestones included a pledge to reverse deforestation with commitments of $20 billion of public and private finance, and plans to speed up the development of ‘green’ hydrogen – produced with renewable energy rather than fossil fuels – to reduce carbon emissions produced by heavy industry.
NOT QUITE THE END OF COAL
COP26 also declared coal had been ‘consigned to history’, with five of the world’s top 20 coal-using countries agreeing to phase out its use and major international banks committing to end all international public financing of new coal projects by the end of this year.
However, one of the big disappointments was that China, the world’s biggest polluter and a major consumer of coal, mostly pushed back against calls to cut emissions more quickly and refused to sign pacts to reduce spending on fossil fuels.
While China has agreed to end overseas coal financing, at home it is still pressing ahead with new coal-fired electricity plants due to the soaring price of natural gas.
THE US IS LEADING THE CHARGE
The long-awaited $1 trillion US infrastructure bill has finally been passed by the House of Representatives, with $73 billion earmarked for clean energy projects such as electrifying public transport and cleaning up soil and groundwater in old mines and gas fields.
While this was lower than president Biden’s campaign target of $100 billion, we can add tens of billions of dollars set aside for infrastructure spending which includes rebuilding America’s electricity grid network and expanding clean energy production.
There is also $55 billion in funding to improve the country’s water infrastructure, from replacing lead pipes to improving the quality of drinking water.
A second bill before the House proposes a sweeping expansion of social care as well as programmes to fight climate change, but with a price tag of $1.75 trillion negotiations are likely to be hard-fought.
‘Generations from now, people will look back and know this is when America won the economic competition for the 21st Century,’ said president Biden in a statement.
NET ZERO AS A GROWTH DRIVER
For many businesses, getting to net zero emissions by 2050 is going to be a tall order, but for many others it is actually a growth driver.
Engineering software firm Aveva (AVV) noted in its half year results that customer activity ‘began to recover as both net zero projects and an improving general pipeline of greenfield asset construction projects started to build’.
As analysts at TechMarketView observed, ‘Customer investments have been expected to boost tech suppliers’ growth but this is probably the first time we have heard a supplier say net zero projects are an identifiable driver. We anticipate it will be the first of many.’
Sustainable fuel technology firm Velocys (VLS:AIM) announced last week it had signed a 15-year deal with Southwest Airlines of the US to supply 575 million blended gallons of net zero sustainable aviation fuel, starting in 2026.
At the same time, the firm said it had signed a 10-year deal with British Airways owner International Consolidated Airlines (IAG) to supply 73 million gallons of carbon negative sustainable air fuel. News of the two deals sent Velocys’ shares 34% higher.
What is Responsible Investing?
At F&C Investment Trust, we believe in responsible investing. We know this term doesn’t mean the same for everyone, so what does it mean to us? As a shareholder in a wide array of businesses, we take seriously the pressing challenge of climate change and have made a commitment to having a portfolio that is net-zero in carbon emissions by 2050 at the latest. We will move more quickly if we can.
Being responsible also means working hard on sustainability. We consider and report on our exposure based on the framework of the UN’s 17 Sustainable Development Goals (SDGs) to give us clear aspirations and measurable targets. We will continue to seek investment opportunities that are both contributing positively to sustainability, and also delivering strong financial returns.
For us, that involves actively engaging with our portfolio businesses to help them improve their performance in environmental, social and governance (ESG) best practices. Our Net Zero ambition, and the Sustainable Development Goals framework, are important drivers of this engagement, as we seek to encourage companies to make sustainability a core part of their business strategy.
We know the task is not easy, so we commit not to overpromise but to do our best to deliver on what we pledge.
BEST AND WORST FUNDS AND TRUSTS
The divergence between the best and worst performing sustainable funds and trusts has been unusually wide over the last year. Even within the same stable, some funds have done much better than other for little discernible reason.
In the case of funds, what we notice is that barring Baillie Gifford Positive Change (BYVGKV5) the top performers are relatively small which means a surge in inflows may have sent their share prices up sharply.
The bottom performers on the other hand were a mixture of sizes but they had one thing in common: they were all bond funds, and with the move up in yields most corporate bonds have done poorly this year, sustainable or not.
In terms of trusts, again the biggest losers were fairly consistent in that they were all heavily exposed to renewable energy stocks with one exception.
The winners were more varied, with notable exposure to energy efficiency and industrial stocks rather than renewables. While, perhaps unsurprisingly now it is under the Baillie Gifford umbrella, Keystone Positive Change (KPC) is laden with US technology stocks.
WHAT TO BUY
Rather than take a long shot and try to pick the sustainable stocks which we think will do the best ourselves, there are plenty of managers out there with the pedigree to do a better job. Also, using funds and trusts to invest in the theme brings the added benefit of diversification.
Therefore, we have picked two funds, one investment trust and one exchange-traded fund or ETF.
Stewart Investors Worldwide Sustainability Fund (B7W3061)
Fund size: £845 million
This fund aims for capital growth rather than income and only invests in shares of high-quality companies ‘which are positioned to benefit from and contribute to the sustainable development of the countries in which they operate’.
Stocks are selected on the basis of their quality of management, social usefulness, environmental impacts, responsible business practices and solid financials, which mean they can invest to grow.
This ‘does what it says on the tin’ approach is a refreshing contrast to many higher-profile funds which claim to be ethical or sustainable but actually invest heavily in technology stocks and multi-asset funds which have half their exposure in government bonds.
The fund has beaten the MSCI All-Countries World Net index since inception and is having a good year, up 24% over the past 12 months. It is rated A for Responsibility by Square Mile, and the ongoing charge is 0.67%.
Pictet Global Environmental Opportunities Fund (B4YWL06)
Fund size: €8.7 billion
Coming from the same stable as the Pictet Water Fund (B516BZ3), which we profiled recently, this fund pitches itself as a ‘growth engine’ for equity portfolios thanks to the long-term opportunities for companies with products and services which cut pollution and maximise resource efficiency.
Pictet typically run high conviction funds, and for its size this fund is unusually concentrated with just 53 stocks. What is more, the top 10 holdings account for nearly a third of the portfolio.
Like the Stewart Investors fund, it eschews the usual technology names, leaning instead towards design and automation software stocks which improve industrial efficiency. It also has sizeable weightings in healthcare, industrial and consumer stocks.
After a strong 2020, when it returned just over 30% against 12.7% for the MSCI ACWI Net Index in dollars, it is slightly behind the benchmark this year with a 12% gain to the end of October which makes this a good time to take a look.
The fund gets a Bronze rating from Morningstar along with five globes, its highest sustainability rating, and comes with a 1.1% ongoing charge fee.
Menhaden Resource Efficiency (MHN) 112p
Trust size: £91 million
The trust aims to generate capital growth by investing in ‘businesses and opportunities that are demonstrably delivering or benefiting significantly from the efficient use of energy and resources’.
Like many of its peers, its portfolio is heavily tilted towards US technology stocks with holdings in Alphabet, Charter Communications and Microsoft making up more than half of its assets.
The managers’ rationale is that Alphabet and Microsoft are big users of renewable energy in their cloud and data operations, while Charter allows people to work from home, reducing carbon emissions caused by commuting.
However, while most tech-focused funds tend to trade at a small discount or even a premium, the trust is currently trading at a 29% discount to net asset value which means investors can own a combination of resource efficiency stocks and a chunk of US tech for almost a third less than it would cost to buy them in the market.
The ongoing charge of 2% is steeper than most of its rivals, and the trust isn’t rated by Morningstar, but the team has done a good job of beating the benchmark over one, three and five years.
iShares MSCI Europe SRI ETF (IESG) £55.10
Size: £3.38 billion
This is the daddy of UK-listed ESG exchange-traded funds with over £3 billion of assets making it extremely liquid for investors who want one-shot exposure.
The fund only invests in companies with high ESG ratings while avoiding firms which don’t meet its value screens or have exposure to fossil fuels, whether that is through extraction, processing, power generation or the ownership of reserves.
Top holdings include hardware and software stocks ASML and SAP, but the fund’s overall weighting in technology is less than 10%. Instead, the top-weighted sectors are financials, healthcare and industrials.
The fund is pan-European and UK stocks make up 15% of the portfolio, just behind Germany and France and well ahead of Switzerland and the Netherlands.
The total expense ratio is 0.2%. The shares have gained 25% over one year and 57% over three years.
DISCLAIMER: The author Ian Conway owns shares in Impax Environmental Markets. The editor Daniel Coatsworth owns shares in Pictet Global Environmental Opportunities Fund.