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Partner Content by Royal London Asset Management

The Cyclical Squeeze On Sustainable Funds

2020 was a good year for Royal London Asset Management’s (RLAM’s) sustainable equity funds, which outperformed their benchmarks, although there was something of a sting in the tail between vaccine day, 9th November, and the end of the year. The start of this year had been more difficult, not because of stock specific issues, which have been no more or less than in an average year, but for the pronounced rotation into value and cyclical names which did not suit our sustainable, growth-orientated, large cap investment approach. Generally, the companies we are invested in continue to perform very well operationally and this became more apparent in April and May when markets, whilst still volatile, were more balanced with a rotation back to growth. This has allowed the strong operational performance to determine the outcome of our portfolios, rather than bond yields.

Out with the old, in with the new

One of our longest standing investments, St Modwen, received a bid recently and we used the opportunity to exit the position. St Modwen, an urban regenerator, works on brownfield sites to develop housing and warehousing for broader use in the economy. We held a stake in St Modwen for over twenty years and are sorry to see it leave our funds. This demonstrates our expectation that many themes, trends and stocks play out over very long-term periods.

Despite markets being at historically high levels there are still opportunities. Two key areas of interest at RLAM are decarbonisation and digitisation – both will make the world environmentally better. Decarbonisation has a subset, which is electrification. The more we can move to renewables to generate our electricity, the more sense it makes to electrify a whole range of industries. We see this with electric vehicles, and it will broaden further. Electricity has been a sub GDP industry for many years, as energy efficiency has offset the underlying growth in demand. We think this is about to change and will benefit several companies we own. Equally we think digitisation in the industrial world can make manufacturing processes and factories more efficient and environmentally friendly. For these reasons we have started a holding in the French company, Schneider Electric, which is the global leader in energy management and industrial automation – a great way to play the dual trends of electrification and digitisation.

Subjectivity transpires

Like oil & gas we have avoided the mining sector – which has benefitted during the recovery – due to its environmental impact and more problematic environmental, social and governance (ESG) standards. However, a critical difference between mining and oil is that oil can be replaced by renewables. Wind turbines cannot be built from wind. There is a saying that we will need to mine ourselves to Net Zero, especially as we need lots of copper to deliver electrification. With this in mind, at the end of June, RLAM’s External Advisory Committee  met to discuss a range of topics of interest to us and our clients, including whether there are any circumstances under which a mining company could be owned by our funds.

The squeeze releases

One of the great features about owning growth stocks is they get cheaper quickly. If we think about earnings growth, a stock growing earnings at 10% will, if the share price is unmoved, be 10% cheaper in a year’s time on headline multiples. Add into this some market rotation, with many growth stocks being 10-15% from their highs, and suddenly we have growth stocks looking 20-25% cheaper than the recent past. This is what is happening currently. The growth stocks we own are continuing to deliver strong profit growth, yet their share prices are down as investors look to invest in more cyclical/value areas of the market. As we look forward to 2022, which investors tend to do as we pass the half year, we think many growth stocks are now looking to be on the favourable side of fair value.