Talking Heads - Investing in the resilience of environmental trends

Talking Heads podcast with Portfolio Manager Sid Jha of the Global Environmental Leaders Fund

Hello and welcome to the BNP Paribas Asset Management Talking Heads podcast. Every week, Talking Heads will bring you in-depth insights and analysis through the lens of sustainability on the topics that really matter to investors. In this episode, we’ll be discussing the outlook for sustainable investing. I’m Daniel Morris, Chief Market Strategist, and I’m joined today by Sid Jha, Portfolio Manager of the Global Environmental Leaders Fund. Welcome Sid, and thanks for joining me.

Siddartha Jha: Thanks, Daniel. Nice to be here.

DM: Given the uncertainty in the outlook today, what are the implications of that for sustainable investing in general and for investing in environmental strategies in particular?

SJ: The trade war that the world is experiencing is clearly extremely disruptive from an economic perspective. CEO confidence is down sharply. Consumer confidence is down sharply. Confidence in employment prospects is dropping rapidly. Corporations are delaying or putting on hold capital expenditure decisions. All of this added up is creating an environment of uncertainty that is generally not a good background for prospective returns in the equity markets.

When I look at the space of sustainable investing and environmental strategies in particular, there’s a different picture emerging. To understand why, you need to understand the context of where these strategies have been over the past two and a half years. Sustainable investment portfolios in general have struggled over the past two and a half years. Part of the reason is that they’ve been underexposed to the key drivers of market performance, whether it is the exceptional concentration of returns in the Magnificent-7, whether it’s the vast outperformance of US stock markets versus the rest of the world, or the dominance of momentum factor in stock market returns.

The way we saw the situation was that the rubber band was very stretched and at risk of snapping back to a more normal trend line. Fast forward to today and some of this tension has been unleashed. You’ve seen stock markets in the rest of world starting to outperform US markets. Returns are no longer being driven as sharply by a small selection of companies. Across the sustainable investing space and environmental strategies, that’s generally been a helpful backdrop for relative returns.

DM: As a portfolio manager, you want to have a medium-term to longer-term view trying to capture the secular trends that are going to see you through troubled times. What are some of the secular trends that you think are the most resilient given the macro headwinds that we face?

SJ: The answer to that question in two ways. The first is in broad portfolio construction principles. What are portfolio managers trying to achieve? And the second is the specific secular trends that are likely to be resilient.

There’s a  saying in the market about you have to wait for the tides to go out before you can see who’s been swimming naked. In volatile times, you want to make sure that the portfolio that you’re constructing has been wearing their swimming trunks. When we construct portfolios on a medium-term view, portfolios are built to be resilient to external shocks. In any investment time horizon, the macroeconomic mood music is sometimes going to be a tailwind and sometimes a headwind. So, your first objective is to construct a portfolio where you can own companies that can prosper in good times and [are] resilient in the hard times. In that context, it helps to identify companies that are be benefiting from multi-decade secular tailwinds.

We know that energy use is going to grow by 50%, food production needs to increase by 70%, water usage is going to increase so much that over half the world is going to be exposed to water stress. Failure to address these challenges is not an option. And meeting these challenges requires technological and business model innovation, which companies are highly motivated to solve for because there are trillions of dollars of revenue potential ahead for the companies that can successfully solve these problems. That’s what we spend our time doing, looking for companies that can benefit from those changes.

DM: Given that context, can you give us some examples of industries or sectors where you see that benefit most apparent?

SJ: We like our advanced water treatment exposure. We believe there are only a handful of companies that are operating at the edge of technological progress in the treatment of potable water. The companies that we own provide advanced water treatment and analytics equipment that are critical to ensuring the supply of safe, potable water across the world. They are attractive as an industry because not only are they the best at what they do, but they do so in a financially attractive way. In practice, that means they’ve got high margins, low capital intensity, conservative balance sheets, and have pricing power. Most importantly, given they service the needs of water utilities around the world, they have a dependable customer base where revenues rarely turn negative. Some of them have not seen a down year in earnings terms in their entire existence.

These are companies that are run by management teams that have excellent track records of adding value from capital deployment. You can buy them for the same free cash flow yield as you currently pay for the border of market despite the fact that they are by far better businesses than the average index constituent. So, in any market environment, but particularly a volatile environment, we view them as excellent homes for capital.

DM: I could summarise some of the key points that you shared with us, Sid. We talked about broadly what is particularly uncertain macroeconomic environment. When you think about the broad picture and how things are today versus say how they looked over the last couple [of] years, we’ve seen a reversal and that reversal arguably helping sustainable investing more broadly. We think about the secular trends. You mentioned rising energy consumption, food and water demand, and you’re looking for companies that can benefit from those trends. One of the sectors you highlighted was advanced water treatment. Well, Sid, thank you very much for joining me.

SJ: Thanks Daniel.

DM: That’s it for this week’s episode of Talking Heads. If you would like more information, please reach out to your BNP Paribas Asset Management contact or check out Viewpoint, our website for investment insights at viewpoint.bnpparibas-am.com. Just before we go, I’d like to mention that the Talking Heads podcast is available on Spotify and on YouTube.

For YouTube, visit youtube.com/bnp/playlist and tap or click on Talking Heads. You’ve been listening to the BNP Paribas Asset Management Talking Heads podcast with me, Daniel Morris, and Sid Jha, Portfolio Manager. Please do join me next week. Until then, take care.