Portfolio Insights – Implementing key developments in the Aqua portfolio

Hello and welcome to the BNP Paribas Asset Management Portfolio Insights podcast. In this episode, we will bring you a deeper insight into the fund and discuss how macro views are implemented in the portfolio currently. I’m Daniel Morris, Chief Market Strategist, and I’m joined today by Justin Winter, Senior Portfolio Manager of Aqua portfolio at Impax Asset Management. Welcome, Justin, and thanks for joining me.

Daniel: Justin, looking at some key trends we’ve seen over the last couple years in water related investments, maybe you can take us a step further and discuss what’s going on in your portfolio. If I can maybe start with a question. How your views on the trends for water, how do they filter into the portfolio?

Justin: some of the big things happening at the moment are things that are impacting economies more broadly. So reshoring of manufacturing is part of that. Manufacturing needs a lot of water.

You might not think about it immediately, but if you look at semiconductor manufacturing, for instance, it’s a very water intensive process. So there are lots of challenges to be met there in treating and moving water around within a semi fab. There are also areas around water quality. So emerging contaminants such as forever chemicals or microplastics.

So these are things that are around now and need solutions, but also things that are going to play out over a very long term. So, something for us as long term investors, we’re very mindful of. And then thinking about decarbonisation of, transportation, there are a lot of challenges there, for instance, in making sure that there is enough lithium around to go into vehicles.

So, lithium is often found in places where there’s a lot of water scarcity. So there is a very acute water challenge to be met there. So thinking about how those things then feed into the portfolio, there are companies that are active in all of those spaces that are held.

So it’s not really a question of looking for, you know, there’s this say new and exciting theme and we’re looking for a solution provider. Normally whether it’s an infrastructure company or a water treatment company. They normally have a lot of different solutions. And so the great thing about it is that, this particular part of their business will be growing to deal with this challenge, but it’s not a one shot go..

Daniel: When you come across companies doing interesting things, innovative things in this space, how does that end up being reflected in positions in the portfolio? And I guess maybe talk about if there’ve been any key changes in sectors where you’ve had shifts recently.

Justin: So there were lots of things that feed into the sizing.

of a holding or even whether or not we hold something. Essentially, we want to own really good businesses and we don’t want to pay too much for them when we take a stake, like pretty simple in theory. The difficulty is if we look at the opportunity going forwards, a little bit of change in the angle of growth.

It can make quite a big difference to how much something is worth now. So that’s a key part of what we’re doing. Typically there aren’t tens of thousands of listed companies who are involved in this space, but there are some really high quality businesses that are operating that are providing these solutions that we look to own.

Hopefully, what you hope for is that there’ll be some sort of mispricing some discontinuity in the valuation, which means you can buy something that’s clearly underpriced. What typically happens is you buy like a really good business, or buy a stake in it for a fair price, and then you sort of enjoy that ride as it plays out, as we have done in this fund, you know, there are things we’ve owned for 15 years. New names come along now and again, and we’re really pleased that we added one back in recently. So this was a group of businesses that were owned inside a bigger conglomerate, and then they have been spun out as a separate listed company. So that means that we’re able now to hold that. So those things come along, maybe once a year, something like that. It’s not a high turnover fund, but, you know, we’re really pleased to have been able to take advantage of that opportunity.

Daniel: Alongside these sectors that you’ve discussed as being interesting, what types of stocks really seem appealing then in the context?

Justin: So there are broad categories within the strategy. So there’s infrastructure names, there are treatment and efficiency names and there are utility names, and all of those in their own way are interesting in solving these challenges. So when we construct a portfolio, we’re looking for diversification, both geographically and by end market, but also in terms of how resilient the underlying businesses are to economic cycles.

So generally speaking, utilities are more resilient to the economic cycle and infrastructure names are a bit more geared into economic growth, but it’s having that balance across those. And then with the ultimate overlay on valuation, which is a key, we have a bottom-up approach.

So all that feeding into a portfolio that’s going to be resilient for the coming years, whenever things happen that we weren’t expecting, which inevitably will happen.

Daniel: Not surprisingly, we’ve been focused on the growth that you anticipate in this space, you know, primarily as a function of the challenges that are quite significant and hopefully that’s what engenders the growth.

Nonetheless we must be balanced and prudent. So when you think about any current threats or headwinds, tailwinds, that are really top of mind right now.

Justin: So in terms of thinking about risks, so we look at the underlying businesses, the key part of it is, you know, understanding the risks that they have, whether it’s, you know, balance sheet, whether it’s, anything to do with potential environmental risks or whatever it is – that feeds in.

So when you’re looking at an individual, business, a key part of our process is to understand those things that we know could go wrong, and then to really engage with management to make sure that they’re mitigating those risks. Because we look at a lot of companies in the water space, we’re pretty well placed to have an informed view about what the risks are.

Another aspect of risk management is the things that we don’t know about. And that’s where that portfolio construction approach, having a balance between defensive and more cyclical names, feeds in. So we manage that unknown. And these are things like the European sovereign debt crisis.

If you think about sort of trade tensions between the US and China going back five years ago when that really kicked off. So managing that broader portfolio risk through this balance and then looking at individual businesses and understanding their individual risk. That’s a fundamental part. So in investing, a key part of that – and it’s something that doesn’t really get talked about – is avoiding things that go wrong. It’s great to have lots of opportunities, but you also don’t want to be owning something that goes bad, and our bottom-up process feeds into mitigating that.

Justin, thank you very much for joining me.