Article 31 January, 2021

European equities: Contributing to a better world

Our first commentary of 2021 is rather different from a usual monthly fund update. From an investment perspective we remain very positive on the potential for a strong recovery post-covid and have built a portfolio to benefit from this.

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Our first commentary of 2021 is rather different from a usual monthly fund update. From an investment perspective we remain very positive on the potential for a strong recovery post-covid and have built a portfolio to benefit from this. Here however, we are going to elucidate how the fund is contributing to positive change in the world and why clients – myself, my family and you – can be proud of owning this fund.

This commentary is split into two parts. The first is a brief description of how we are satisfying our mandate to build a portfolio that not only is generating investment performance, but that clients – particularly the end clients whose capital it is – can be very proud of owning, because they are contributing to a better world.

By way of three examples, the second section is a practical demonstration of the specific contribution that clients’ capital – through the companies they own – is making to society. If this practical demonstration is of the greatest interest, then readers should skip the first section.

Section 1: incorporating ESG

When we launched the fund a key aim, which I believe is increasingly important to the end client, was to bring to life the impact that the companies we invest in have on society. In a world of ESG jargon and accusations of industry greenwashing, we are keen to take a back to basics but innovative approach to incorporating sustainable investing into our process. In fact, with a blank sheet of paper we can define the fund’s terms and so we have defined a clear mandate: alongside our quest for investment returns, we are only interested in investing in companies which have a positive impact on society.

The word alongside is very important. We are not neglecting any of the fundamental parts of our process such as a desire for strong management, a robust franchise, or valuation discipline. In fact our ethical considerations enhance those investment pillars. We also take a holistic view and consider direction of travel to be important. In practice, our ability to build the right portfolio for any given point in the cycle, composed of robust bottom up investment cases is and remains unconstrained and even improved. Through engagement and deployment of capital we in turn have a positive impact on wider society.

Within the PVT team, we have developed a robust framework where we assess each company’s activity and behavioural impact on wider society through three pillars which are People, Innovation and Environment. The process covers the business model, the corporate behaviour, ESG risks and controversies, governance and where appropriate, engagement and is summarised below.

Figure 1: Sustainable PVT Pillars

Source: River and Mercantile Asset Management LLP

One question we are asked, is “what does a positive impact actually mean?”

In reality, every company has both positive and negative externalities to both their fundamental business model and corporate behaviour. For example, at a very high level they will employ people and by aiming to increase profitability sustainably should contribute to productivity and economic growth, but their business activities probably emit carbon, or they may sell a product which can do harm to their customers. These negative externalities are rarely acknowledged in ESG commentary, which too often focusses on ‘ticking the boxes’ and this lacks credibility.  For us it is the balance of these positive and negative impacts which is important and we are looking for the net effect to be one which is making the world a better place. This is an additional vector to more traditional ESG considerations which are also of course important and incorporated in our process.

“We have defined a clear mandate: alongside our quest for investment returns, we are only interested in investing in companies which have a positive impact on society.”

Section 2: the positive impact of the fund

Figure 2: UK Sustainable Development Goala

Source:, UK in collaboration with Project Everyone

Figure 2 above shows all 17 of the UN’s sustainable development goals. In this note I intend to reveal three examples of the positive impact our companies are making with reference to these goals.

Example 1: Volkswagen

Ever the contrarians we will start with a controversial one! The interplay between a positive and negative contribution – and how both need to be acknowledged – is clearly seen in our holding of VW which we believe has a strong claim that it is making a positive contribution, in contrast to the consensus view.

We are all aware of a significant controversy involving VW – namely the “dieselgate” scandal. Indeed some third party ESG analysts give VW their lowest possible score on the back of the scandal, and the stock market capitalisation is one eighth of Tesla which is a reflection of the low rating the earnings attract. It is right to acknowledge this extremely poor corporate behaviour.

However on a holistic basis - considering all the positive and negative impacts of VW on society - I strongly disagree with the above assessment. Whilst appalling corporate behaviour, the scandal gave impetus to direct VW’s R&D program (the third largest R&D spend in the world behind Amazon and Google) firmly at transitioning to electric vehicles (EVs). They are the only European Original Equipment Manufacturer (OEM) with the scale and innovation to have a fully dedicated Electric Vehicle (EV) platform – the MEB platform for their ID series of cars – at a cost of about €30bn. As a consequence, by 2023 VW will be selling almost as many electric cars as Tesla, but at fraction of the valuation, and with a very large and profitable traditional auto business too!

Figure 3: Market value of Tesla plus next largest 14 global auto manufacturers. Tesla is now larger than the next eight combined

Source: Deutsche Bank

Example 2: NKT

Next we discuss the theme of renewable energy and the conundrum of valuation bubbles.

There is no doubt that pure-play, well known ‘energy transition’ stocks are highly valued – time will tell whether the companies are able to grow into these multiples – my somewhat unhelpful prediction is that some will, and many won’t! However, off the beaten track in Europe there are still lots of opportunities which are less well discovered (‘twas ever thus). We can happily invest in these without having to risk the valuation bubbles bursting. Indeed, this is a key exposure for the fund as energy transition will be a dominant investment theme for this upcoming business cycle. By owning this fund your clients’ capital is helping to contribute to that energy transition which is something to be proud of.

How do we gain exposure to these themes without the bubbles? Consider an off-shore wind farm – the growth of which is going to be very significant. The pre-eminent operator of these is the Danish company Ørsted which is a fantastic business with a fantastic management team. We are clearly not the only ones to think so though, with the share price up 431% since IPO and the valuation is much too high for our tastes. Even more fundamentally there is trouble brewing: almost every European oil and gas company is trying to muscle in on their market. Competition is just about to get a lot tougher…

But the growth in offshore wind is very real. Maybe we could gain exposure via the wind turbine manufactures or OEMs? Siemens Gamesa has the highest exposure to offshore turbines of these OEMs: making wind turbines is all it does. Long seen as a bit of a disaster investment given its huge cyclicality and habit of profit warning, the company has rerated to a cool 101x price-to-earnings from its usual 15-20x. This is borderline bubble stuff.

But digging a little deeper we find the cable companies – who connect up these offshore windfarms using high voltage cables – to be much more interesting investment cases. Because they have other strings to their bows than just offshore windfarms, such as grid infrastructure and industrial production (the outlook for both being attractive) we can access the long-term theme of energy transition without paying excessive premia. Time and again in our investment universe these ‘second line’ opportunities present themselves.

After an ill-advised acquisition in 2017, the cable company NKT is a recovery phase investment of ours which we bought at fund launch to take part in the recent recapitalisation.  It has been a successful investment since. To connect an offshore wind farm High Voltage DC cable is required, which is a very technical product dominated by three (European) companies with consequently very good margins, and an amazing growth outlook. By supporting the rights issue of NKT not only have we made money, we have strengthened the balance sheet and funded a capacity increase for the business.  This will allow them to support the accelerated roll out of offshore wind – a positive contribution indeed and again, an investment of which to be proud!

Example 3: Novo Nordisk

Innovation is the lifeblood of a sustainable business – in fact it is one of the key pillars of our Sustainable PVT framework for analysing the ESG impacts of our investee companies. All else equal, good innovation is a win-win for society and the company doing the innovating.

The final example is a more traditional example of a company with strong sustainability credentials. In our portfolio Novo Nordisk is a great example of a highly innovative company. The company invests heavily in R&D, which is borne out in its consistent track record of new and improving products for their customers which have transformed, and transform millions of lives. Despite this heavy investment, it is the highest return business we own. This Danish diabetes drug company is the only business I have come across whose goal is to do itself out of a market – to “defeat diabetes” – a disease which kills twice the number of people per year that Covid has to date (at the time of writing).  Why then do we invest in the company? And why can your clients be proud of owning it?

Apart from the transformational impact their R&D has on the millions of diabetes sufferers worldwide, their new generation of drugs, so called GLPs, have the ability to be used in a far wider suite of applications than just the direct treatment of diabetes. Without their wonderful culture of innovation, these are applications and drugs which may not have been developed. The most notable of these is the biggest underlying killer in the developed world – not heart disease or cancer – but obesity. As they continue to build a franchise addressing this issue, the world will become a healthier, happier place for it. It is this opportunity to build another Novo Nordisk franchise in a different end market which makes for an interesting fundamental investment too.

These are but three examples. Clients should know that across the portfolio, every day, their investee European companies go to work to generate returns for them, and at the same time improve society as a whole. And in a world that for a long time never had so many different global societal challenges, that is something to celebrate. We will return to this topic again.

This information has been prepared and issued by River and Mercantile Asset Management LLP (trading as “River and Mercantile” and “River and Mercantile Asset Management”). River and Mercantile Asset Management LLP is authorised and regulated by the Financial Conduct Authority (Firm Reference Number 453087).
Please note that individual securities named in this article may be held by the Portfolio Manager or persons closely associated with them and/or other members of the Investment Team personally for their own accounts. The interests of clients are protected by operation of a conflicts of interest policy and associated systems and controls which prevent personal dealing in situations which would lead to any detriment to a client.
The value of investments and any income generated may go down as well as up and is not guaranteed. An investor may not get back the amount originally invested. Past performance is not a reliable guide to future results. Changes in exchange rates may have an adverse effect on the value, price or income of investments.

European equities

A philosophy and process designed to find the opportunities in Europe most likely to produce attractive returns for investors, while making a positive contribution to society

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