Q: What is the history and objective of the fund?

Our fund began as a global thematic strategy in 2008, believing that to beat benchmarks over time, we need to differ from those benchmarks. So, rather than use any particular benchmark, the fund’s foundational strategy is to identify powerful global growth themes. We are not value-oriented investors, though we have a disciplined approach to valuing securities.

I took over management of the fund in 2013, at which point we narrowed our thematic focus to sustainable investment themes, themes that benefit society or the environment in some way, such as renewable energy, clean water and sanitation, and financial inclusion. 

We use the United Nations’ SDGs, their sustainable development goals, as the underlying framework, as we believe sustainable themes linked to those SDGs offer investors a powerful combination of long-term growth potential and favorable risk characteristics. 

This is a global fund so about half is invested in U.S.-domiciled companies, about 30% in non-U.S. developed markets, and about 20% in emerging markets.  Currently, we have about $2 billion overall invested in the strategy.

Q: How does the fund differ from its peers?

As I mentioned before, we are thematic. We build this portfolio around the most attractive long-term investment themes we can find rather than around a benchmark. And we directly align our portfolio with the UN’s SDGs, so every stock in our portfolio aligns with the broader themes of climate, health, or empowerment. Those are our three primary buckets. 

The goal is to generate a portfolio with characteristics and performance as attractive as any peer global fund while also delivering positive impact on the world around us.

Q: How many themes do you have in total?

Well, there are the three primary themes I mentioned—climate, health, and empowerment—plus 15 subthemes.

Within the 17 UN SDGs lie 169 sub-targets. Now, not all may be investable. Some of those 169 sub-targets are geared more toward policy initiatives, but some do present interesting opportunities for private capital to add value and provide solutions. So, we begin by distinguishing between those that are policy driven and those that feature opportunities for private capital.

For example, within climate lie the subthemes low-carbon generation, energy efficiency, clean transportation, water and sanitation, and recycling. We examine these to see if they offer interesting and powerful roles for private capital. 

Within the health theme lies medical innovation, affordable care access, healthy lifestyles, food security, and physical safety. And the category of empowerment features financial inclusion, gender equality, economic infrastructure, and enabling technologies. 

Q: Do you exclude any particular themes?

Any parts of the SDGs that we deem more explicitly unsustainable, like weapons, nuclear power, coal, alcohol, tobacco, pornography, gambling, and GMOs, are excluded. Also, these tend to represent more classically value-oriented parts of the market, while we focus on growth-oriented parts of the market.

Q: How would you describe your research process?

With the themes defined, our next step is to look at the broad universe of all global companies at around $500 million in market cap and up. We have a universe of approximately 1,500 companies with some degree of revenue exposure—that sell products and services—levered to these individual subthemes. So, the first step in our process is top down.

Our thematic approach is really a combination of a top-down and a disciplined bottom-up approach to add value. Out of those 1500 companies, only 30 to 60 will make it into the portfolio. 

We have an internal rate of return (IRR)-based valuation methodology where our investment team of eight analysts models out five years of financials for every company we consider, and we use proprietary methods to develop bull-, bear-, and base-case scenarios. Building out the valuation with conservative exit multiples at the end of five years gives a return expectation, an IRR, for every potential company. 

At that point, we compare return to risk. We calculate a unique cost of equity for each company by quantifying a number of risk categories, including Environmental, Social & Governance (ESG) risks. The cost of equity serves as the hurdle rate for a particular company to enter the portfolio. Riskier companies have a higher cost of equity; less risky companies have a lower cost of equity.

What we don’t have is a mandate where a company must have a certain level of revenue growth or return on invested capital or balance sheet level. Ultimately, we compare the IRR, which is the spread between return and the cost of equity, and the higher the spread, the more attractive the stock is to us. 

Q: Are there any other facets to your research process?

We do something we call “materiality mapping.” 

Part of our bottom-up risk assessment involves environmental, social, and governance (ESG) risk analysis, because the environmental risks a bank may face, for instance, differ from the environmental risks an oil and gas company faces. We map out the most material ESG risks for companies across 68 industries in a specific manner, and drill down at the industry level. 

This type of risk analysis increases our confidence in the cost of an equity, and is something we don’t see a lot of other firms doing.

Q: Do you follow a different approach for emerging markets?

Yes, and it’s another part of our process that distinguishes us from our peer funds. We call it “grassroots research.” It informs how we invest in emerging countries, given that each investment theme touches on emerging markets in some way. The goal is to establish the nuances of our sustainable investment themes by directly engaging local households and businesses in those markets on critical environmental, social, and even economic issues.

Our onsite visits comprise extensive in-home interviews with people across the socio-economic spectrum in those markets using proprietary questionnaires tailored to each market. That can range from office visits to sitting in a hut, on a dirt floor. Going directly to the source demonstrates what’s happening on the ground, gives us invaluable insights into the challenges and opportunities of global sustainability, and helps us identify where we want to invest. 

Over the last five or six years, we’ve visited about two dozen emerging and frontier countries, looking more at the theme level than the country level—things that may have powerful tailwinds for a long time to come. Examples include how healthcare is being delivered, how people access the financial system, the role of women in society, and the impact of pollution on local communities.

Within many emerging markets there are durable and powerful investment themes.

Q: Can you give specific examples of this grassroots research process?

One of our largest holdings in the portfolio is the Danish company Vestas Wind Systems A/S. It is a global wind-power provider. 

While not a Chinese company, it is involved in the further development of China’s wind industry because of its technological leadership, high quality wind turbines, and the services it provides. We recently visited several cities in China at the grassroots level to discuss the impact of pollution on people’s lives and met with government ministers in Beijing about increasing the share of wind power within their energy mix over the next five to 10 years. We also met with local wind-turbine manufacturers to gain a greater understanding of Vestas’s role.

PP Telecommunication Sdn Bhd, in Indonesia, is another interesting company that’s been in the portfolio since last year, after a trip to Jakarta, because of its intersection of technology and social inclusion. The deepening of a country’s technology infrastructure is closely correlated with greater sharing and dissemination of information and rising opportunities for women. 

Indonesia is beginning to see broadband penetration and the deepening of high-speed data within the country. If that trend takes off, PP Telecom will directly benefit, and could translate to greater social equality in Indonesia. 

In terms of healthcare access, in India, Apollo Hospitals Enterprise Limited, a leading company there, is a hospital chain pushing greater access to healthcare. During some of our grassroots trips there, we initially found people had a somewhat fatalistic attitude toward illness and disease, but Apollo is one of several companies dedicated to improving healthcare access and, as a result, more individuals seek medical care now.

Q: How does your investment process work?

I am the sole decision maker in terms of which stocks are added to the portfolio. My analysts are sector experts with as much as 30 years’ experience in their respective sectors. They recommend companies they want to research, but I also suggest names they should research.

We start by doing a “triage” on a company: taking a basic look at it, identifying what theme applies and the company’s competitive position, and rigorously debating its merits. If we agree it has potential, the analysts build their five-year financial models and perform extensive risk analysis and materiality mapping process, valuation work developing IRRs and the cost of equity and the spread, and then present all this to the team for further debate. We typically engage with the management teams of these companies as well on material financial issues, which includes Environmental, Social and Governance issues. 

Ultimately, though, it’s my decision as to whether a company goes into the portfolio.

Q: How do you construct your portfolio?

Diversification is important in managing a sustainable portfolio. In the 1,500-stock universe tied to our themes, every single GICS (global industry classification standard) sector and geography is represented. We own 10 out of 11 GICS sectors today (the traditional Energy sector is the lone exception) and invest in developed U.S. and non-U.S. markets and emerging markets, so it’s balanced and diversified.

We like to have somewhere between 20%–50% of the portfolio invested in each of our three primary themes, climate, health, and empowerment, at any one point in time. 

And while we don’t necessarily tether ourselves to a benchmark, the accepted benchmark for this strategy is the MSCI ACWI Index. Sustainability and ESG benchmarks also exist, but we don’t use those because we view our alignment with sustainable themes as a competitive advantage over other global funds, so a comparable benchmark makes sense to investors. 

Q: How do you define and manage risk?

We view risk in a few different ways, but we are primarily concerned with individual company risk. Our bottom-up security valuation process features an extensive risk component, an assessment of what we think are the most material ESG risks a company faces, but also the potential strategic, operational, and financial risks, and which risks matter most to each particular company. 

We quantify those and embed them into our stock selection decisions. We focus mainly on the risk of holding individual securities, and also style and factor risks.

Now, all else equal, we prefer to take idiosyncratic risks rather than a lot of style or market risk, the simple reason being that our core competence is research and stock selection. We generate reports and monitor it very closely to see the kind of risk we are emphasizing in the portfolio and the extent that changes over time to understand why it’s happening.

Q: What lessons did you learn from the global financial crisis?

One clear by-product of the financial crisis was the greater need for sound governance and sustainable business models that perhaps work better for society as a whole as opposed to just a few people at the top. 

Sustainability, which we have defined fairly broadly, includes environmental and social sustainability as a major secular driver of potential growth, and we think consumers, governments, and CEOs have come to increasingly understand that. 

In light of the crisis, we are satisfied by how our thematic approach with this fund has evolved to focus exclusively on sustainability and the UN’s sustainable development goals.