The Ethical Investor: Bell Asset sees the ESG value in small to medium caps
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Global funds manager Bell Asset Management (BAM) sees rising geopolitical and macroeconomic risks ahead, and has cut its exposure to large global companies in favour of smaller and mid-sized (SMID) stocks.
The fund manager says there’s a risk that China’s growth slowdown could impact the global economy, along with growing risks that central banks may hike rates too sharply to combat rising inflation.
But on the bright side, BAM also sees plenty of buying opportunities, especially in the SMID end of town where 42% of its portfolio is now invested.
Currently, the Global SMID Cap Price/Earnings (P/E) ratios stands at a significant discount (15x) to the MSCI World Large Cap Growth Index (at 24x).
It’s also trading at a discount to the main MSCI World Index, which is a rarity given that small caps’ multiples have been trading at an average premium of 12% in the past 10 years.
Adrian Martuccio, co-portfolio manager at BAM, explained that there are two reasons why smaller caps are trading at a discount.
“The first is that investor sentiment has been quite poor on small and mid caps recently which made them underperform the larger cap cohort,” Martuccio told Stockhead.
The second reason, according to Martuccio, is to do with earnings risk.
There’s potential downgrades as a result of companies missing their earnings in the quarters ahead, and a lot of that risk is concentrated in the very small companies – those capped under a billion dollars.
“We invest into the more liquid area of these small caps, which are usually around $2 billion to $5 billion,” said Martuccio.
In this bracket, Martuccio says that you can generally find a lot more mature companies which have better returns on capital, as well as better ESG (Environmental, Social and Governance) characteristics.
BAM’s investment approach focuses on companies that meet certain thresholds, including consistent profitability and a strong focus on ESG factors.
“Fundamentally we believe that if you have a portfolio with great ESG characteristics as well as meeting other quality metrics, then it’s going to help you outperform,” Martuccio said.
“There is a very tight correlation between quality companies and good ESG outcomes,” he added.
BAM’s funds screen out fossil fuel stocks and instead look for companies that have strong ESG characteristics and business models that fit into the world’s carbon neutral transition.
Martuccio feels that he’s been through enough cycles to know the current volatility or appreciation we’re seeing won’t last long.
“We feel that we have to stay true to our ESG philosophy and investment style,” says Martucci – adding that the rising energy prices we’re seeing now are the result of unfortunate geopolitical events as opposed to long term fundamentals.
“We’re happy to not allocate to energy or dirty utilities, for example, because there’s just so many other opportunities out there.”
Right now, the BAM funds are finding value in stocks with low carbon footprints that have the potential to outperform over the long term.
As a result, BAM has managed to reduce the carbon intensity of its portfolios to around 80% lower than the benchmark.
Currently, the portfolio consists of overseas names such as Denmark-listed Novozymes – a company focusing on industrial enzymes, microorganisms, and biopharmaceutical ingredients.
It also holds UK-listed Croda, a specialist chemicals company, as well as logistics play Zebra, and IT services company Broadbridge.
“We take a really pragmatic approach to ESG. We’re not saying that we’re an impact style of investment, but what we do is look for profitable, high quality companies that have a proven business models already.”
According to Martuccio, identifying stocks like these involves a bottom up ESG materiality assessment which covers not only environmental factors, but also social and governance.
This means not investing in companies that address their operational and reputational risks poorly.
“There are often times that we would exclude companies due to poor management or governance,” said Martuccio.
BAM’s funds meanwhile have all been assessed by the Responsible Investing Association of Australasia (RIAA).
As a firm the company has also been a member of the UN PRI (Principles of Responsible Investment) since 2014.
Martuccio believes that the conversation around ESG is only going to intensify.
This means companies that haven’t got ESG at the front and centre of their operations will find it difficult to compete.
For fundies, Martuccio reckons it’s all about engaging with the companies you invest in, helping them understand what’s important to investors and how to attract capital to their businesses.
Proxy voting is also another way for BAM to improve the outcomes of its investee companies.
“By being pragmatic about ESG and having an integrated bottom up process, and having really defined sustainability targets at a portfolio level keeps us on track to generate not only good returns, but also sustainable ones,” said Martuccio.
“I think that’s most important to investors, especially as we go forward the next couple of decades.”
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