One of this fund's longest-held stocks is also its winningest

alt headline: How to avoid the hyper-growth companies that end up becoming hyperduds

Note: This interview was taped on Friday 15 November 2024.

The term, the Magnificent Seven, was first coined in a financial context by BofA's Michael Hartnett and it seems to have stuck ever since. Although the term may be new, the companies that make up this exclusive club are hardly new. The newest two of the lot, Tesla and Meta, have both been around for over 20 years.

There is a problem, however. The Artificial Intelligence opportunity set is a lot larger than these seven companies, although they take up most of the real estate when it comes to press coverage, analyst research, and so on. Goldmans' long-term AI portfolio has 50 stocks while State Street's equivalent includes more small and mid-cap AI plays.

The same analogy could be said for sustainable investing. The theme is a lot more than just buying windmills and solar panels. Yes, energy efficiency is a key theme. But sustainable investing is also about finding companies that are working on solutions to deal with ageing populations, food security, financial innovation, and so much more. Needless to say, not all companies that work in this space are of equal quality. 

In this edition of The Pitch, Eddie Orchard sits down with David Winborne to talk about Impax Asset Management's approach to understanding and harnessing the power of sustainability investing. He'll discuss a fact that he feels needs to be talked about more, a myth that needs to be busted, and how he finds quality companies in the sustainable investing space. 

He'll also delve deep into the comparisons that equity bears love making - that 2024 is a lot like 1999. Is this time really different? Finally, Winborne will talk about a stock the fund has held for eight years - and we're willing to guess you won't be able to work out what it is before you read it.

edited transcript

What is a fact about sustainability investing that you feel is not talked about enough?

If I was to summarise the opportunity set at a high level, really there are two paths you can go down in terms of sustainable investment. 

The first is environmental sustainability, which is providing solutions to energy efficiency and resource efficiency type problems. The second is social sustainability, which is finding solutions to some big societal pressures like ageing populations, or dietary change and the companies are involved in providing solutions there, or things in the financial space like financial inclusion in emerging markets or companies providing banking services for people that previously didn't have them. 

Now, what I think is quite interesting is that the first leg of environmental sustainability, which is the bread and butter of impacts is where we started back in 1998. That opportunity encompasses essentially a very wide range of sub-opportunities at a very high level. 

• It starts off as energy efficiency - making existing processes much more energy-efficient.
• Water infrastructure, which has very different dynamics, but these are the companies that make the pumps, pipes and valves that replace crumbling infrastructure in many developed nations.
• The whole food value chain
• Circular economy
• Digital environment, and 
• Clean and efficient transportation. 

When you think about those six groupings, there's an enormous number of opportunities there. 

Similarly, on social sustainability, that complete opportunity set is [found] across all sectors of the global economy. Healthcare is a very important part of the investment universe for us. In the global opportunities fund, healthcare is about 21% of the fund. 

There are numerous, exciting sub-opportunities under each of those ones. It's the sheer breadth of that opportunity and the number of exciting or exciting paths you can go down to look for alpha-generating opportunities. 

What is a myth you often hear about sustainable investing that you feel needs correcting?

The Impax team talks about investing in “high quality companies with sustainability tailwinds.” What does quality mean to you?

Last time you were here (2022), you mentioned that Impax has benefited from avoiding the “hyper-growth” companies. What are some of the defining characteristics/red flags of a hyper-growth business vs a sustainable growth business? 

Winborne: As I mentioned, the Global Opportunities Fund has that quality investment focus. Now, you could argue maybe one of the drawbacks is that you miss out on the really early-stage growth opportunities because we are investing in mature, established businesses, which still can grow into the future but are already generating good margins and good free cash flow. 

But the point I was referring to a couple of years ago is that if you look at what led markets up to 2021, were companies I would term to be "hyper-growth" tech companies. These were a group of companies that captured the imagination of investors. You could see incredibly rapid top-line growth and everyone assumed that growth would continue for an extended period. The poster child examples were things like Peloton (NASDAQ: PTON), Beyond Meat (NASDAQ: BYND), and Oatly (NASDAQ: OTLY). 

Part of the reason why I was so sceptical about these companies is that I used to be a tech analyst and I joined the industry just after the tech bubble burst in the early 2000s. But I've done a lot of reading on the 1999 tech bubble. And one very clear pattern from that time is that people extrapolated out fantastically high growth rates for a very long period of time and they just weren't delivered on at all. 

Cisco (NASDAQ: CSCO), for example, was a poster child at that time and grew earnings by 40% in 1999. By 2002, it was down to 10-12% or something like that. 

The thing for those hypergrowth companies is that they haven't kept up that hypergrowth, which they benefitted from during the COVID period. And if you think back to what you saw in terms of the sell-side analysis back then, they were assuming you'd see 20, 30, or even 40% revenue growth into almost perpetuity. We never invested in those companies. 

On the flip side, I can say that a company that we've held in the portfolio for eight years now, and it's actually been the single best contributor to alpha over that time, is a US company called Cadence Design Systems (NASDAQ: CDNS). 

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Impax Global Opportunities Fund

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