The investment attracting 84% of all flows

It may surprise some to learn that one theme, and one theme alone, has attracted the lion's share of global flows over the past two years. In fact, according to Calastone, US$84 of every US$100 invested into equity funds has flowed into ESG-focused products. 

Now, before you switch to a small or micro-cap focused yarn (and believe me when I say I enjoy them as much as the next punter), it's important to recognise that is serious money. A total of US$15.1 billion out of a possible US$18.1 billion, to be exact. And yet, Calastone found that Australian and Asian inflows are lagging around two to three years behind their global peers.  

So, listen up. Investments in sustainable products are seriously ramping up, with Aberdeen Standard Investments' deputy head of Australian equities Natalie Tam arguing pressures at a governmental, corporate and social level have forced businesses to take action. Meantime, she has also noticed an acceleration in asset owners - the likes of our superannuation funds - starting to put their money where their mouth is. 

"The time has long passed for taking a 'head in the sand' approach to climate change. The time is now," she says. 

This trend is truly starting to kick into gear, says Aberdeen Standard Investments head of Australian equities Michelle Lopez. 

"In the final quarter of last year, we saw more flows than we did for the whole of 2020 and 2019 combined. So there is serious money now going into ESG funds and solutions," she says. 

In the interview below, Lopez and Tam share some of the insights gained from the newly launched Aberdeen Focused Sustainable Australian Equity Fund, a high-conviction all-cap portfolio of sustainability winners and losers. 

These include the data uncovered from the firm's propriety ESG and climate tools, which are able to distinguish the winners and losers of the climate race. As well as the one company, in particular, which is likely to take a fall. 

Lopez and Tam also share their thoughts on the current market environment and share why they are feeling optimistic about Australian equities. They name two tech stocks they have recently picked up at a discount, as well as three stocks they would buy in the case of a market crash. 

5 key takeaways from my interview with Michelle Lopez and Natalie Tam

1) Now is the time to be investing in equities 

Lopez and Tam believe that the outlook for equities is looking pretty rosy, pointing to increased government spending towards economic growth and record-low rates for their bullish outlook.

"Companies are telling us that CapEx programmes are back on the agenda across all the different sectors. Businesses are starting to reinvest, so that's very, very supportive," Lopez says. 

She also believes interest rates will remain at record-low levels for at least the coming two years. That is, until central bankers start to see full employment and a sustainable inflation annual rate of 2% or higher. 

"So the implication that has for investing and the markets more generally is that there is absolutely no incentive to keep your money or keep your capital in the lower risk asset classes, such as bonds, deposits or cash," Lopez says. 

"We've seen net positive earnings revisions for the past eight months, and we haven't seen a string of eight months of net positive earnings revisions for the past two decades," Tam adds. 

"So conditions for businesses are very strong and I think that does paint quite a rosy outlook for equities, in general, at this point in time." 

Tam points to three stocks that the team would pick up if any volatility or weakness continues in the market; Tyro Payments (ASX:TYR), Temple & Webster (ASX:TPW) and Spark New Zealand (ASX:SPK). 

The first, a "clean recovery play", suffered from widespread terminal outages earlier in the year -which Tam believes will be "more muted than the market's expecting". 

"We like divisive, that gives us the opportunity to earn an outsized return, which we love,"  says Tam. 

She also believes that Temple & Webster will continue to be able to grow its sales by multiples over the coming five years.

"I would be buying that business ... but I think there'll be a bit of volatility. We might get our chance to buy it on a 20% fall," Tam says. 

In the case of a 20% correction, Tam recommends investors flock to safe, "steady-Eddie" defensive names. 

"I would be rotating into something like Spark New Zealand; which is New Zealand's telco operator. It's got a 5% yield, it's got very low earnings volatility. And during crisis times we need our mobile networks, don't we? So that's something that I know would outperform in a really high volatile market."

2) Households and businesses are cashed up

Australia went hard and fast with its stimulus measures to tackle the COVID-19 financial crisis, Tam says, which has helped to add some extra cushioning to both household's and businesses' wallets. 

"Household savings rates are up 5% to 20%. If we look at excess deposits as a percentage of GDP, that's sitting at 10% now," she says. 

Another tailwind for equities, as mentioned above, is the RBA's low cash rate. Which, in case you hadn't noticed, has sent the housing market to the moon of late. 

"The Big Four banks are seeing a 40% increase in loan applications. So there's a huge demand," Lopez says. 

"The challenge though is converting those applications into drawdowns and they're not seeing that convert yet. And that's really a bit of friction in the market around supply. There isn't enough stock of houses to be able to fulfil the demand that's clearly coming through."

3) The easy wins from the rotation have already been had

The deep value opportunity that investors saw at the end of last year has played out, Lopez says, and investors need to think about what could happen next. 

"If you think back to November, which is where we saw the sharp recovery on the back of very positive news flow around vaccine efficacy, we saw the COVID unwind trade play out," she says. 

"In November alone, Unibail-Rodamco-Westfield was up 73% in one month, and it was categorically cheap at that point in time prior to that. So it was trading at just above 0.2 times book. It's now a 0.8 times book, which we think is fully valued." 

Travel also performed exceptionally well, with Webjet up around 60% and Flight Centre up 50%, Lopez says. 

"Now you need to think, 'Okay, what's next in this part of the cycle?' And we're starting to see some headwinds emerge in the sense of friction within supply chains and also rising costs - particularly wage pressure, that's starting to come through," she says.

4) Digitisation and sustainability are taking the market by storm

Tam and Lopez are adamant that digitalisation will continue to drive portfolio returns over the coming decades, despite the sell-off we have seen in some of the world's - and Australia's - major tech names of late. 

"These are huge trends; the adoption of Cloud, 5G and what that will enable from the point of view of IoT or Internet of Things," Tam says. 

"If we can get exposure to companies that have businesses exposed to these themes, then they're going to be propelled along with that growth as well. So they're the kind of opportunities that we're looking for at the moment." 

Interestingly, over the last few weeks, markets have become more nuanced with investments in tech, with a clear preference for cashflow positive companies emerging within the market. 

The duo believes Altium (ASX:ALU) and Xero (ASX:XRO) - two stocks that have been battered in the sell-off - have plenty of upside ahead of them. 

"Altium's an interesting one because they're in the sin bin a little bit in a number of ways;  they've had a couple of downgrades but they've also been impacted by COVID," Lopez says. 

"We're still very strong believers in the product, the embedded nature of it, the management team and kind of the long-term strategy that's been created there. So that's one that we've been slowly picking a little bit more as it comes down." 

Meantime, Xero was sold off around 10% following its result as people "got quite nervy around its margin". 

"They have taken the view of building out the long-term value creation of the business and they're clearly bringing customers on because subscriber growth is at record highs," Lopez says. 

"But it's come at the expense of putting a bit more money in to grow that, and we're comfortable with that because we understand the business and what they're trying to do there." 

However, the companies that will really stand out over the coming years will be those leveraged to sustainability, Lopez says: 

"From renewable energy, through to batteries and electric vehicles, and environmental management - the companies that offer technologies that are going to play into that trend. I think they're the ones that are going to really stand out over the next five years plus," she says.

5) Under almost all climate scenarios renewable energy companies win, and AGL loses

Aberdeen Standard launched a climate scenario analysis tool earlier this year, which allows the firm to run 16 different climate scenarios to see how it would impact individual stocks. 

"So, for instance, a Paris-aligned scenario at the very top level, it translates that scenario into an economic shock, like a carbon tax, and then it generates an impairment or an uplift in the valuation at the stock level," Tam says. 

"So interestingly, when we run all our central scenarios for climate change analysis across the S&P/ASX 200, the most affected and most highly-impaired company is AGL." 

It comes as AGL moves to restructure its business, with Australia's oldest energy company announcing it would break off its coal power plants into a separate business (PrimeCo), while the new AGL would focus on zero-carbon electricity. 

"I think at the end of the day, the board and management team can see the future and the way climate scenario analysis and policy is changing, and they need to do something at this point in time to pivot the business, in a sense, to try and address that impairment risk... because it is there," Tam says. 

Meantime, the winners - under almost all climate scenarios - are renewable energy generators, Tam says. 

Access ASX leaders in the worlds biggest thematic

The Aberdeen Standard Focused Sustainable Australian Equity Fund invests primarily in a concentrated portfolio of around 20-35 companies that are listed or proceeding to listing on the Australian Securities Exchange (ASX) and have the potential for capital growth and increased earning potential. For more details use the contact form below, or visit their website. 

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