Liontrust Responsible Capitalism Report 2024 - Flipbook - Page 68
Investment process for equities
The investment process is a high-conviction, bottom-up approach
whereby sustainability is explicitly integrated throughout. The
process is designed to capture long-term investment opportunities
from transformative changes in the global economy, tied to the idea
that over time economies become more sustainable. The investment
process follows two core stages.
STAGE
STAGE
Identifying superior stocks
for the equity portfolios
Constructing resilient
portfolios
1
2
• Management quality (rated from 1 to 5): Assesses whether a company
has appropriate structures, policies and practices in place for
managing its ESG risks and impacts. Management quality in relation
to the risks and opportunities represented by potentially material ESG
issues are graded from “1” (excellent) to “5” (very poor). Companies
must score C3 or higher to be considered for inclusion in the funds.
3. & 4. Business fundamentals and valuation analysis:
Companies in which the team invests have robust business
fundamentals with a proven ability to deliver high returns on equity
(RoE) through sustaining margins and asset turnover. Typically, these
companies have a maintainable competitive advantage through
scale, technology or business model. For any stock in the team’s
portfolios, the team would expect to find the following:
The first stage – stock selection – has four key filters: thematic;
analysis; sustainability analysis; business fundamentals; and
valuation. For idea generation, any investment needs to satisfy
these four key filters to be eligible for investment.
• Growth: theme-driven: growing addressable market, market share
gainers, structural tailwinds
1.
• Quality of earnings: resilient, dependable – recurring revenues,
cash flow conviction. The team then predicts the likely sales,
earnings and other financial returns it expects to see from these
companies over the next three to five years, integrating a view of
its quality into these.
Thematic analysis: the team works to better understand the big
sustainable trends that are happening and analyse these themes
to check which companies will be potential winners or losers from
major multi-decade changes in different parts of our economy.
Why is this relevant to investors? This helps identify potential areas
of the economy and the companies that will experience structural
growth, and helps inform the investment decisions and give the
team conviction in the businesses they own. The team feels most
investors under-estimate the speed, scale and persistency of such
trends within our economy. The team therefore looks at the world
through the prism of three mega trends:
Better resource efficiency (cleaner): using our resources more
efficiently (water, recycling of waste, lower-carbon energy
sources and energy efficiency)
Improved health (healthier): improving quality of life through
better education, healthier lifestyles and diet or better healthcare
Greater safety and resilience (safer): making the systems
consumers rely on safer or more resilient, including car safety,
keeping our online data safe with cyber security and spreading
risk through appropriate insurance mechanisms.
The team then examines 20 themes within these and identifies
companies with significant exposure to at least one of these themes.
2.
Sustainability analysis: While a company might have
significant exposure to a theme, the team also has to check
how sustainable the rest of its activities are. For each business,
the team determines the key ESG factors that are important
indicators of future success and assess how well these are
managed via the team’s proprietary Sustainability Matrix.
Every company held in the portfolio is given a Matrix rating, which
analyses the following aspects:
• Product sustainability (rated from A to E): Assesses the extent to
which a company’s core business helps or harms society and/or the
environment. An “A” rating indicates a company whose products or
services contribute to sustainable development (via the investment
themes); and “E” rating indicates a company whose core business
is in conflict with sustainable development (such as tobacco or very
polluting activities such as coal-fired electricity generation).
68 - Responsible Capitalism Report 2023
• Resilient returns: high-quality companies – high barriers to entry,
aligned management team, sustainable and a competitive
advantages that will endure
The team then predicts the likely sales, earnings and other financial
returns it expects to see from these companies over the next three to five
years, integrating a view of its quality into these. Applying the relevant
valuation multiple allows the team to derive a price target achievable
in the next three years. When this shows significant upside (the team
typically looks for greater than a 10% return per annum), the investment
is recommended as a buy and available to be included in the funds.
Building resilient portfolios
From the superior stocks identified, the team builds portfolios combining
the best 40 to 60 names to diversify risk and reduce volatility of
returns. This results in exposure across a wide variety of industry sectors
(via a spread of the team’s sustainability themes) and benefits from
potentially distinct and uncorrelated growth drivers. Outperformance
will come from the stocks the team chooses, while disciplined portfolio
construction aims to minimise the volatility of returns.
There is low turnover in the portfolios, with holding periods typically
greater than five years. Apart from continual monitoring of relevant
news, research and price movements, there are also annual reviews
of every position’s investment thesis.
The team prefers to sell a stock when it reaches a valuation where
it cannot see further upside, and where the case for selling and
recycling it into an investment with greater return prospects is
compelling. The alternative case is when the future does not turn
out quate as envisaged and events reveal a side to the company or
sector the team did not anticipate. Where this negates the original
investment thesis, the team will sell the stock.
The team will not formulate new reasons to hold on to an underperforming investment. Although selling is sometimes necessary, the
team looks through short-term fluctuations in markets or share prices
and focuses on the long-term investment horizon. The depth and
rigour of the research gives the team the confidence to stand firm if
the fundamentals are strong, even when the market moves against it.