Sustainable Growth Q4 investment update

As with any investment, your capital is at risk. Past performance is not a guide to future returns.

Alasdair McHugh (AM): Hello and welcome along to this Sustainable Growth update. I'm Alasdair McHugh. I'm an investment specialist on the strategy, and I'm joined today by Katherine Davidson, who's one of our co-managers.

As a reminder, in Sustainable Growth, our aim is to build a portfolio that our clients can be proud of. So proud of for its financial returns, but also proud of the value that it creates for society. And our philosophy is very much to look for companies that are sustainable in both senses of the word, able to deliver enduring growth over time, but also that enduring good for society.

Katherine, Happy New Year. I hope you've had a restful break.

Katherine Davidson (KD): No, of course not. No, I've been painting ceilings for most of the break. So, I'm actually excited to come back into the office for a rest. But the one benefit of minor physical labour is that it gives you an opportunity to create a bit of headspace. It's been a good opportunity to reflect on the year that's just gone and think about priorities for the year ahead. And it's nice to see everyone else coming back in with plenty of energy and a renewed vigour for new projects.

AM: I think actually that gives us quite a good structure for our conversation today. So reflections on the year that's passed and also the priorities for the year to come. We’ll maybe start with the reflections then and bring you a bit further back than a year, because it's now two years since you launched Sustainable Growth. So, what are your reflections over that period?

KD: Yeah, so in the high level, the main thing that we're focused on is performance. And there we're frustrated, we're disappointed, we haven't delivered what we hoped to for clients. But when we look at the underlying building blocks, we think we have delivered on the key things we set out to achieve two years ago.

So, we go through those in turn. Firstly, we wanted to broaden out the portfolio, so encompassing more drivers of growth and with less correlation between the holdings. Secondly, improving the resilience of the underlying names. One of the things we've talked about over the last two years is the double negatives, so stocks that are both negative earnings and negative free cash flow. And we've gone from 18 of those to now one coming into the year.

And thirdly, raising the bar on sustainability. So, I think we've got lots of really exciting, well-aligned names in the strategy. And one of those, Edwards, which pioneered non-invasive heart surgery, for example, and clients can read about all of our holdings in our new Sustainability Report, which has just dropped.

AM: Okay. And I think it's important to emphasise that we've managed to achieve those improvements to diversification, to resilience and to sustainability, you know, without compromising on that double digit earnings growth rate that we aim for.

More recently then, the theme of 2024 has definitely been one of index concentration of particularly US mega cap stocks, most frequently those in the technology space really driving forward that index performance. Last quarter we talked with Toby about that broadening out somewhat. Has that continued into the fourth quarter of last year?

KD: Unfortunately, not. So we saw quite a concentrated market again in the fourth quarter, again dominated by US tech, but also other parts of the US market. So smaller caps and financials responded very well to the election result, as did energy companies given some of the ‘drill baby drill’ rhetoric from Trump. But we can't attribute the performance entirely to regional positioning or asset allocation. We had some very poor single stock results as well in 2024.

Our worst performing name over the year actually ended up being L'Oréal, which while it's continued to grow, has suffered from more challenging environment in China. It's done better than peers like Estée Lauder, but it's still been showing much, much weaker sales growth there, which we think is down to younger cohorts experimenting more with new brands and maybe with local brands. So we're looking for L'Oréal to step up their innovation to revive growth this year.

AM: And obviously that US presidential election was a big event in the fourth quarter and a big driver of markets. So, I'm sure clients will be interested to understand what a second Donald Trump term means for the Sustainable Growth portfolio.

KD: I wish we had more clarity on what a second Trump term means for anything, really. But hopefully, we'll get more policy clarity over the next weeks and months. It's interesting to us that the market is quite clearly extrapolating what happened in Trump's first term in terms of the performance of small caps, financials, industrials, etc. Whereas we see some bigger tail risks given where we are in the market and in the economic cycle at the moment. 

So, tariffs are pretty unambiguously a bad thing for stock markets. And the other tail risk is that we see inflation blowing out again as a result of fiscal spending. So, we're not sure that it's an unambiguously positive environment for US equities.

AM: Okay, and have you changed your positioning at all in the wake of those events? Or indeed, how are we positioned versus the US market? And why?

KD: No, we haven't changed the positioning. You know that BG don't try to call the macro or take a top-down view. Our investment cases for our holdings are premised on a 10-year view, so well beyond one presidential term. And part of improving resilience has been about not holding names that are very exposed to policy environments, companies that can make their own weather, we call it.

That said, we are quite significantly underweight the US, and we haven't been rushing to close that gap. We're much less underweight, incidentally, when you look at the revenue exposure of the portfolio rather than the domicile. So it's not a big bet against the US economy, it's more against the U.S. stock market. And that's primarily on valuation grounds. The premium that the US is trading over the rest of the world is as wide as it's been in 20 years. Some of that's justified. But when you look at the profitability, it's 70% of the index versus 50% of the index profits. So, a big chunk of it has been multiples.

In that environment, we're maybe going to look for some contrarian ideas in the US. And we're generally seeing quite attractive opportunities in other geographies, so Europe, Japan, China, etc.

AM: That feels like a good segue into the priorities for the coming year and beyond. So where is your focus for 2025?

KD: First and foremost, it's on performance and in improving the outcomes for clients. But that's an output and we can't control that. So what we can control is our inputs. When we look at the portfolio today, we're broadly happy with it.

We think we've got the right combination of names for a quite uncertain environment. And we're tracking the operational progress very closely. And that's in line or ahead of our thesis for the vast majority of our names. But we do want to make sure that there's always high competition for capital.

So, while we like our current holdings, we want there to be plenty of names on the sidelines jostling for position and seeking to constantly upgrade. So, as well as those contrarian names, we'll be taking a look at areas of the market that might be outside our comfort zone, places where we've got less exposure and making sure that we've explored the whole of our opportunity set.

AM: Okay, we'll check back in next quarter on progress on that. Thank you for your time today.

I think the summary for clients is that we're very pleased with the inputs into the strategy. So, whether that's enhancements we've made to our portfolio construction, whether it's the idea generation that's flowing through the team, or indeed, whether that's the operational performance of the companies that we hold, all of those inputs are pleasing.

We're aware that the outputs have been disappointing. To some extent, that's to be expected because we're not going to do as well as a very concentrated index. But nevertheless, our focus is very much on improving that relative performance for clients. This past quarter, if anything, the range of potential outcomes has widened even further. So, we're very happy with our positioning for a range of different growth drivers in your portfolio.

So, thank you for joining us today and we'll update you on our progress with all of that next quarter.

Annual past performance to 31 December each year (net%)

Annualised returns to 31 December 2024 (net%)

*31 December 2022

Source: Revolution, MSCI. US dollars. Returns have been calculated by reducing the gross return by the highest annual management fee for the composite. 1 year figures are not annualised.

Past performance is not a guide to future returns.

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