136. Taxing the cryptocurrency traders
From tax returns to elective surgeries, and from national grids to who’s watching what on TV, there...
As a pioneer of responsible investing, EdenTree offers even the most discerning client a justifiable investment opportunity. Responsible investing is a key factor in decision making, for the EdenTree Amity UK fund, with any potential investment having to pass through a rigorous multi-factor screening process. Although it can invest in companies of any size, the portfolio is very different to many of its peers, as it invests in a large proportion of smaller and medium-sized companies.
Read more about EdenTree Amity UK
23 October 2020 (pre-recorded 21 October 2020)
Below is a transcript of the episode, modified for your reading pleasure. Please check the corresponding audio before quoting in print, as it may contain small errors. Please remember we’ve been discussing individual companies to bring investing to life for you. It’s not a recommendation to buy or sell. The fund may or may not still hold these companies at your time of listening. For more information on the people and ideas in the episode, see the links at the bottom of the post.
Darius McDermott (DM): I’m Darius McDermott from FundCalibre and this is the Investing on the go podcast. Today I am joined by Ketan Patel, manager of the EdenTree Amity UK equity fund. Good afternoon.
Ketan Patel (KP): Afternoon Darius, hope you’re keeping well.
DM: Yes we are doing as best as we can in these strange and interesting times.
DM: So let’s talk about the fund. When we met last year, you talked about exciting opportunities in healthcare. Obviously it’s been a very topical theme given the pandemic, but you talked about pharma, drugs, technology, and this has been a huge area of focus for you. How’s this impacted companies and has there been a huge acceleration in some of the change in those areas?
KP: Yes. Healthcare is one of the core pillars for us at EdenTree. We are a responsible and sustainable investing house. The Amity UK fund was launched in ‘88 so it has a long history and has a long history in investing in healthcare.
Now what the pandemic has done, it’s accelerated the manner in which the wider healthcare sector operates. So R & D [research and development] timelines, for example, have been accelerated because there is a race to find a vaccine or treatments for COVID. The diagnostic sector obviously has had to pivot to mass production of testing kits, like never before, so there’s a real challenge there in terms of finding materials and also distributing as well. However, you know, one of the kind of catalyst has been the actual realisation of technology, and that’s been a massive game changer. So a good example here would be something like telehealth, which is been given a massive turbo boost by the pandemic. And I think this will result in better health economics and also superior patient outcomes as well.
Now that the companies that are, which are in, are a part of the portfolio, which are all going to play a part and maybe a major part in terms of a solution to the pandemic from R & D and also manufacturing. So both AstraZeneca from R & D in terms of producing a vaccine and also Glaxo which will play a bigger role, I think, in terms of the manufacturing and the distribution of any vaccine that comes out either at the end of 2020 or 2021.
DM: Has Astra said anything about their vaccine recently? That’s in collaboration with Oxford, isn’t it?
KP: It is indeed. I mean…
DM: Glaxo seems to have gone a little quiet on that one.
KP: Yeah. I mean, we’ve done a lot of work in this area in terms of vaccines. So if I were going to give you an example, since 1973 only 12 vaccines have come to the market, the fastest one took four years by Merck.
KP: So that’s, you know, tells you how difficult it is to produce a vaccine for one single area. Can you imagine trying to treat seven and a half billion people?
A good example here is that Astra, sorry no Glaxo and Sanofi, make 2 billion doses of vaccines for everything in the world, there’s 2 billion. We will need 10 billion, cause this will be a double dose. There’s not enough vials or syringes, et cetera. So it’s a real challenge. But I think the first part we have to do is hopefully there will be a COVID vaccine which will work, you know, and we can distribute to the most vulnerable parts of the community. And then it will be a case of getting the rest of the population vaccinated, if they choose to do so as well there’s still an issue, people may not want to get vaccinated.
DM: Yeah. Well as you say, it’s not just the vaccine itself, is it? It’s the production of the medical equipment to distribute them and the production of the vaccine.
KP: And people don’t forget that you need a cold supply chain technology, the vaccines have to be sorted at a certain temperature and in certain parts of the world it will work easily, if it’s the US or Western Europe, but in other parts of the world where the environment is a lot more challenging and the tech isn’t there. And it’s a huge challenge in terms of logistics I think personally.
DM: Yeah. Another interesting area is big data and AI, artificial intelligence, and this is a sort of a theme that you’re keen on as well. Maybe if you just give us a little bit about your thinking, but also the ethics in some of these areas.
KP: I mean, if you think about in terms of drug discovery in particular, you know, there’s been a real challenge around kind of using large numbers in terms of generating an outcome. Years ago, you know, there were animal testing models that we used and were quite wasteful and actually, you know, it caused a huge amount of misdirection in terms of product discovery. However, by using big data, in particular AI, that accelerated that process. So earlier candidates, which weren’t going to ever, ever pass those are dropped. So you’re affectively getting a refined process by using technology. That’s obviously fantastic for healthcare companies also fantastic for animals as well, because we need to test less in that area. So we can bring about products much more earlier and safer as well. So massive tick there.
However, there is a real challenge here and that’s the ethics, and we’ve done a large amount of work through my colleague Neville White, who’s head of RI and also my fellow fund manager, Thomas Fitzgerald, who leads on US tech in particular. The area is uncharted territory. Most industries that we know very well are regulated, I’m talking about consumer products, utilities, telcos, you know, they’re all regulated. However, in tech, because it’s so fast moving the actual regulations haven’t caught up and that’s a real issue.
So if I gave you an example of a data, your personal data, that your children’s data in terms of whether it’s DNA, health, et cetera, who owns that data? Where is it stored? How is it manipulated? How is it sliced and diced? Who’s it sold to? And what if it fell into the wrong hands? So cyber security is a real key area and this sector got to get it right. If you think about it, if your bank details get stolen, the bank hopefully will reimburse you because if it wasn’t your error, so that’s easy. So there’s financial compensation. However, if your health records go public or are lost, or in somebody else’s hand, insurance companies will have a lot more data. So it’s about ownership of data and also storing it and actually making sure that it doesn’t get compromised. Those are not easy challenges. We’ve seen so many companies that have been hacked over the last couple of years and paid massive fines. I think healthcare companies are going to have to really work very hard to ensure that any transfer of data from the GP to the insurance company or in the US with PBMs, et cetera, or your employer, even, ultimately and these are real challenges that the industry is going to have to face.
DM: Do you invest in cyber security then?
KP: We’ve got a small company called NCC in the UK and they’re ethical hackers. So their skill set is to go into companies to try and break either from inside or from external firewalls as well. It’s a huge industry in the US, you’ve got Cisco, which is leading the way because you need to scale in this area as well, but in the UK, the very nature of the market, we’re very cyclically heavy in oil, gas, in mining, tobacco, et cetera. We don’t have a very high quality tech sector like in the US where five companies effectively lead. I mean, the only large cap tech company in the US, sorry in the UK, is Sage. And that’s been around since the ‘80s and has been an extraordinary compounder in Amity UK, but I don’t get the same choice as my US fund managers who are absolutely loving how fertile that space is.
DM: So when, when you started, you talked about EdenTree being a socially responsible investment firm. Maybe, can you tell the listeners what that means to you? Industries you maybe do, and don’t invest in, what do you screen out? How does that part of your process work?
KP: Yeah, so, you know, so the responsible and sustainable approach at EdenTree, it looks at companies that pass both a negative and positive screen. So we don’t invest in the usual sin stocks, which we’ve got used to, which is basically fags, booze, bombs, gambling, and pornography. In addition, we don’t invest in fossil fuel companies, so there’s no oil, gas, there’s no mining. We have a very carbon light footprint on the fund, which is measured every five years against the FTSE All Share. We also screen against animal testing, which we only allow for pharmaceutical research, but not for cosmetics or for household products. Also, we have policies on intensive farming and oppressive regimes as well. So in terms of the ESG issues that we take into account, we have six core pillars which are focused on business ethics, governance, community, employment, environment and human rights. And four themes as well: education, health and wellbeing, social infrastructure, and sustainable solutions.
Now that always sounds lovely, but actually, can you give us a real world example? So a recent example of an industry that we avoided is fast fashion. So when Boohoo came to market in 2014, it failed our screening process and we didn’t invest. So it failed the E, S and the G bizarrely. So it was AIM listed…
DM: That’s good work it is.
KP: So dominant founder, AIM listed, lack of independent board, no environmental strategy. And also the very nature of the sector. I mean fast fashion is built on two core pillars, right? Cheap and disposable, both of which are not sustainable. And this is a real great example of a company that was obviously vetted and over 20 ESG funds invested in Boohoo, some very high profile ones. And they’ve had to divest, but not all have, you know, the argument, they still think that there is a case to be made for investing fast fashion. We don’t, we would like very much to say that you can invest in the fashion value chain, Darnell, Next, if you want to go European Inditex as well. And these are the three great companies, Marks [& Spencers], which we don’t own and we sold out years ago because we think it’s structurally challenged. All these companies have a very strong, robust supply chain, which has been ethically tested as well. So there are options. You don’t have to go for fast fashion.
DM: So given the makeup of the UK market and a big chunk of it that you can’t or won’t invest in, how do you construct a UK fund? I mean, I know there are thousands of companies for you to pick from, but certainly the bigger end of the market, when you take oil, mining, tobaccos out, there’s well, a third of the FTSE ,just like that, so how do you construct a portfolio? What characteristics from a financials point of view, do you like? Do you like cheap stocks? Are you a growth manager? Tell the audience how you put the social principles and the financials together.
KP: So for us you know, this value/growth argument doesn’t really work for us. Fundamentally you want to pick quality companies which are growing their earnings. There’s three actual buckets, we look for compounders, growing earnings between 25%, growth between 5% and 10% and high growth, 10 to 15%. And the real skill here is buying quality at a reasonable price. Now, the very nature of the UK market ,you’re right, a third of the FTSE goes, but I’ve still got the balance off the rest of the mid cap, small cap and also some AIM companies all FTSE fledgling.
So the current portfolio is 50% FTSE 100, which is very different to my peers – all my peers are small and mid cap. But I found high quality companies in the FTSE 100, which passed our stringent screens as well. But the majority of the portfolio is very much 30% in the 250 and the balance in small cap funds, sorry stocks.
We are looking for companies primarily that have, you know, what I call a dominant market position and high recurring revenues. If you get those things right, it translates into cash flows, profits and margins, and hopefully earnings growth, and therefore an increase in the price. Now, that sounds easy when I’ve said it, but actually it’s quite a difficult thing to find high quality companies. However, we are lucky in the UK for one thing only: the UK for 150 plus years, has been a centre of innovation in terms of R & D, not just in terms of science, but also engineering in particular. So I’m overweight industrials in the portfolio.
Now, I think once the pandemic has gone, and it will go one day, and Brexit will come to pass, because it will one day. I know it sounds tortuous that it will be going through at the moment, but those industrial companies are selling high quality products and services around the world with UK IP [intellectual property] and engineering excellence. We may not manufacture as much in the UK anymore, but we are still selling our excellence in terms of IP and engineering knowhow so, from my perspective, that is a core part of the portfolio and I’m hoping in 2021, 2022, when we move away from Brexit and the pandemic eases up, these companies which have got amazing operational gearing, we’ll be able to deliver returns on the fund.
DM: So we talked about the market and you mentioned obviously Brexit alongside the pandemic, but lots of recent surveys which’ve come out that show that UK equities as an asset class is totally unloved. How do you see maybe this sort of, as you said post-Brexit there will still be a stock market and still there will be funds, hopefully we’ll all still have jobs…
DM: But what do you think the long term picture for UK equities is?
KP: The UK market has been, sorry the equity market, has been a global outcast since you know, we made a decision to leave the EU in 2016. It’s the nature of the actual market itself, you know, heavy in banks, fossil fuels, tobacco, et cetera. And these have just lagged massively. So the UK lags Europe and the US, the US obviously has a huge tech sector, five companies that dominated that area. And, you know, we’ve seen astonishing returns globally in the market since the March low, but the UK’s lagged. And Brexit is a key part of that. However, I guess the question is, are we positive for the long term future of the UK? We are, we think small to mid-cap companies, which have defensive models that will do very well whilst Brexit come.
However, I think the FTSE 100 as an index, people will start to look, you know, one of the cases we make about guys being active versus passive, the actual FTSE has always been dominated by oil, mining, gas, banks, et cetera. Two of the largest companies today in the FTSE 100 and AstraZeneca and GlaxoSmithKline. The argument that if you buy an index, the you’ll be safe, no, indices basically are structured around companies that are part of that. And I think that FTSE 100 has pivoted into a very skewed index. If you look at the dividends in the UK as well, massive concentration risk you know, the, I think 15 companies represent over 60% of dividends and there’s not a lot of cover as well. So the structure, when we talk about the UK market, I think we should break that down and say listen where are you seeing opportunities. For me, the mid-cap and the small-cap leads for companies that are operationally really well geared and are going to sell services globally. I think that will work very well.
However, if you ask me, what is the prospects for real estate, the REITs or telcos, I don’t understand how telcos will pay off all their 5G and try and recoup that revenue without any content, because when it comes to teleco’s and wireless, it is a race to the bottom in terms of price. The likes of BT and Vodafone for me, I think, I just don’t know how they are going to pay those bills. I mean, Vodafone is going to obviously sell its towers business. BT could maybe break up with Openreach, but these are, these are structurally challenged businesses. REITs, in particular, if you look at what’s happened with online, you know, British Land, Land Sec [Securities] et cetera, the office environment, you know, we’ve got to change. I mean, how long office or regional office REITs, you know, we do, we cover property here as well, and we’ve seen a warehousing and logistics REITs do really well, or specialist REITs and whether it’s PRS or just the homeless REITs, which in which came out last week. But I think generally for normal REITs like British Land and Land [Securities], they do need to either reinvent themselves or find a way of making sure that their net asset value is actually a real reflection of those assets.
DM: Yeah and an observation that I have made is particularly on the FTSE 100, is in aggregate the FTSE 100, looks like a value index. And I wonder if that has contributed in this low rate environment that we find ourselves in, where there has been a chase for growth compounders, high growth, medium growth, the sort of things you look for. Globally people look at the FTSE 100 and go yeah, that’s a declining index of all structurally challenged stuff.
KP: You could call it a analog because the argument we would argue is actually more what would it take for these companies to come back into fashion? Someone would say, well it could be, you know, inflation could rise. Interest rates are going to rise, but as you’ve seen what’s happened is the central bankers have flooded the market with cash. So the prospects of an interest rate hike, sorry, a meaningful one, is now getting further and further out. So the UK, so in the FTSE 100 is going to get structured challenge and those companies and those sectors in particular.
DM: Ketan thank you very much. That’s been really interesting, a great chat on how you can invest profitably and responsibly in the same go. This has been FundCalibre’s Investing on the go podcast. If you’d like more information on any of the funds please visit fundcalibre.com or subscribe on any of your usual podcast channels.
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