281. Navigating changing demographics through impact investing

2 October 2023 (pre-recorded 19 September 2023)

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.

[INTRODUCTION]

Staci West (SW): Welcome back to the ‘Investing on the go’ podcast brought to you by FundCalibre. To kick off Good Money Week, we dip our toe into the world of impact investing today, with two specialists from Montanaro Asset Management. We focus on the built environment, net zero and the importance of engagement with smaller-sized companies.

I am Staci West, and today I am joined by two ESG and impact specialists at Montanaro, Kate Hewitt and Harriet Topham. Kate, Harriet, thank you very much for joining me today to talk about all things impact investing.

Kate Hewitt (KH): Thank you for having us, Staci.

Harriet Topham (HT): Great to be here, thanks.

[INTERVIEW]

SW: Now, ESG has been embedded into Montanaro for over a decade now. So, before we dive into a number of different themes, let’s set the stage. What is impact investing?

HT: Yeah, so impact investments are investments made with the intention to generate a positive and measurable social and environmental impact, alongside a financial return.

SW: And what are the kind of core characteristics of this at Montanaro?

KT: So, first and foremost, we try and practice what we preach. So, we try to behave as sustainably as possible and have pursued certain accreditations in order to certify that we’re doing that. So, one of the key ones is our B-Corp status, which effectively means we have been third party verified to contribute to the environment and society through the course of our business. And we think that’s really important to show. We’ve also set our own net zero targets as well. So, this means that when we’re talking to our investee companies, and encouraging them to be more sustainable in their behaviour, we’ve tried to be a role model in that as well.

Now, in terms of impact investing, in 2018 we launched our [Montanaro] Better World Fund. So, that fund has just celebrated its 5th birthday, and we try to identify companies that are making a contribution to sustainable challenges using six themes that we think are really important. So, first and foremost, we have environmental protection, the green economy, healthcare, innovative technology, nutrition, and wellbeing. And those six themes have been selected in accordance with the United Nations Sustainable Development Goals.

SW: And can you just briefly explain what those goals are? Why use them when developing the themes for the fund?

HT: Yes, of course. So, the United Nations Sustainable Development Goals were part of the United Nations 2030 agenda. So, they selected 17 goals with 179 underlying targets that are designed to pinpoint what are the key challenges facing humanity, and outline a plan to address those challenges. So, we thought that this global unifying framework was a good basis for us to select those six themes.

SW: And now just kind of looking more thematically since, as you said, the [Montanaro] Better World Fund, which is Elite Radar’ed by FundCalibre, looks at six different themes – we definitely don’t have time to look at six different themes, but I wanted to highlight one. Because we often talk about demographics in the context of emerging markets or India, for example, but changing demographics globally can have a really significant impact on investments, regardless of the region. And one of the big sustainable development challenges we face is around these changing demographics. So, for example, more people means more building, more roads, more food for everyone to consume, et cetera. So, how can we accommodate these demographic shifts in a sustainable way? And then perhaps one step further from that, how do these kind of considerations feature into your impact research that you’re doing on a day-to-day basis?

KH: Yes. So, changing demographics is a really interesting challenge for us. So, you mentioned that yes, that these shifts are something that we have to monitor and be aware of, but it’s a really exciting opportunity to spot trends and patterns. One of the things that we’re particularly looking at [at] the moment and is going to be the focus of a deep dive engagement project for us, is the built environment and urbanisation.

So, the UN predicts that by 2050, 68% of the world’s population will be resident in cities. And this is a big change from what’s gone on in the past. And you also need to factor into that that 68% [is part] of a growing global population as well. So, this is the built environment, and the urban environment is effectively going to be humanity’s habitat. And what do we mean by the built environment? This is all human-made features of our landscape. So, infrastructure, buildings, anything you can think of that has had a man-made approach, that is what features in the built environment. So, it’s a really broad topic.

It also features as a challenge identified in the Sustainable Development Goals. So, Sustainable Development Goal 11 is sustainable cities and communities. And we’ve used this to identify areas that go beyond just the environmental sustainability of our buildings and the built environment. But thinking about the social consequences of urbanisation; who has access to important social features like education and healthcare? And where are those positions? How is planning being undertaken to make sure that the communities within these urban environments are equitable?

So, we’ve started conducting a bit of research, as I say, as in the form of our deep dive. And we found that the themes that are most applicable within the [Montanaro] Better World fund are the environmental protection and the green transition themes. And those are the sort of areas where our current holdings sit and contribute to the improvement of a sustainable built environment.

SW: And do you maybe have an example that you can share that will kind of illustrate this theme?

HT: Yeah. So, Marshalls [Plc] is a company that’s held in our portfolio, and Marshalls are a hard landscaping building manufacturer of both the construction and home improvement markets. Their permeable paving products are important for climate resilience as they help mitigate flooding risk and manage surface water runoff. We actually had a meeting with the CEO and CFO of Marshalls recently where they highlighted how a real focus of research and development for them was on developing lower carbon products. So, they’re seeking to have lower carbon products versus their competitors. So, in this, they’re looking at the environmental performance of these products over their entire lifecycle. And an interesting and innovative product that they have is part of their carbon sequestration program, where they’re actually injecting waste carbon back into the mix of bricks in order to negate the carbon from cement. And aside from this, they also highlighted solar as a growing area for them.

Another company I wanted to talk about is a more recent addition to the portfolio, and that’s Bentley Systems [Incorporated]. So, Bentley are an infrastructure engineering software company that enable the development of better and advanced and more sustainable infrastructure. So, that’s from the design through to the construction and operation of these assets. So, Bentley uses modelling, simulation and digital twins to do this.

SW: Can I just interject, what are digital twins? I’ve never heard of that, what is that?

HT: Sure. So, digital twins are a realistic virtual representation of a physical asset. So, that could be a replica of a city to help in the planning and management of city infrastructure. Or it could be a digital twin of rail or bridges or clean energy assets like wind, solar, and geothermal. But their software helps increase climate resilience, increase energy efficiency and the resource efficiency of land, water, and materials to enable their customers to reach sustainability goals.

The last company I wanted to mention was Sdiptech. So Sdiptech are a specialist technology group that acquire and develop niche infrastructure companies. So primarily in Europe, to create safer, more sustainable and resource efficient urban environments. So, we have a growing population, we have increasing urbanisation, and we’re battling climate change, and all this adds stress on ageing and under-invested infrastructure assets. So, Sdiptech’s subsidiary companies help in these solutions. So, in their water and energy companies, they have solutions for wastewater treatment and water purification systems as well as products and services for the power supply and electric vehicle and outdoor charging. And they also have solutions to monitor and control indoor air quality and climate. So, the construction, operation, and maintenance of the built environment accounts for almost 40% of global greenhouse gas emissions. So, without sustainable and smart solutions to improve the carbon footprint of these buildings and infrastructure assets, then we won’t be able to hit net zero targets by 2050.

SW: And you mentioned net zero there, so let’s just take a little bit of a step back. So, why do we need net zero? Why is it so important to hit these net zero targets by 2030? And then, also importantly, how does this translate into your companies? You mentioned earlier Montanaro’s target for 2030 but when you are engaging with companies and talking to them, what does that look like for them? What’s that process?

HT: Net zero effectively means reducing carbon emissions by as much as possible, so, we’re talking over 90% and then effectively selecting offsets – but really carbon removals – to negate that last tiny portion that isn’t able to be omitted from a company’s operations. And the reason that’s important is that the climate science and investigations done by the IPCC [Intergovernmental Panel on Climate Change] as well as others, have shown that we need to keep global warming below 1.5 degrees to avoid a tipping point whereby humanity is no longer in a safe operating space.

And, as a result, that requires everybody, not just governments or individuals, but businesses as well, to decarbonise their operations. And that is something that we advocate for our portfolio companies to do. So, when we are engaging with them, we try and encourage a movement to a credible and ambitious climate action plan that is in keeping with climate science, and that effectively means achieving net zero emissions before 2050.

SW: And what are these science-based targets that we hear about? And I guess, how does that differ from non-science based targets? Is one better than the other? Are they trying to achieve different things maybe?

HT: Yeah, so science-based targets are targets that have been developed to align with the Paris Climate Agreement. So, this says that we must limit global warming to 1.5 degrees Celsius above pre-industrial levels. So, if companies are setting carbon reduction targets, but are not considering the timeline or whether these targets are ambitious enough to align with this 1.5 degree scenario, then these targets can’t be considered science-based. So, science-based targets are definitely preferable to non-science-based targets. But any climate action is better than a ‘business as usual’ approach! Having said this, without the backing of climate science, we can’t be sure that carbon reduction efforts will have the desired effect on climate change. So, the Science-Based Targets Initiative [SBTi] helps companies by offering third party verification and guidance on their published targets to make sure that they do align to the Paris agreement. And we encourage our companies to seek approval with this initiative.

SW: What are then the biggest barriers to achieving net zero for your portfolios?

KH: I think the biggest challenge is the fact that it is sort of out of our control. So, we have set our own Paris-aligned target for all of our portfolios to reach net zero by 2050. But obviously this is reliant on the underlying holdings doing their bit. So, I think that’s the biggest challenge – is that, although we can use our voices as stakeholders to encourage credible climate action, if that doesn’t happen, for whatever reason, then we’ve got limited levers to pull other than engagement and divestment.

That being said, I think the tone of the conversations that we’re having with CEOs and sustainability directors at various companies, they’re very much on board with our vision as well. And we’ve seen that with signups to the Science-Based Targets Initiative. They’ve increased enormously over recent years, so we are seeing greater ambition, more climate action, and a greater level of understanding that this is everybody’s responsibility and action should be taken. So, a challenge, yes, but it’s one that we can see being overcome.

SW: So, is looking at these net zero targets and the science-based targets and all of these initiative for your companies, is this something that is happening kind of across companies? Because I know we talked a lot of this, we talked about construction and we talked about environmental impact and decarbonisation, but you mentioned earlier themes like healthcare, for example. So, in that side of the portfolio where you might not naturally have this link to the environment or the green economy, are you still having these conversations? Are those companies still setting their own targets, but perhaps it’s something that’s to do with their supply chain, for example, instead?

KH: Yeah, so, it is interesting that those who seem to be the leaders and the first actors are actually probably some of the more carbon-intensive companies within our portfolios. And I think that’s because they are coming under the most scrutiny. And, as a result of that, it’s been those companies that we’ve seen signing up to Science-Based Targets Initiative and maybe participating in other voluntary certification and frameworks like the CDP [Carbon Disclosure Project] for example.

And you mentioned healthcare there. It’s interesting, I think, because they have potentially faced less scrutiny in the past, healthcare companies are sometimes lagging slightly behind other sectors when it comes to setting ambitious climate targets. And I think particularly in the small and mid-cap space where there are fewer resources to spend on sustainability initiatives anyway, I think sometimes it’s the healthcare companies, and maybe some of the service provider companies that don’t necessarily have a large footprint, who haven’t necessarily considered how they impact the environment and how they emit. So, I think it’s interesting how certain industries have become laggards despite not having a particularly large climate footprint. But as I say, we are now seeing that change. Healthcare companies are understanding that it’s not a challenge for another sector. They too need to be looking at how they can reduce their emissions.

SW: And then, just finally, does that present you with more opportunities for engagement? Because you mentioned in the beginning about Montanaro setting the tone and wanting to work with your companies…

KH: It is interesting because we’ve almost seen a bit of a role reversal, where as we’d be approaching companies to engage, there’s been a number of occasions over the past couple of years where we effectively act as a bit of a consultant, where companies that are on the smaller end of the market cap spectrum are just beginning on their sustainability journey, are approaching Montanaro because they know that we are sustainability specialists and asking, what is it that you like to see? You know, we have limited resources, what should we prioritise in the first instance? And we are able to help them with that and collaborate almost on what we would like to see from a comprehensive sustainability strategy. So, that’s been a sort of interesting turn of events and a change from the traditional ‘we’re approaching them to ask for something,’ – they’re using us as well, to get our expertise.

SW: That’s amazing, thank you Kate and Harriet for your time today. That was incredibly interesting, and a really great look at just a fraction of what is on offer within the impact investing space and a few of the holdings in the [Montanaro] Better World fund as well. So, thank you very much for your time.

KH: Thank You Staci.

HT: Thank you.

SW: Montanaro has a long-standing history of integrating ESG into it funds. The Montanaro Better World fund employs a straightforward positive impact screening process to identify around 50 high quality, growing businesses, with good management teams. To learn more about the Montanaro Better World fund, visit FundCalibre.com — and don’t forget to subscribe to the ‘Investing on the go’ podcast, available wherever you get your podcasts.

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 the time of listening. Elite Ratings are based on FundCalibre’s research methodology and are the opinion of FundCalibre’s research team only.

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