There are not many investment funds that focus on small and medium-sized companies and apply strict sustainability criteria. Triodos Pioneer Impact Fund takes this one step further and invests exclusively in companies that demonstrably contribute to the transition to a sustainable economy. The result is a concentrated portfolio of ‘impact leaders’.
The fund’s biggest trump card? Dirk Hoozemans does not need to consider this for long: the fund's low correlation with the market and its fundamentally different investment approach compared with other (sustainable) investment funds. “We do not track an index but construct the portfolio bottom-up. As a result, we diverge considerably from the benchmark. Around 40% of the portfolio is invested in the US, which has a weight of around 60% in the benchmark. We invest almost 20% of our assets in Japan, compared with 10% for the benchmark.”
Different from other investment funds
Due to the focus on small and medium-sized companies with a sustainable nature, well-known names such as Facebook, Apple, Amazon, Netflix and Alphabet (Google) are absent in the portfolio, notes the fund manager. “Nowadays, many investment funds are quite similar. Often up to 40% of the portfolio is invested in the 10 big well-known stocks that have increasingly come to dominate the equity markets. The same thing has happened for sustainable funds: almost everyone holds the same large companies.”
On top of that, Triodos Investment Management's selection is forward-looking. “Whereas many other sustainable funds rely on ratings that are based past performance, we focus on what lies ahead. What impact will the behaviour of a company have with regard to the future? Many funds carry out a retrospective sustainability check, but we make our selection ‘at the front door’. We are not interested in the winners of the past. What we look for are the winners of tomorrow. These tend to be small and mid-cap companies”, explains Hoozemans.
“In many sustainable strategies you will find a relatively large proportion of big companies, often because these companies have dedicated departments that propagate sustainability. However, the main outcome of their efforts tends to be better sustainability reporting and higher ratings from various data providers, but these are often no indication of the central issues: corporate behaviour and business practices. It is not about what you say, but about what you actually do.”
A solid building block for a sustainable investment portfolio
The limited exposure to large caps makes the strategy an attractive means of diversifying institutional portfolios, says Hoozemans. In this context, the active divergence from the benchmark also offers added value. “Moreover, investing in smaller and less researched companies means that you can achieve a great deal by doing your homework, through engagement and by means of active ownership. That potential impact appeals to a lot of investors.”
In addition, the fund’s strict screening aligns with the growing importance of ESG in many investment portfolios. Selected companies must make a positive contribution to the seven themes that Triodos Investment Management distinguishes as part of the transition to a sustainable economy: sustainable food and agriculture, sustainable mobility and infrastructure, renewable resources, circular economy, prosperous and healthy people, innovation for sustainability and social inclusion and empowerment. These themes are closely aligned to the UN's Sustainable Development Goals (SDGs).
Companies are selected on the basis of a comprehensive and integrated assessment of their financial, social and environmental performance, as well as their corporate governance. Hoozemans: “In doing so we apply the Minimum Standards defined by Triodos, which are among the strictest in the sector. This means that companies that offer sustainable solutions but nevertheless do not meet these standards, for instance with regard to animal testing, hydrocarbons or biodiversity, will not be eligible for investment after all. We are very much on the ball and periodically screen every company to assess whether it still meets the criteria. We also take a close look at its valuation, during which we put a financial value on the company's sustainable features.”
The strict selection process results in a concentrated portfolio of around 50 stocks out of an investment universe of around 200 companies. For comparison: the benchmark comprises over 5,000 companies. Despite the strong concentration, proper diversification across and within themes ensures a balanced portfolio, says Hoozemans.
What about risk and return?
In terms of risk and return, the perception of sustainable and impact investing has made huge progress, says Hoozemans. “Whereas in the past there was a tenacious myth that sustainable investing meant lower returns, it is now recognised that sustainable investments can generate similar or even higher returns. Because you invest in solutions that the world really needs. This not only improves the return potential, but you also remove significant risks from the portfolio. The risk of stranded assets, for instance.”
Last year, the pandemic proved a tough test for investors. Triodos Pioneer Impact Fund weathered the storm well, with a positive return of 22.2%, versus a return of only 6.3% for the MSCI World Small & Mid Cap Index (the benchmark). “Oil stocks, banks and insurance companies were among the stocks that were hit hard and we don’t own those,” says Hoozemans.
Also, the Covid crisis led to growing awareness that we need to start steering a more sustainable course. Hoozemans:” The motto was ‘build back greener’. This had a positive effect on sustainable investments. Also, the world increasingly moved online. Big tech companies were the main beneficiaries. Given the market segment that we focus on, we don’t invest in these companies, but we do invest in semiconductor manufacturers. These benefited from a sharp increase in demand for their products.”
Year to date, the fund has not quite managed to keep up with the market. Small and medium-sized companies tend to be growth stocks and in the first couple of months of this year it was actually the value stocks that staged strong performances, explains Hoozemans. “During this rotation from growth to value, the fund momentarily treaded water.”
Valuations have risen sharply and a correction cannot be ruled out, which makes Hoozemans cautious for the rest of 2021. “We have slightly raised our cash position in order to build in some resilience in case of a downturn. There are some big risks: governments may raise taxes in order to fund their expenditure during the pandemic, central banks may pull on the brakes or further climate taxes may be introduced. In case of the latter event, our back is well covered.”
Finally, a positive development is the introduction of a new European regulation that forces asset managers to become more transparent about the negative impact of their investments (SFDR) and includes a sustainability classification. “Our funds already qualify for the highest dark green - article 9 - classification. This is an important point in our favour, but the main thing is that this new regulation will contribute to the whole sector becoming more sustainable.”
Webinar 'Investing with impact through small and midcaps'
Watch the webinar with fund manager Dirk Hoozemans and investment analyst Caithlin Marugg, and learn more about the benefits of investing in listed small and medium-sized companies.