Regnan Sustainable Water and Waste Fund (JOHCM)

Sustainable, Responsible &/or ESG Policy:

The team believes that there is no economy without water and no sustainable economy without waste management. The story of water and waste is as old as the story of civilisation. Every major city in history has been built around solid water and waste networks. This has been the story for the past thousands of years and will be the same for millennia to come. As the global population has grown, so too has humankind’s need for resources, to such an extent that we are now consuming resources at an unsustainable rate; one which far exceeds the earth’s regenerative capabilities. The world must improve its management of water resources and physical waste if it is to grow sustainably and enable future generations to meet their own needs.

Sustainable water management practices will bring opportunity for companies operating throughout the water value chain. The team also expects the waste management market to continue to expand as societal, environmental and economic pressures, and innovation bring continued investment opportunities.

Given the long-term structural drivers, the Fund is positioned to generate strong returns from an overlooked perpetually defensive growth theme. While the secular theme of water and waste is powerful, companies naturally exhibit cyclicality by virtue of the end markets they are exposed to, as well as geographies and regions where they have a presence. The team tries to minimise those risks in their strategy with deep, fundamental and sustainable research.

The team also believes that by investing in companies which operate with high standards of corporate responsibility and overall ESG objectives, the Fund can further protect and enhance investment returns for their clients.

The combination of both water and waste themes is a truly differentiated and unique proposition and one that has been pioneered by the investment team. Companies exposed to these two themes share similar long-term fundamental growth drivers:

• urbanisation and concentration of population;
• consumption driven economy;
• infrastructure adaptation for developed and developing countries;
• supportive regulatory environment;
• support physical constrained world.

Many water and waste solutions are interconnected and intrinsically linked. In order to deal with more circular solutions for waste, economies need water (i.e. to clean plastic before recycling, water is used in paper recycling and products are cleaned with water before re-use) but water solutions also need sound waste management systems (i.e. collection, prevention of solid, liquid or gas waste polluting water resources). The water and waste nexus is a reflection of a healthy, functioning body integrating water and matter, and sustainably managing used water and waste. Failure to manage these two together efficiently generates unsustainable economies.

Water and waste companies also provide unique diversification characteristics when combined. Companies in these sectors typically operate locally with limited overlap across geographies and sectors providing a low intra-correlation within the portfolio, hence improving stability (i.e. there is very low correlation between a US regulated water business and a Chinese waste to energy company, although they share similar long-term drivers).

Exclusionary screens

Exclusions are one of the two key tools (along with sustainability assessment) that the team applies to ensure all investee companies meet minimum standards of ESG risk and sustainability management.

The Fund will avoid investing in companies which directly:

• Coal:
  • Derive 5% or more of their revenue from the extraction, exploration, or distribution of coal, or from thermal coal power generation.
  • Derive 5% or more of their total revenue from the extraction, exploration, distribution, or refinement of oil and/or natural gas, unless a science-based target is in place.
• Unconventional oil and gas:
  • Derive 5% or more of their total revenue from unconventional oil and gas products and services, including hydraulic fracturing, oil / tar sands, shale oil and/or gas, coal seam methane and Arctic drilling.
• Nuclear power:
  • Derive 5% or more of their total revenue from mining of uranium for the purpose of nuclear power generation, the generation of nuclear power, or the provision of products and services to the nuclear power industry.
• Tobacco:
  • Derive 5% or more of their total revenue from the production or distribution of tobacco, or related services (including tobacco-related products).
• Weapons and armaments:
  • Derive any revenue from manufacture of controversial weapons (such as anti-personnel mines, biological or chemical weapons, cluster munitions, depleted uranium weapons, nuclear weapons, white phosphorous weapons); or
  • Derive any revenue from distribution of, or related services to producers of, controversial weapons; or
  • Derive 5% or more of their total revenue from manufacture, or provision of related services to, conventional weapons or armaments.
• United Nations Global Compact:
  • The Fund will avoid investing in companies with breaches of the United Nations Global Compact principles, which are categorised as structural and severe.

All reasonable care is taken to implement the Fund’s exclusionary screens to meet the criteria described above. The team draws on external and supplementary internal research believed to be accurate, to determine whether an issuer is subject to the exclusionary screens.

The firm regularly monitors compliance of the Fund’s holdings with the exclusionary screens and this is overseen by the Compliance team.

In addition to the threshold and activity-based screens above, the team take account of the following ESG issues as part of the Regnan Sustainable Value Assessment (SVA). For details on purpose, roles and accountability; philosophy; research approach; core ESG factors; scoring and quality assurance please refer to Sustainable Value Assessment Methodology which can be found at:

https://www.johcm.com/uk/our-funds#Regnan

Procedure on Biodiversity

Where the Regnan analysis identifies biodiversity as material to the company the Regnan SVA will typically capture and assess biodiversity in other environmental management and/or stakeholder factors. We recognise the importance of biodiversity to global sustainable development.

Procedure on Water Use

Where the Regnan analysis identifies water use as material to the company the Regnan SVA will typically capture and assess water use in water security and/or stakeholder factors. We recognise the importance of water to global sustainable development.

Procedure on Pollution & Waste

Where the Regnan analysis identifies pollution & waste as material to the company the Regnan SVA will typically capture and assess pollution & waste in other environmental management and/or stakeholder factors. We recognise the importance of water to global sustainable development.

Procedure on Gender & Diversity

Where the Regnan analysis identifies gender & diversity as material to the company the Regnan SVA will typically capture and assess gender & diversity in the human capital management factor and in board skills, structures and management.

The Regnan position paper on diversity can be found at:

https://regnan.com/wp-content/uploads/2021/07/Regnan_Beyond-diversity_2021.pdf

Procedure on Taxation

Where the Regnan analysis identifies taxation as material to the company the Regnan SVA will typically capture and assess taxation in the audit factor.

Process:

The investment process of the Fund can be broken down into four separate stages:

• Idea generation
• Fundamental stock research and selection
• Portfolio construction and risk management
• Portfolio monitoring and oversight

Investment Universe

The team’s focus is on the water and waste universe and its sustainable characteristics. They have filtered the global investable equity universe into a subset of approximately 350 stocks representing currently approximately USD 2 trillion in market cap, which comprise of companies involved in both the water and waste value chains and related services or industries.

The Fund’s investment themes are described below:

• Water solution providers spread across the water value chain and related services or industries. These include but are not limited to companies involved in water production; water conditioning and desalination; water suppliers; water treatment, transport, and dispatching; treatment of wastewater, water infrastructure equipment and services; water related construction and consulting and engineering services.
• Waste solution providers spread across the waste value chain and related services or industries. These include but are not limited to companies involved in waste collection, transporting, sorting, and recycling; sewage treatment plants; hazardous waste management; air filtering and cleaning; sanitization; site remediation; pollution prevention and control; sustainable packaging; environment planning; and related consulting and engineering services.

Idea Generation

The initial stage of the investment process ensures the investment opportunity is aligned to the theme of the Fund i.e. alignment to the water and waste management value chain and related services or industries.

Idea generation originates from the experienced team who have built a comprehensive universe over many years. Incremental ideas for the Fund are expected to originate from the investment team, collaboration with Regnan’s impact team, Regnan Insight and Advisory Centre* (Regnan Centre), ESG specialists, and other investment teams within JOHCM as well as third-party broker research and specialised thematic related topic source providers.

*Regnan serves as a Responsible Investment (RI) brand within the wider Group (including J O Hambro Capital Management), acting as a global centre of excellence for RI practices. It is also the brand for our sustainable and impact investment strategies.

Fundamental Stock Research and Selection

The team monitors around 350 companies that make up the current investment universe. A rigorous stock-selection process using a multi-factor model, including proprietary and external ESG research, leads to the construction of a portfolio of 35 to 50 stocks. The research and stock-selection process can be broadly categorised into three stages:

• Bottom-up analysis of business quality using ten equal-weighted key factors to rank companies: Forward three-year EPS CAGR for earnings growth potential; Return on Equity, Return on Capital Employed, Recurring Net Income Margin to assess scope for value creation and profitability; Net Debt/EBITDA for Balance Sheet strength; Free Cash Flow Yield and Dividend Yield for cash generation and income earning capabilities; Price to Earnings, EV/EBITDA, and Price to Book Value ratios to assess the attractiveness of market valuation.
• Assessment of absolute upside potential: Five valuation techniques used to measure upside - Normalised P/E, Dividend Discount Model, Discounted Cash Flows, Sum-of-the-Parts, and Free Cash Flow Yield.
• ESG Due Diligence: Conducted on the stock’s management of material environmental and social exposures and governance practices which meets minimum expectations. In addition, at least 70% of the portfolio will be invested in securities deemed to have sustainable characteristics. Companies with sustainable characteristics are those which the team believes have effective governance and management of environmental and/or social issues.

The remaining portfolio (up to a maximum of 30%) will be invested in companies that demonstrate improving sustainable indicators. Improving sustainable indicators are companies classified as such through the trajectory outlook of ratings providers or issuers which, in the view of the team, demonstrate the potential for improvement through the implementation and execution of a formal engagement plan.

The team is able to draw on the specialist knowledge of the Regnan Centre team or their network of external specialist contacts at any stage of the process. The Regnan Centre maintains diverse professional and industry experience, and subject matter expertise that spans the suite of ESG issues. In undertaking additional, proprietary analysis of companies, the Regnan Centre aims to supplement the ability of the investment team to exploit ESG-related market inefficiencies by bringing specialised expertise and a view that is independent of any particular investment management approach.

Application of Internal and External ESG Ratings in the Sustainability Assessment

ESG ratings from the following sources are key inputs to the team’s Sustainability Assessments:

• MSCI ESG Ratings are designed to measure a company’s resilience to long-term, material industry ESG risks. A rules-based methodology is used to identify industry leaders and laggards according to their exposure to ESG risks and how well they manage those risks relative to peers. MSCI ESG Ratings range from leader (AAA, AA), average (A, BBB, BB) to laggard (B, CCC).
• Regnan’s Sustainable Value Assessment (SVA) is a forward looking and bottom-up analysis of ESG factors undertaken by experienced, specialist resources. Regnan’s methodologies have been designed to promote comprehensive evaluation of ESG factors, while also providing flexibility to incorporate company specific and novel considerations. Scores for each ESG factor and pillar (E, S and G) are assigned from 1-5 reflecting the extent to which sustainability management is assessed to contribute to sustained value creation: detractor (1-2), neutral (3), support (4-5). Accompanying momentum assessment (stable, improving or weakening) indicates the expected direction of change in the score. Overall ESG scores are an average of the E, S, and G pillar scores.

Further details on Regnan’s SVA methodology are available on our website at:   https://www.johcm.com/uk/our-funds#Regnan

Portfolio Construction and Risk Management

Portfolio construction and position sizing will be based on level of conviction, liquidity, concentration risk, market timing and other supportive catalysts and events. The final portfolio will be comprised of around 35 to 50 stocks, with highest conviction names making up the larger positions. The team will rarely exceed a 5% position for a single stock and would rather reduce stock-specific risk with other opportunities if an investment theme has been identified as promising.

Typical illustration of portfolio construction:

• Core long-term holdings: > 3 years compounders – Largest part of the portfolio
• Medium-term winners: 1-3 years – Second most important contributors
• Short-term opportunities: <1 year – Capacity to extract value from market dislocation and opportunities

Portfolio Monitoring and Oversight

At the stock level, the team undertakes a thorough analysis of the fundamental risk of the company and the investment thesis. The team also constantly monitors ongoing developments at company and sector level. The robustness of the investment thesis and ongoing knowledge of the company’s fundamentals and developments are the first line of defence.

Companies are assessed using quantitative and qualitative factors and in doing so, the team uses data from proprietary models, local intelligence, undertakes company visits and uses data, analysis and ratings provided by internal and/or external ESG specialist providers to form an assessment of a company’s sustainable characteristics.

Buy/Sell Discipline

Buy Discipline:

Companies selected by the team will typically display the following characteristics:

• A core business model focusing not only on sales and profits but also on how much of their value is exposed to the global water and waste investment theme definition.
• Long-term winners on the basis of parameters such as strong sector positioning, secular growth benefits, sustainable business model, management quality, and cash generation visibility.
• Meet the risk assessment standards considering ESG issues among other relevant factors.

Sell Discipline:

At a stock level, position sizes may be trimmed after review when:

• A position exceeds 5%.
• There is an opportunity to recycle profits into new, attractive investment opportunities.

Full exit is considered when:

• An event invalidates the investment case, especially where there is risk of further downside.
• The story is fully valued with no more upside.

From an ESG perspective, if a company held in the portfolio is downgraded by an external provider or internal research, the team will consider this in their ongoing monitoring. A downgrade will not automatically trigger a sell decision, if the investment team believes that management has the issues under control and is credible in its commitment to ESG improvement. However, if assurances are not credible and/or engagement is not yielding progress then the Fund will divest. The length of time to divest will depend on market conditions and the size of the underlying position.

Stewardship Approach

Regnan is a leader in responsible investment with a long and proud heritage engaging and advising on important themes and ESG issues. Over the years, Regnan and its forebears have celebrated a number of eye-catching milestones, achievements and intellectual breakthroughs.

Regnan engages with companies on behalf of clients to improve the management of ESG risks and the realisation of ESG opportunities. It also helps clients with their own engagement activities. This includes assisting with preparation for crucial meetings, designing and implementing bespoke engagement plans and measuring the outcomes of clients’ engagement.

The team will be supported by the Regnan Centre in implementing and evolving the following stewardship practices:

• The team will vote their shares, drawing on expert advice, both internal and external.
• The team will engage with portfolio companies in pursuit of enhanced ESG practices and performance, e.g. by sharing their company evaluations, insights on ESG themes for the sector, and promoting good practices and relevant standards.
• The team will advocate for enhancements to the enabling environment, e.g. by responding to relevant regulatory consultations and contributing to the development of voluntary standards.
• The team will contribute to the evolution of Responsible Investment practice, for example, publicly sharing research on the investment implications of ESG issues, and prioritising collaboration.
• The team will be transparent with clients and stakeholders about their stewardship activities and outcomes.

In addition, J O Hambro Capital Management (JOHCM) is a signatory to the UK Stewardship Code 2021.

Engagement

Improvement Potential

In determining whether a company demonstrates potential for improvement in sustainability attributes through engagement, the team will draw on internal expert views and consider:

• How large the gap is between current performance and minimum standards.
• The nature of the changes that would need to be made and any barriers this presents to change.
• Expected company openness to engagement, considering factors such as shareholding structure, company policy or track record on investor engagement, engagement norms in the local market and any historical experience the team has had in engaging with the company.
• The existence of aligned initiatives that may support achievement of the changes sought.

These considerations apply also to engagement with holdings that maintain sustainable attributes, but where the team, nonetheless, sees potential for improvement in the investee’s response to material ESG risks and opportunities.

Engagement Approach

At the outset of each engagement for change, the team defines engagement objectives – the specific changes sought - to assist them in pursuit and monitoring of engagement progress.

A range of engagement methods may be employed over the course of an engagement in addition to private dialogue (letters, calls and meetings with management and / or the board), such as:

• Coalition building among investors and / or other stakeholders and participation in collaborative initiatives.
• AGM statements.
• Proposing or supporting relevant shareholder-initiated resolutions.
• Considering ESG performance in relevant voting decisions, e.g. on director elections.

Engagement for change typically requires multiple instances of engagement and time, not only to make the case for change, but for changes to be implemented.

The team will regularly review engagement progress. If there is no evidence of change in progress within 18 months of including the stock in the portfolio on the basis of potential for improvement via engagement, the Fund will exit that position as soon as is reasonably practicable, having regard to the interests of investors. No stock will be held in the portfolio for longer than 24 months on the basis of potential for improvement via engagement.

The team will report on engagement plans and progress as part of their broader stewardship commitment to transparency.

Dialshifter

This fund is helping to ‘shift the dial from brown to green’ by…

……investing in companies which provide solutions to global water and/or waste related challenges. The team invests across the water and waste value chains, including in companies developing new technologies to meet the ever-growing demand for solutions to these challenges.

At all times, the Fund will invest at least 70% of its assets in the shares of companies that operate in the water and/or waste related sectors and provide solutions to global water and waste challenges.

SDR Labelling:

Sustainability Focus label

SDR Literature:

• Consumer Facing Disclosure