Sustainable, Responsible &/or ESG Policy:

Responsible investing has been around for over 30 years in a variety of forms, but how much positive impact has it had on capital markets or the world at large? We believe that until recently, most approaches have only achieved incremental change. What is actually needed is transformational positive change and to affect that transformational change, a different approach is required.

Our fundamental belief is that we are more likely to find positive impact where there is change and we are more likely to find change where there is disruptive innovation.

We believe that unprecedented sustainability challenges (demand) are converging with technology-led disruptive innovation (supply). This intersection is driving positive change in global markets and creating opportunities for forward-thinking companies – and for investors. In this context, our primary aim as positive impact investors is to think long-term and spend our time learning about these evolving supply and demand curves. Our success depends on figuring out which companies can disrupt the unsustainable status quo and capture significant economic value from doing so.

“Creating social impact through an innovative and profitable business model reshapes the nature of competition and makes social impact a part of capitalism itself. This requires going way beyond a checklist of material factors.”

Michael Porter, Where ESG Fails, October 2019

To identify disruptive, positive impact investment opportunities, our investment process, which we outline in detail below, explicitly considers ESG/positive impact at a number of stages. The process combines exclusions, filtering for growth, positive impact and finally detailed bottom-up analysis. In this detailed, bottom-up analysis we carefully consider ‘Does the company have a positive impact?’ and answer this using a framework which considers a company’s ‘intentionality’, ‘additionality’ and ‘materiality’. These are widely recognised impact investing principles and essentially mean:

• Intentionality – Is the company’s vision and mission consciously aligned with positive impact?
• Materiality – Does or will the company have significant positive impact on the world if it successfully executes on its strategy?
• Additionality – Is the company attempting to disrupt an unsustainable incumbent system?

This in-depth Product Impact analysis is both qualitative and quantitative in its considerations and results in a score for Intentionality, Additionality and Materiality respectively. The sum of these individual component scores is the Product Impact score which determines whether a company is suitable for investment and ensures each portfolio company has demonstrable positive impact.

The fund currently invests in companies which provide climate solutions, pollution prevention, medical technologies, fitness, alternative proteins, emergency communications and the circular economy.

Process:

We follow a 5-step investment process which ensures that each investment decision has:

• Positive Impact – We must satisfy ourselves that the company has positive impact.
• Conviction – We must satisfy ourselves that this opportunity has a higher long-term return than the idea it replaces in the portfolio.
• Influence – The position size is big enough to meaningfully influence aggregate portfolio performance.

STAGE 1: Product exclusions

We use the MSCI All Country World Index as a reference for investable stock markets by country. Any stock listed in a country deemed appropriate is included at the outset. Subsequent to liquidity and size filters, we exclude the types of company listed below based on the products and services they offer. This reduces our investable universe to approximately 5000 stocks globally.

• Alcohol: companies deriving more than 10% of their revenues from alcohol;
• Tobacco: companies deriving more than 10% of their revenues from tobacco;
• Weapons: companies that produce or sell civilian firearms and/or manufacture or sell armaments, nuclear weapons or associated strategic products;
• Nuclear power: companies that own a nuclear power facility;
• Gambling: companies deriving more than 10% of their revenues from gambling;
• Animal testing: companies that produce or sell cosmetics tested on animals;
• Adult entertainment: companies that own an adult-entertainment company or produce adult entertainment;
• Genetic modification: companies involved in the uncontrolled release of genetically engineered organisms into the environment; and
• Fossil fuels: companies engaged in the extraction of oil, gas or coal.

STAGE 2: Positive growth filter

We apply a series of quantitative filters to identify companies that are growing their revenues at above- market rates, while simultaneously removing pre-revenue companies. We never consider pre-revenue or private companies for investment. This generates a dynamic list of approximately 1000 stocks that are potential candidates for further research. Stocks can be added to and subtracted from this list at any time based on bottom-up observations. We formally review this list every six months.

STAGE 3: Positive focus

We want to identify innovative companies which are creating disruptive positive change at the intersection of the most critical sustainability challenges. As such, we focus on key societal frictions and track emerging technologies that intersect with them. This creates a depth of knowledge in the areas that matter and helps us identify fertile sources of market inefficiency. We then look for shifts in the basis of competition, which are linked to these changes. Incumbents tend to be optimised around the key drivers of economic value in their industries. These are what determine the basis of competition and, while they persist, incumbents are unlikely to be displaced. However, a shift in the basis of competition creates opportunities for entrepreneurs to build businesses around new sources of value. Strong empirical evidence suggests that incumbents, who are optimised to old economic value drivers, find it challenging to reorganise their cultures, processes and bureaucracies around such change.

We estimate that this focus on disruption and positive impact reduces our list of potential investments to about 300 stocks globally. We do not fix this list, because the trends and opportunities in the market are continually evolving.

STAGE 4: Analyse

In order to meet our threshold for investment, we designed six key questions, which define a successful, transformative, positive impact investment for us.

Each question must be answered positively before we will invest in a company:

• Does it have positive impact?
• Is it radical enough?                                      
• Is the leadership authentic?      
• Will it capture value?                                   
• Can we earn a return?
• Are we prepared to be wrong?
• Does it have positive impact?

Does it have positive impact?

Positive impact is embedded in our investment philosophy and process. We thoroughly assess a company's first and its less obvious second order impacts and we believe that incorporating impact analysis into our fundamental analysis generates unappreciated investment insights. We think of impact analysis in three dimensions:

• Product Impact – A company‘s products and services have the biggest impact on the world. Analysing the direct and indirect impacts of these are paramount to understanding the company’s impact. Product impact is directly aligned with the company’s strategic positioning.
• Practices Impact – A company’s leadership, culture and operational quality will determine its long-term outcomes. The impact it has on the world will be significantly influenced by these. Practices impact is directly aligned with operational quality.

• Future Impact – The world is dynamic and in a continual state of flux. Businesses must set ambitious goals and seek to continuously improve or risk being left behind. Assessing the positive impact vision and track record of management helps identify strategic and operational change before it occurs. Future impact is directly aligned with the pace of innovation.

Understanding Product Impact in particular is critical to our investment process. As we have also outlined in our answer above, we do this via a framework that considers intentionality, additionality and materiality, which are widely recognised impact investing principles. In the context of our process this means:

• Intentionality – Is the company’s vision and mission consciously aligned with positive impact?
• Materiality – Does or will the company have significant positive impact on the world if it successfully executes on its strategy?
• Additionality – Is the company attempting to disrupt an unsustainable incumbent system?

This in-depth Product Impact analysis is both qualitative and quantitative in its considerations and results in a score for Intentionality, Additionality and Materiality respectively. The sum of these individual component scores is the Product Impact score which determines whether a company is suitable for investment and ensures each portfolio company has demonstrable positive impact.

We believe that framing impact using intentionality, materiality and additionality is powerful and is directly linked to a company’s long-term strategic positioning. The causal feedback loops of the virtuous cycles created by being well positioned can be significant, while poor positioning increases the likelihood of a corporate death spiral taking hold.

However, whilst strategic positioning is critical for success, we also need to asses operational quality. This includes internal controls, audit, board oversight and disclosures. An entrepreneurial spirit is to be encouraged and typically aligns with the pace of innovation, but only within the right risk framework.

We therefore regularly speak to companies on a range of material impact issues to enable us to update our investment thesis. This engagement allows us to identify and monitor strategic and operational change before it occurs and ensures a progressive management philosophy.

Finally, we expect that investee companies should set ambitious goals and seek to improve continuously.

As part of our positive impact analysis we identify and track material company-specific impact KPI’s for each business that we invest in. Since we believe that climate change and diversity are highly relevant for every company, we have a particular focus on these two issues. Specifically:

• Climate Change – We seek disclosure of Scope 1 and 2 emissions using well-established methodologies and that companies set meaningful targets to reduce their emissions (where this is not already undertaken). In addition, we plan to ask all companies we invest in to consider moving towards Net Zero.
• Diversity – We seek that all portfolio companies achieve an appropriate level of boardroom diversity as well as seeking evidence of practices to ensure diversity throughout the workforce.

Why these specific issues? We believe there is a clear social and business rationale. A focus on these particular issues can achieve a positive impact on broader society while also future-proofing a business against strategic risks and regulatory change.

Voting naturally forms an important part of the engagement process and is one mechanism by which we can seek to effect positive operational change at the companies that we invest in.

Is it radical enough?

We seek radical businesses. By this we mean instigators of transformational systemic change. Our framework for assessing this revolves around the investments potential significance from both a positive impact and portfolio performance perspective and links directly to our approach to additionality.

We seek the potential for extreme upside. Such potential usually comes with the tariff of higher uncertainty, volatility and failure rate. Therefore, if it does not feel psychologically uncomfortable it is unlikely to be contrarian enough to be considered radical.

We believe significant positive impact and extreme returns are much more likely to emerge with transformational change and disruptive (‘additional’) innovation which is intentional and material. Furthermore, we aim to be disruptive and additional as an investment team ourselves, by providing long-term capital to companies at an early stage in their lifecycle.

  Is the leadership authentic?

Delivering value for all stakeholders – inclusive of the environment and society – requires leadership with vision, integrity, a strong mandate and a commitment to the long term. Albeit not exclusively, many of these characteristics tend to be evident in founder CEO's, who are more likely to be at the helm of an emerging growth business. Culture evolves from this and can be a powerful and enduring asset (or liability) for a business. We look for evidence of these traits in the management's record and in its ambitions for the future.

We engage with management prior to investing and closely assess impact factors when making decisions. We seek to understand, from the bottom up, what impact factors are material to the successful and responsible running of the business. We set KPI's for the management team that are linked to these and expect certain thresholds to be met before we invest.

 Will it capture value?

We use Hamilton Helmer's seven powers framework to determine which companies have the potential for persistent differential returns on capital. This process involves identifying emerging (dynamic) power rather than established (static) power. Emerging power typically occurs around flux that is created by a disruptive innovation, which changes the basis for competition in an industry. The seven powers are:

• Counter positioning – A newcomer adopts a new, superior business model which the incumbent does not mimic due to anticipated damage to their existing business.
• Cornered resource – Preferential access at attractive terms to a coveted asset that can independently enhance value.
• Network economies – The value of a service to each user increases as new users join the network.
• Scale economics – A business in which per unit cost declines as production volume increases.
• Switching costs – The value loss expected by a customer that would be incurred from switching to an alternative supplier for additional purchases
• Branding – The durable attribution of higher value to an objectively identical offering that arises from historic information about the seller.
• Process power – Embedded company organisation and activity sets which enable lower costs and/or superior product.

Can we earn a return?

We seek to invest in emerging companies that are growing revenues at above-market rates, with cash-flow generating power that is underappreciated or just emerging. Valuing our investments requires us to estimate the probabilities of a range of outcomes. These future scenarios can be widely dispersed. Returns on capital at maturity, estimates of total addressable markets, rates of growth and future  optionality must be considered when deciding whether an investment’s intrinsic value has been misjudged, thus allowing us to earn an above-market return for our clients.

We believe this type of insight is very difficult for quantitative, passive and short-term investors to price in. We hunt for four key sources of unappreciated value in this context:

• Unappreciated power – Emerging competitive advantage typically occurs around flux that is created by disruptive innovation which changes the basis of competition in an industry. During periods of high flux, it often takes time for cashflows to reliably reflect power.
• Unappreciated ‘TAM’ - Total addressable markets can expand or adjacent markets can be attacked. New markets can be created. Demand for disruptive new products is often underappreciated by traditional market analysis.
• Unappreciated growth inflection – ‘S-curve’ adoption patterns are non-linear and can sustain for years. The rate of change in growth can be surprising to our non-linear instincts and the compounding effect of this over a number of years is significant and regularly missed by normal distributions and mean reverting forecasters.
• Unappreciated optionality – The embedded value of non-revenue generating assets such as intellectual property or adjacent capabilities is often ignored by the market until its value is tangibly proven, yet the probability of such an asset creating value is often significantly greater than zero.

Intrinsic value should be determined by the returns that a company has and will earn on both its existing assets and its future assets. Therefore, we focus on the fundamentals of a business and how it creates value. We measure value quite traditionally by measuring and forecasting cash-flows. Future cash-flows are determined by the operating profits made by the business and its ability to reinvest these in future growth.

Profits are earned on the assets that a company has, whether traditional physical assets or intangible assets. However, we believe accounting does a terrible job in representing the value and future value of intangible investments.

They are concerned with physical assets and the manufacturing of ‘things’ and not on the development of intangible resources such as patents, trademarks, culture or brand equity.

The costs of developing these intangible resources are expensed immediately on income statements but the value of the asset never appears on balance sheets. This overstates costs and understates assets. This is not a good place to begin when assessing a business’s power or its continued development. For the purposes of our analysis, we therefore make some estimates about the duration of these assets and adjust expenses and assets accordingly. We now have a realistic and representative place to start to think about the relative attractiveness of a business.

We then use multiple future scenarios to model different potential outcomes. Rather than simply using one central scenario that we think is most probable, we try to incorporate plausible positive and negative ‘tail’ scenarios (high-impact but low-probability outcomes). The market does not conform to a standard deviation and long-term returns are driven by the tails.

Given that we are often assessing fast-growing companies with embedded optionality, the potential for underappreciated positive tail events is what we are trying to find. A low probability applied to a highly value-creating (or destroying) scenario can have a meaningful impact on the assessment of value.

This approach helps us to visualise possible tail events and fully understand which (if any) sources of value are being underappreciated by the market.

The determinants of value, are not multiples, they are future cash flows. These are determined by successfully understanding emerging competitive power, rates of growth, intangible asset values, addressable market opportunities and future optionality.

 Are we prepared to be wrong?

This question has two functions. First, it is a reminder that we must be individually and collectively brave enough to be wrong in the short-term. We must not avoid risk simply because it is uncomfortable. Second, we must be practically prepared in advance, so that we recognise our mistakes quickly and take action to correct them. In short, we must plan for the plan not going according to plan.

Being wrong is inevitable, particularly when investing in disruptive, fast-growing businesses. The price of admission to this approach is less certainty and more volatility. This is hard. The psychological toll of failure is well documented, so this approach is not easy and is subject to behavioural errors.

Cognitive dissonance – manifesting as a failure to accept one's own errors – and the resultant ‘thesis creep’ is a powerful example. As a result, we try to counter such effects with another psychological insight called prospective hindsight, or pre-mortem analysis.

Unlike typical risk analysis, which asks what might go wrong, pre-mortem analysis operates on the assumption that the investment thesis was wrong and asks, from that imagined future perspective, what did go wrong? This subtle shift in perspective has a powerful effect. The future failure is much easier to accept when you have already imagined it occurring. This technique makes it much easier to accept failures and make course corrections when they happen.

STAGE 5: Invest with impact

As a small team, debate occurs throughout the process as ideas emerge and as research is carried out. However, when a member of the team concludes that action should be taken, the team formally debate the investment thesis. New evidence can be requested and further work may follow. A decision to act requires a team majority and when a decision is made, we act quickly. We aim for each investment decision to have:

• Positive Impact – We must satisfy ourselves that the company has positive impact.
• Conviction – We must satisfy ourselves that this opportunity has a higher long-term return than the idea it replaces in the portfolio.
• Influence – The position size is big enough to meaningfully influence aggregate portfolio performance.

This results in a portfolio of 35-45 stocks, each of which has impact.

Resources, Affiliations & Corporate Strategies:

The team of four fund managers that work on the Artemis Positive Future strategy have over 40 years of combined experience in impact investing. In addition to the fund managers, Artemis has a dedicated stewardship team of two people.

Inez Oliver joined Artemis in 2005. She is a specialist in corporate governance and advises Artemis’ fund managers on this and on environmental and social issues. She has a degree in information systems and management from the University of London; a Masters in sustainability from the University of Cambridge; and holds the advanced certificate in corporate governance from the Institute of Chartered Secretaries and Administrators.

Antonia Stirling joined Artemis in 2019 from Standard Life Aberdeen where from 2010 she was Head of Corporate Stewardship. Before that, Antonia spent five years at Deloitte, where she became ACA qualified. She holds a MA in Human Sciences from the University of Oxford. Antonia also holds the Certificate in ESG Investing from CFA UK.

Both Inez and Antonia report into the Artemis Chief Investment Officer. Artemis’ investment committee is responsible for the oversight of our investment activities and stewardship role.
At Artemis, our fund managers take the lead on stewardship including ESG integration, as part of their investment processes. In our view, ESG should not be considered separately and in silo, it must be embedded in everything we do. The stewardship team's role is to support, discuss and challenge approaches and the team works with fund managers on a range of activities including; ESG integration, engagement & voting and participation in industry-wide initiatives to develop and promote best practice internally and across the industry.

We became a signatory to the 2021 UK Stewardship Code this year. As well as being a signatory to the PRI since April 2015, we are members of a number of industry bodies, committees and initiatives, including: The Investor Forum – we were a founder member of the forum in 2015. SASB Alliance – We became members in 2019.

Institutional Investors Group on Climate Change (IIGCC) – we became members in October 2021. Net Zero Asset Managers initiative – we became members in November 2021.

Dialshifter

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

Responsible investing has been around for ~30 years, but in reality achieved relatively little. At best, most approaches have achieved only incremental improvement and haven’t significantly ‘shifted the dial’. However, rather than incremental improvement, what we actually need to address the environmental and social challenges we face in the timeframe we have is transformational change. Hence our focus on investing at the intersection of disruptive innovation and the unsustainable status quo rather than the more traditional approach of investing in established, incumbent companies, which, almost by definition – tend to favour the (often unsustainable) status quo over change

SDR Labelling:

Unlabelled with sustainable characteristics

SDR Literature:

• Consumer Facing Disclosure link