Market
backdrop

Market backdrop

2022 was a highly challenging year for equity markets as growth slowed much more than anticipated. Not only did inflation fail to ease as expected but it accelerated further. In response, central banks embarked on the most rapid cycle of policy tightening in 40 years.

The supply chain problems that emerged in 2021, following the initial economic recovery from Covid, extended into 2022. To compound the impact of the Russian invasion of Ukraine, which led to sanctions and the removal of supply that greatly disrupted global energy markets, the global jobs market tightened considerably also. That kept upward pressure on wage growth, which moved well above its long-term average across most regions.

These factors directly contributed to core inflation remaining greatly in excess of central bank targets, with headline rates reaching double digits in most economies. That led all developed market central banks outside Japan to raise policy rates into restrictive territory.

In response to the dramatic move up in real rates, virtually all global asset classes saw declines in 2022. The only major market to see positive performance over the year was commodities, but even there it was largely restricted to energy and agriculture. The dramatic shift in cross-asset correlations was also accompanied by a significant increase in asset market volatility.

The profile of market returns, with energy – and in particular fossil fuel companies – outperforming by a wide margin created a notably unfavourable backdrop for sustainability-themed strategies. Moreover, as the cost of funding rose, there was a clear shift of sentiment away from the ‘growth’ stocks that typically dominate ESG portfolios into the relative safety of slow-and-steady ‘value’ sectors.

Natural Transition Capital Global Equity Fund

Fund performance

Further to the market environment described above, more specifically in the portfolio, the largest detractor was German sportswear manufacturer Adidas, which disappointed investors with two profit warnings. The company suffered much lower sales in China and western Europe than had been expected. Announcing a €500 million cost-cutting programme, the management cited “significant cost increases resulting from the inflationary pressure across the company’s value chain as well as unfavourable currency movements”. Adidas was hit further by negative publicity relating to its tie-up with controversial rapper Kanye West.

Shares in Trex, the US manufacturer of wood-alternative decking and similar products, gave back many of the strong gains accrued in a rally that began in 2017. While financial performance for the first quarter surpassed expectations, investors were concerned about the business’s outlook as the surge in home renovations seen during the pandemic faded as households began to tighten their purse strings in the face of a slowing economy and rising interest rates.

Other notable detractors included Dutch ingredients company Koninklijke DSM, Salesforce.com and Infineon Technologies. The top-contributing holding over the year was the German re-insurer Münchener Rückversicherung (Munich Re). The company’s shares rallied on expectations of a shift in corporate profitability driven by an increasingly positive pricing environment with the departure excess and disruptive capital from the sector. Munich Re produces key industry research on climate change impact and natural catastrophes, and insurance products can contribute to mitigate the impacts of physical biodiversity risk.

AstraZeneca was also a notably profitable position. Boosted by a series of new drug approvals, the pharmaceutical maker benefited from strong sales and profit growth and increased its earnings guidance. Industry allocation had a positive overall impact on returns over the year. Despite the lack of exposure to the strongly rallying energy sector, the portfolio benefited from an overweighting of materials and an underweighting of information technology and communication services.

Past performance is not a reliable indicator of future performance – see next slide for full performance information.

As at 30 Sep 2023 – Performance in USD

Performance

	Cumulative (%)					Annualised (%)
	1M	3M	6M	YTD	1Y	3Y	5Y	Since inception
Fund	-5.07	-4.81	-1.05	7.38	16.36	-	-	-11.11
Benchmark	-4.14	-3.40	2.56	10.06	20.80	-	-	-3.64

Past performance is not a guide to future performance.

Performance basis: Mid to mid, in the share class reference currency, gross of tax payable by the Fund with income reinvested. Net figures are net of ongoing charges and fees. Net and gross performance does not include the effect of any exit or entry charge. The Fund’s performance is compared against the MSCI All Countries World Index (the “Benchmark” or the “Index”).

Calendar year returns

	2018	2019	2020	2021	2022
Fund net	-	-	-	-	-26.25%
Benchmark	-	-	-	-	-18.36%

Share class is used for illustrative and indicative purposes and may not be available in all regions. For further information on other share classes please see the website.

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Main portfolio changes

Over time, the portfolio will have a balanced exposure between transition-orientated companies and those which meet our solutions criteria (although some companies can fit into both categories). However, over the course of 2022, there was a shift in terms of exposure towards the transition sleeve where we often find companies with lower cyclicality and duration in their earnings. This additional flexibility of our fund helped the portfolio to drawdown less than more solutions-focused peers during the first half of 2022 in particular. We reined in our exposure to some of the more cyclical areas of our industrials holdings as we were concerned that the rising cost of capital and cost inflation could dent demand towards the end of the year and into 2023. We also reduced our overweight exposure to semiconductors, trimming Infineon and On Semi. Whilst we are convinced of the growing medium and long-term demand for their leading product in the faster growing EV segment, the market appears more fixated on the potential for a near-term cyclical demand slowdown.

Towards the end of the year, we reduced our overweight exposure to materials, trimming Stora Enso in anticipation of a further rolling over of global pulp prices and also concerns over forestry prices. Additions to the portfolio included industrial gas company Linde (solutions company), as well as IT services and consulting group Accenture and consumer staples manufacturer Nestlé, which are all transition leaders in their respective sector on environmental and biodiversity risk management. We see positive risk/reward for these companies in the long term. We sold out of our position in Beyond Meat based on further cash burn concerns and structurally more competitive landscape where we have seen little evidence of brand equity strength despite first-mover advantage.

Outlook

We believe that financial markets are not efficiently pricing the costs and consequences of natural capital depletion or taking the necessary measures to reduce biodiversity loss, regenerate our planet and transform our economy into one that is nature positive. The fund seeks to address and exploit these market inefficiencies by investing in both Solution providers (companies contributing to the protection of natural capital) and Transition orientated companies (companies aligning their business models for a nature positive world).

Monetary policymakers continue to search for the level of restrictive policy required to slow growth sufficiently to create spare capacity and ease inflation. This late-cycle dynamic can see equities outperform for longer than expected, but the turn can create material downside risk.

While technology companies are fuelling the NASDAQ and loose monetary policy is propelling Japan, the UK and China are in the doldrums. This heterogeneity is mirrored in the dispersion across sectors, with the most interest-rate sensitive market areas continuing to underperform. However, positive growth surprises and the ability of many firms to pass through input cost increases to maintain margins are powering most indices to renewed strength.