Fund manager Q&A: A broader view of sustainable investing

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Posted: Jan 19, 2017 2:01 PM
Fund manager Q&A: A broader view of sustainable investing

People who favor investing in a way that helps preserve the environment have more options than strictly focusing on companies that offer Earth-friendly products or services.

Companies that make solar energy panels, electric vehicles or household products sourced from sustainable materials may fit the bill, but not necessarily offer attractive returns.

Brown Advisory Funds' Sustainable Growth Fund (BIAWX) keeps this in mind. It focuses on companies that are growing even as they use environmentally sustainable practices in their business or offer a service or product that helps other companies do the same.

That means the fund has lots of big-name companies that one wouldn't immediately think of as having a green or environmentally friendly focus, such as Amazon.com, UnitedHealth, Facebook and Visa.

The fund lagged its benchmark index last year, the Russell 1000 Growth index, but its annualized returns have been nearly identical to the index since its inception in 2012.

Karina Funk, co-portfolio manager of the fund, weighs in on how the fund is expanding the definition of environmentally conscious investing. Answers have been edited for length and clarity:

Q: Explain what you look for when selecting companies for the fund.

A: The way to make money on companies that have sustainability characteristics is to start with fundamentally strong companies. A green or sustainability thesis is not a silver bullet for automatically making money or losing money.

So there are three primary characteristics that we require in our portfolio companies:

They must be fundamentally strong. They must have sustainable advantages. And we also must buy them at attractive valuations.

With these criteria, we believe we find the management teams that are making the right investments in their own long-term sustainability, in their own economic self-interest, so they can compete and continue to be a part of our everyday lives for decades to come, and that is in line with our long-term investment approach.

For us, sustainability is a means and not an end in and of itself. Our end goal is to invest in companies that will outperform the broad market. And one of our means of doing this is to find fundamentally strong companies that are using sustainability strategies to add value for shareholders.

Q: How do you gauge whether a company's investments in sustainable business practices make it a good fit for your fund?

A: We need to see evidence of sustainability adding value in very specific ways, either through stronger revenue growth and improved cost structure, which improves margins, or increased customer loyalty, or what we call enhanced franchise value.

In terms of growing revenues faster, this could be by offering a product or service that helps customers reduce their cost of doing business by reducing or eliminating certain materials or equipment, saving on energy, saving on chemicals, water, inputs or outputs. In short, it's about helping to drive productivity and efficiency for their customers and saving them money.

Q: What's a good example of a company whose product or service fits this bill?

A: A.O. Smith. They make the highest efficiency water heaters on the market and for really high volume use cases, like hotels or hospitals, you can get a payback on energy savings alone in less than three years, and that's really compelling for high-volume water users.

So that's an example of a product or service that has a compelling growth driver, because they improve productivity or efficiency for the end customers.

Q: Is it more important that a company is making an environmentally-friendly product versus, say, just operating in a way that makes their business more sustainable?

A: We truly believe you can find sustainability drivers in just about every sector of the economy, but they're not easy to find.

When you look at our holdings it looks like a large-cap growth fund, but I can tell you that it's a large-cap growth fund where we avail ourselves of information that most money managers miss.

Amazon is our top holding. It's companies like Amazon that are important sustainability investments in ways that move the needle on environmental and sustainability profiles in more significant ways than some smaller companies.

They can leverage (their) IT system for thousands of customers external to them and provide computational resources in real time that have literally eliminated the needs of many companies to build up their own data servers and storage and computational capabilities. So that is significant in terms of reducing hardware, software and energy usage.

It's not like there's some database out there that tells us that Amazon is green. We're willing to invest in these strong sustainability drivers before it might be recognized by the market.

So, when you look at our portfolio, there's a strong sustainability driver for every single one of those, even though they may not be in your usual suspect, green sectors like renewable energy.

In a nutshell, we're looking for fundamentally strong companies that are outperforming in part of, not despite, their sustainability strategies.