Fund Spotlight: this climate change strategy delivers superior returns

Against the backdrop of British political parties watering down net-zero commitments, Europe continues to cement its position as the global leader in climate action. Overall support for ambitious carbon reductions in the region offers this fund’s Paris-aligned strategy solid long-term structural tailwinds that should see its strong track record sustained.

M&G European Sustain Paris Aligned Fundseeks superior returns above its benchmark (MSCI Europe ex UK) by investing in companies with robust competitive advantages and on meaningful decarbonisation pathways that align with the targets of the Paris Agreement. The agreement aims to limit the increase in global temperatures to well below 2°C above pre-industrial levels, in order to avoid reaching an unreversable tipping point in the Earth’s climate. 

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The strategy was the first on the market to introduce a Paris-aligned framework in 2021, to reflect the manager’s differentiated approach to doing good while doing well. This means carbon reductions are actioned at a company level, rather than portfolio level (simply excluding heavy emitters from the portfolio). The fund maintains a weighted carbon intensity, the amount of carbon emissions per million US dollars of sales, that is 50% lower than the benchmark.

As a result, the portfolio seeks companies with strong sustainable credentials that are actively reducing their own carbon emissions or providing solutions for others to do so. After filtering the investment universe against negative environmental, social and governance (ESG) screens, the highly experienced and well-resourced team utilises a detailed and bottom-up stock-picking approach(focusing on fundamentals of a business over the macroeconomic backdrop).

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The manager has a long-term outlook, with low turnover and an emphasis on capitalising on the compounding potential of quality companies, while exploiting short-term issues for appealing entry points. Subsequently, meaningful engagement is a key part of this fund’s long-term strategy, working closely with companies to put solid decarbonisation programmes in place, as well as ongoing engagement on wider ESG commitments. 

Portfolio manager John William Olsen has a strong track record of managing this strategy both at M&G since 2014 and previously at Dankse Capital since 1998. Managing both the European and Global strategies, he has successfully beaten the benchmark since taking over the European strategy (July 2014), returning 112.6% versus the benchmark’s 88.9%. Performance over this period highlights the resilience of the portfolio and capabilities of the team to navigate challenging markets.

What does the fund invest in?

The portfolio is concentrated, typically holding fewer than 35 companies (30 currently). The team has a fairly unconstrained mandate, with at least 80% of the fund invested in companies of any sector or market capitalisation that are based, or do most of their business, in Europe. Olsen utilises this flexibility to hold a handful of very high-conviction companies, with a large-cap growth bias.

The team also exploit bottom-up stock picking to further aid performance and limit drawbacks by diversifying across a broad composition of sectors, stylistic factors and business models. The portfolio comprises a balanced split of “stable growth” companies (stock weights 3%-5%) and “opportunities” (stock weights 1.5%-3%). This allows the manager to include an allocation to high-risk, high-reward companies while maintaining a smoother risk curve and managing volatility down.

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The top 10 holdings account for nearly 50% of the portfolio, with the three largest positions being Novo Nordisk A/S ADR (NYSE:NVO) (6.6%); Schneider Electric SE (EURONEXT:SU) (5.6%); and Scout24 SE (XETRA:G24) (5.4%). These companies are a Danish leading provider of diabetes care products, a global supplier of electrical and industrial automation equipment, and an operator of an innovative real estate platform in Germany. The trio performed well in the first three quarters of 2023, contributing to year-to-date performance of 29.6% versus 19% for the benchmark.

The fund is overweight to industrials (29.6%) versus the benchmark (16.5%), as well as displaying a bias towards financial services (16.5%) and healthcare (13.1%). The portfolio has an off benchmark overallocation to Northern European countries, with over 40% of the portfolio held in Denmark (20.7%) and Germany (20.5%).

How has the fund performed?

The concentration in number of investments can mean higher volatility versus the benchmark as the performance of a single holding can have a larger impact on that of the whole portfolio. Despite this, the M&G European Sustain Paris Aligned fund has comfortably outperformed the benchmark over five years (returning 40.1% versus 36.4%) and Morningstar category peers (32.7%).

Rising inflation, subsequent rises in interest rates and geopolitical unknowns have presented an uncertain environment for European markets over the last couple of years. However, the portfolio has benefited from strong stock selection, particularly with large holdings in the financial services sector that were able to claw back losses in the first three quarters of 2022, to display a positive one-year return of 16.6% for the portfolio. Big contributors were AIB Group (EURONEXT:A5G), Dutch-based ING Groep NV (EURONEXT:INGA) and German reinsurer Hannover Rueck SE (XETRA:HNR1). Industrials and technology stock selections also boosted performance.

Source: Morningstar Total Returns (GBP) to 31/10/23.

Why do we recommend this fund?  

Olsen’s strong-track record and robust investment strategy makes the M&G European Sustain Paris-Aligned fund a compelling option for investors looking to commit capital to the carbon reduction path to net-zero, while seeking superior returns.

Management invests in quality companies that look to add stable economic value over time. Higher volatility and risk are a result of the highly concentrated nature of the portfolio versus peers, but Olsen has proved his ability in stock selection and long-term successful management of the strategy. Given the high-risk rating of the portfolio, it is recommended to hold this investment for a minimum of five years.

The fund faces an array of short-term headwinds, such as wars in Ukraine and the Middle East, high energy prices and interest rates. Nevertheless, long-term tailwinds for the fund, such as ambitious carbon reduction targets in the EU remain resilient and provide a positive outlook.

Accordingly, the fund is included in interactive investor’s ACE 40 list as an Adventurous offering for sustainable investors. Please find the fund factsheet here. The fund is competitively priced at 0.55% a year.