Strategically Speaking: Montanaro Asset Management
As a Europe-focused small and mid-cap manager, the decision of London-based Montanaro Asset Management to launch its Better World fund, a global impact focused fund after a 27-year track record as a European house, was most certainly a change in strategic direction.
For Cedric Durant des Aulnois, CEO since 2016, the move was an intuitive one, however. His reasoning centres on the multi-national 10-strong analyst team, which comprises of sector specialists able to leverage their knowledge to a global stock universe.
For instance, Andrea Shen, senior analyst, is fluent in Mandarin and Japanese, knowledge obviously easier to leverage outside Europe. “All that’s happened really is that the analysts have covered an extra two, three companies outside Europe,” as Durant des Aulnois puts it.
Second, in choosing impact as the focus for this fund, a global approach seemed important given the transnational characteristics of the UN Sustainable Development Goals (SDGs).
Having long embedded ESG in the investment process, it would also have been counter-intuitive for Montanaro to launch a dedicated ESG fund. This is a broader dilemma for the asset management industry as investors digest the recent wave of ESG integration and what it means for investment processes.
Impact investing – which aims to generate positive social and environmental impacts alongside a financial return – is a relatively new discipline in listed markets. It needs to rest on solid foundations, most notably in reporting and engagement, if it is to be taken seriously and to avoid accusations of ‘impact washing’.
Montanaro’s fund has just passed its first anniversary, with respectable performance of 17% since launch in sterling terms (6.8 percentage points above the MSCI World SMidCap index). It was the culmination of months of development work, assessing both the investable universe and developing a thematic framework that supports the aims of the SDGs. Durant des Aulnois is convinced that there is natural harmonic relationship between impact and Montanaro’s quality-growth approach to small and mid-cap equities.
“When you talk about ESG, people think risk mitigation. When you talk about impact, you’re talking about $12trn of business opportunities between now and 2030.”
“So suddenly, you’re thinking, ‘Oh, actually, this is a top-line growth story’. And suddenly, it all starts to make sense. Because to actually address the SDGs and get them resolved by 2030, there needs to be a huge amount of new investment.”
Less than 10% of the 11,700 small and mid-cap companies globally, or about 1,000, are of high quality according to Montanaro’s quality screen, and the firm assesses 300 of these as being suitable candidates in impact terms. Quality is assessed using 14 criteria, including growth, profitability, leverage, cash and volatility metrics. Montanaro has also refined the 17 SDGs to six impact themes – environmental protection, low-carbon economy, healthcare, innovative technologies, nutrition and well-being. Following in-depth due diligence and company site visits, the investable universe of 300 is narrowed down further to create a portfolio of 50 stocks.
So what is an ‘impact’ stock exactly? Assessing a company for inclusion, according to Durant des Aulnois, involves making “a qualitative judgment as to whether the company as a whole, through its operations, through its products and services, is making a positive impact”.
Part of the work involves aligning the revenue stream with the fund’s six themes. Achieving 100% revenue alignment with the themes in a given company would be highly unlikely; 60-65% would be more typical for a company held in the Better World Fund, according to Durant des Aulnois. “This can be a complicated task for companies with a large product range. Then there is the added complication of having to evaluate a company’s commitment to making a positive impact, how its R&D and capex plans might reflect this ambition, how its products differ from the competition and whether there are any negative impacts to consider. Impact investing is more of an art than a science and there is no shortcut to doing your homework.”
The area is riddled with apparent contradictions, and overlap between ESG and impact is not a given: a company can lead on ESG metrics but not on impact. And high impact does not necessarily mean a good ESG score. Montanaro’s internal ESG committee provides oversight to the investment team’s impact analysis and vote on whether or not a company is eligible for investment.
In the two years or so since work started in earnest on the new strategy, the ESG committee has assessed over 100 companies, rejecting some 20% of new ideas. Many have been the subject of intense debate for inclusion but were ultimately rejected.
Operating in the small and mid-cap sector understandably means dealing with sometimes less clued-up corporates than their large-cap brethren. Nevertheless, Durant des Aulnois notes: “The companies are very open to communicating with us to understand what it is people want and how they should prioritise their resources.
“So one key area of engagement for us is increasing disclosure and improving reporting. Do it, but do it smartly. Don’t try to report on absolutely everything. Just because plastic is the theme of the day it doesn’t mean you have to report on plastic and measure everything if plastic is not relevant to your business.”
Greenhouse gas emissions are a tricky area in reporting terms and an even bigger challenge for smaller companies which are less well resourced. For Durant des Aulnois, a sensible approach could be to offset emissions output against emissions saved within the value chain in a holistic approach – representing a next stage in the process of assessing carbon impact.
While this is clearly work in progress, the holy grail of impact investing for the CEO is dialogue and engagement with corporates. As Durant des Aulnois puts it: “For me, it’s the engagement element, because that has tangible results.”
And for Montanaro, operating in the small and mid-cap sector ultimately leverages impact: much of the work to meet the UN’s SDGs will take place outside the large-cap space, so directing capital to smaller companies will be essential. For investors concerned about whether impact investing can successfully be carried out in public markets, a small and mid-cap approach is an interesting way to alleviate some of the concerns about applying an SDG investment approach in larger, liquid markets.