Jupiter Green Investment Trust PLC — Quality growth through environmental solutions

In spite of heightened geopolitical tension and emerging evidence that the world’s largest economy, the US, might be past its cyclical peak, global equity markets have continued to perform strongly. As shown in Exhibit 2 (left-hand chart), smaller companies have outperformed large-caps globally over the past five years, and environmental technology stocks – in common with technology stocks more generally – have led the pack. However, as shown in the right-hand chart, equity valuations are also high on both forward P/E and price/book measures, while there is limited support from dividends in an environment where bond yields could start to rise. Against such a backdrop, a disciplined investment process that focuses on finding genuinely innovative companies at reasonable valuations could find favour with investors.

Jupiter Green Investment Trust (JGC) was launched in 2006, the third in a succession of environmentally-focused investment trusts managed by Jupiter Asset Management, which had pioneered the sector with the launch of the open-ended Jupiter Ecology Fund in 1986. The trust is managed by Charlie Thomas – head of environmental and sustainability investment at Jupiter, and also manager of the Ecology fund – and Abbie Llewellyn-Waters.

JGC invests globally in a portfolio of c 60 companies that provide solutions to environmental challenges, with the aim of benefiting from the secular growth of environmental and sustainable investment, and achieving capital appreciation. The portfolio is diversified across the market capitalisation spectrum, although the trust’s relatively small size and closed-end structure means it can invest in smaller and less liquid companies than would be appropriate or permissible for the £574m Ecology fund. JGC is not constrained by any benchmark, although it measures its performance officially against the MSCI World Small Cap index and informally against the environmental technology-focused FTSE ET100 index. At launch the trust outsourced its US stock selection to Winslow Asset Management, and until 2010 had a composite benchmark made up of the FTSE Global Small Cap ex-US and Russell 2500 Growth indices, in proportions dependent on the percentage of assets managed by Jupiter and Winslow. The current benchmark was adopted in June 2010 at the same time as stock selection was brought fully in-house.

The trust may invest up to 5% of total assets (at the time of investment) in unlisted securities, and the managers may use derivatives and short positions in order to mitigate risk. A two-tier monitoring process aims to ensure that JGC is appropriately diversified by stock, sector and geography.

We spoke with managers Charlie Thomas and Abbie Llewellyn-Waters after Donald Trump’s vow to withdraw the US from the Paris climate agreement, ratified late in 2016. They commented that while the development is outwardly negative, it has had a strong galvanising effect for other countries, as well as many states within the US that have their own targets on emissions reduction, to get on and deal with the issues. Regardless of the rhetoric, there is also a strong political imperative for the Trump administration to support renewable energy, with 80% of US wind farms being located in Republican heartlands such as Ohio and Texas, and providing an important source of employment.

Thomas comments that as environmental solutions become more developed and less dependent on subsidies, political risk diminishes. Technological advances in wind turbines are reducing downtime through remote reporting and the ability to schedule maintenance for non-wind days, so no output is lost. This is bringing down costs for wind power generation and making it more competitive with other energy sources. JGC portfolio companies benefiting from this trend include Vestas Wind Systems and recent purchase, Dong Energy. The managers are also tapping into greater acceptance of the need for a move towards electric vehicles, although they prefer to access the sector through parts suppliers such as semiconductor manufacturer Infineon Technologies.

Meanwhile, Llewellyn-Waters notes that it has become a little harder to find compelling investment opportunities, as valuations on portfolio holdings and stocks on the watch list are high relative to history. However, with companies being punished more for missing earnings expectations than they are rewarded for beating them, there may be opportunities to buy on the dips.

Jupiter’s environmental and sustainability investment team selects stocks on a bottom-up basis from three interlinked areas where it believes environmental and economic issues connect:

JGC focuses on companies that can have a deep and lasting impact on these areas through the provision of environmental solutions. It classifies its investments as transformational – companies that are disrupting the status quo through new technologies – or transitional, meaning those that are improving environmental sustainability in areas that might not usually be considered ‘green’. The increasing global acceptance of the need for environmental solutions has expanded the trust’s investment universe from fewer than 100 companies at the strategy’s inception to c 1,200 today.

The investment team monitors this universe, looking for themes and trends, such as increased development and adoption of electric vehicles. Through the use of financial screens, monitoring market and technological developments, attending industry conferences, talking to companies (the team undertakes 300-400 company meetings each year) and making use of broker networks, the managers identify potential investments. Candidate companies should have proven technologies, strong balance sheets and cash flows and good-quality, experienced management teams.

Potential investments undergo a financial assessment, looking at capital structure and the ability to generate sustainable profits and return on equity. The managers also analyse end markets and factors such as political risk – which can cause volatility in share prices even where the genuine impacts are less than headlines may suggest – and specific risks such as a lack of take-up of a particular technology. Detailed financial modelling is used to analyse a range of historical and forward valuation metrics, while the team also assesses governance and sustainability factors.

Where the managers decide to invest in a company, they will usually take an initial position of less than 1% of the portfolio, with a view to increasing it over time as their investment thesis is validated. The portfolio has c 60 stocks, and positions will normally be trimmed if they exceed 5% of assets. Holdings may be sold if the managers feel valuations have become overstretched, if a product or service is no longer viable or competitive, if challenging conditions occur in an area of the market, if long-term return expectations are not met, or in cases of management change. The strategy has low turnover of c 10% pa, but the managers keep a ‘shopping list’ of companies they would like to own but where valuations are too high; names from this list may be added to the portfolio on any dips.

At the 31 March 2017 year-end, JGC had 61 holdings. The top 10 stocks at this date made up 32.6% of the portfolio, with concentration falling marginally to 31.2% at 31 July 2017 (31 July 2016: 34.6%). Holdings are well spread by geography and industry, with the largest sector weightings currently being in industrial engineering and support services (see Exhibit 1) and the largest geographical weightings in the US, UK and Japan (Exhibit 3).

The managers have taken a number of new positions in recent months. These include Dong Energy, Fjord 1, Innogy, Lenzing and va-Q-tec. Thomas says Dong Energy is a classic transitional stock – originally the Danish national oil & gas supplier, it is now the world’s largest developer of offshore wind power. Lenzing is an Austrian textiles company that makes Tencel fibre out of wood pulp. Llewellyn-Waters says the fibre has superior performance characteristics to cotton, while being far less resource-intensive: Lenzing uses a closed-loop manufacturing system so no water is wasted; conversely, it takes 2,700 litres of water to manufacture just one cotton T-shirt. Two new holdings since the year-end are Norwegian local ferry operator Fjord1 and Prysmian, which is an Italian cable manufacturer selling into the energy and utility sectors. Most exits from the portfolio have been as a result of M&A (see Performance section). Other recent notable changes in the portfolio include additions to holdings in US companies Clean Harbors (environmental services) and Itron (energy solutions) and reducing the size of the positions in Cranswick (UK food producer) and Wabtec (US provider of technology products and services to the transportation industry).

JGC has performed strongly over the past year (Exhibit 4), with its share price total return also surpassing the return on the MSCI World Small Cap index. Medium-term returns have also been compelling on an absolute basis, annualising at close to 15% a year over five years. As shown in Exhibits 5 and 6, the trust has tended to lag the large-cap ‘green’ FTSE ET50 index, although its global portfolio has helped it to outperform the main UK FTSE All-Share index over most periods.

Positive performance drivers in FY17 included Republic Services and AO Smith, on the expectation of a pick-up in US industrial activity following Donald Trump’s election, while Xylem and Itron were rewarded by a strong demand environment, and Japanese stocks also did well. US solar power stocks First Solar and Sun Power fell on fears of less support for renewables under the new regime. More recently, M&A has boosted returns, with the takeovers of EDPR, WS Atkins and Whole Foods, while Vestas Wind Systems and waste-sorting specialist Tomra Systems also performed well. Whole foods supplier United Natural Foods and Shimano have detracted from returns.

At 24 August 2017, JGC’s shares traded at a 5.5% discount to cum-income NAV. This is broadly in line with the one-year average of 5.8%, but a little wider than the three- and five-year averages of 4.8%. Having widened in a period of risk-aversion in early 2016 and again in the immediate aftermath of the UK’s EU referendum (reaching a five-year high of 13.4%), the discount has settled back into a 4-6% range. JGC’s board aims to keep the share price close to the NAV and may buy back or issue shares to manage a discount or a premium. In the past 12 months, c 0.8m shares have been bought back at a cost of c £1.4m.

Structured as a conventional investment trust, JGC has one class of share, with 21.1m ordinary shares in issue at 24 August 2017. The shares have subscription rights that entitle shareholders to subscribe for one new share for every 10 shares held at 31 March each year, at a price equal to the undiluted NAV per share at the previous year-end. A discount/premium management programme aims to ensure that the share price does not materially vary from the NAV. Gearing is permitted up to 25% and is available via a £3m flexible loan, which, if fully drawn, would equate to gearing of 7.5% based on 24 August net assets. So far none of the borrowing has been drawn.

Jupiter is paid an annual management fee of 0.75% of net assets (reduced from 0.85% with effect from 1 January 2017), after deducting the value of any Jupiter-managed investments. A performance fee structure is in place whereby the manager receives 15% of outperformance of the MSCI World Small Cap index over a financial year, subject to various conditions (see our initiation note) and an overall fee cap of 1.75%. The last time a performance fee was paid was in FY14, and ongoing charges as at end-FY17 were 1.58% (FY16: 1.63%).

JGC invests for capital growth, and only pays dividends to the extent required to maintain its investment trust status, the rules for which state that no more than 15% of income received in the course of a financial year may be retained. Dividends have been paid each year since FY11 and have tended to reflect portfolio income, meaning that they have fluctuated from year to year. The FY17 dividend of 1.2p per share is equal to the revenue earnings per share for the year. This is 85% higher than the FY16 dividend, partly reflecting the translation effect of a weaker sterling on income received from overseas investments. The dividend will be paid on 6 October to shareholders on the register at 15 September, and represents a yield of 0.7% on the current share price.

The AIC’s Sector Specialist: Environmental sector is a small group but still includes a diversity of funds with more and less similar mandates to JGC’s. The Impax and Menhaden funds invest broadly like JGC, while Leaf Clean Energy has a narrower focus on renewables. The sector is dominated by the large Impax fund, whose strong performance skews the weighted averages, whereas JGC is the smallest in the group. JGC’s NAV total returns are ahead of the simple average for the sector over one, five and 10 years, and broadly in line over three years. The trust ranks second in the group over all these periods. Performance has been broadly similar to the open-ended Jupiter Ecology fund, although the two portfolios are quite different, with JGC having more of a focus on smaller companies. JGC’s ongoing charges are above the weighted average but below the simple average. The trust is ungeared and has the narrowest discount in the peer group. It is one of only two closed-ended peers with a yield, and it also yields more than its open-ended cousin.

As a small trust, JGC’s board is cognisant of the impact of fixed costs such as directors’ fees on the ongoing charges ratio. As a result, the board is small, with only three directors, but all are experts in the environmental sector. Chairman Michael Naylor was appointed to the board in 2009 and took on his current role in 2015. His background is as a private equity investor in the sustainable asset class. Dame Polly Courtice is a leading environmental academic and has been on the board since launch in 2006. Simon Baker was appointed in 2015 following a career in fund management. He headed Jupiter’s green investment department from 1994 to 2006.