Regnan Sustainable Water and Waste Fund

Water and Waste review and outlook

Review & Outlook Regnan Sustainable Water and Waste Fund

For Profesional Investors Only.

Water & Waste - 'View from the ground' Regnan Sustainable Water and Waste Fund

A relief rally

Global equities have had a tough 2022 as broad global indices entered bear-market territory in mid-June (down 20% year-to-date). A combination of rate hikes, surging inflation, lingering COVID disruptions (especially in China), supply chain issues and the Russia/Ukraine war has been the driver of this decline. Investor sentiment has been broadly negative highlighted by the latest Bank of America's (BofA) July Global Fund Manager Survey where the Bull & Bear indicator was at the “maximum bearish”.¹ The BofA survey also sometimes considered as a contra-signal, where excessive bearishness is considered as bullishness. Interestingly, the title of the latest survey was “I’m so Bearish, I’m Bullish.”

Since the mid-June bottom, we have seen a relief rally across the board with the MSCI ACWI Index rising almost 10% (in USD as of 5 August 2022). A somewhat resilient earnings season and hopes of less hawkish central banks have been the primary drivers of this rally. Macro data has been mixed with disappointing growth data and flash Purchasing Managers’ Index (PMI) surveys losing momentum. Labour markets have been resilient with tight jobs markets driving nominal wage growth. The weaker data in recent weeks has been digested well by the market given it has pushed down bond yields and rate expectations. Expectations for monetary policy easing over the next year have increased in both Europe and the US. Markets appear to have turned more optimistic on the 'central bank put', reverting to a 'bad news is good news' regime.

¹https://fortune.com/2022/07/19/bofa-investor-pessimism-at-dire-levels-bull-bear-indicator-in-max-bearish-zone/

Expectations for monetary policy easing have increased over the last month

Source: Bloomberg, Fed Fund Futures, implied overnight rates, as at 9 August 2022. (WIRP).

Tech and Consumer lead but water and waste do well

The recent rally has been led by information technology and consumer discretionary sectors. This was a reversal from the year-to-date drawdown as these were the two worst performing sectors in that time period. Meanwhile, energy and materials were the worst performing sectors generating negative returns as the market rebounded. Fundamentals for water and waste companies continued to be strong and the themes confirmed their past track of generating a robust “up-capture” while showing defensiveness when the markets tend to be weak. This supports the natural defensive growth profile of the integrated water and waste universe.

Water and Waste theme has done
well in the recent rally

Global equity markets returned 18.5%

(as measured by the MSCI ACWI in USD terms)

Source: Bloomberg, Regnan, total returns in USD from 16 June 2022 to 5 August 2022.

Fund fundamentals on track – Resilient 1H 22 earnings season and sound outlook

In-line with our view prior to the earnings season, we have seen that demand continues to be healthy for most of our companies. In particular, business-to-business (B2B) companies have performed better than business-to-consumer (B2C) counterparts. We continue to have less exposure to direct-to-consumer businesses. Pricing power continues to be good, especially on the waste side, with capacity to do a further raise if needed (visible pricing momentum for another c. 18 months). In general, we have continued to see the mention of supply chain issues in some of the earnings calls and management teams have broadly kept outlook unchanged, leaving room for positive surprises in the coming quarters as we step into 2023.

At a stock level, the most positive surprises came from our holdings in Clean Harbors, Mueller Industries and Advanced Drainage System. Clean Harbors, Inc. provides a variety of environmental remediation and industrial waste management services. The company beat estimates by a strong margin and issued a significant raise to full-year guidance. It continues to benefit from its vertically integrated industrial/hazardous waste platform which we believe is still underappreciated by the market. Maker of water drainage supplies Advanced Drainage System also rallied on the back of a strong quarter helped by falling resin inputs, improving manufacturing and transportation productivity, and solid volumes. It continues to be one of our top holdings. Elsewhere, our UK-based waste holding Biffa also had a good quarter.

Fund fundamentals on track – Resilient 1H 22 earnings season and sound outlook (cont'd)

On the other hand, there were a few negative surprises. Pool-related infrastructure and distribution companies have recently underperformed given profit taking from previous strong performance and fears of outlook for 2023. Despite having better-than-expected Q2 earnings, both Pool Corp and Pentair saw decline in share prices. We believe the market has overreacted to the situation. Pentair’s exposure to quality residential products, recent M&A and a focus on simplifying business will help margin expansion. For Pool Corp, being a distributor in this business area, we believe that the growing installed base will drive non-discretionary, recurring sales. Strength in household balance sheets, the continuation of WFH hybrid models, and a shortfall in the supply of homes should help remodelling activity. Sustainable packing company Ball Corp. also slumped post results as there were concerns on end-market volume growth and change in capital deployment by the company. We believe that the overhang on the stock will continue for the foreseeable future with further downward pressure on the share price and we have exited the position. Over the last quarter we have re-enforced our positions in stable and cash generating companies with sound balance sheets and favourable valuations. Being risk aware, we actively managed the portfolio by reducing size or fully exiting companies with asymmetric downside risk and with lack of technical support and near-term catalysts. We may further revise a few positions as we roll over our estimates into 2023.

Positioning

We have made a couple of small changes in the portfolio and exited two names where we believe there might be stock-specific issues in the coming quarters. We are finding a few exciting new opportunities within the universe and stay positive on the long-term fundamentals. It is important to keep a blended portfolio as volatility continues to persist. We expect the market to favour strong balance sheet companies, especially if growth slows and credit spreads widens. As previously mentioned, we continue to focus on companies with pricing power and strong balance sheets.

Based on our 2024 estimates, investors should find a compelling entry point as the theme is better positioned than in 2008 and 2011-13 corrections, with better balance sheet (1.1x ND/EBITDA vs 3.0x in 2008), higher margin and cash conversion. Dividend yield has increased over time and has often been topped up with buy-backs. The sector provides value creation above cost of capital and currently trades at 14 years of cash flow for a perpetual story. As compared to long-term trends, we currently see a c. 20% discount to historical forward valuation, which compensates for the earnings risk in case of potential economic slowdown. As a reminder, one of the key factors of the theme is earnings persistence.

Past performance is not necessarily a guide to future performance. The value of an investment can go down as well as up as a result of market fluctuations, and currency fluctuations (where relevant), and investors may not get back the amount invested. The scenarios presented are an estimate of future performance based on evidence from the past on how the value of this investment varies, and/or current market conditions and are not an exact indicator. What you will get will vary depending on how the market performs and how long you keep the investment/product.

Key metrics for the W&W universe based on our 2024 estimates:

P/E	16.0x
Div. Yield	3.1%
EV/EBITDA	8.9x
FCF Yield	7.0% (c.14 years of cash flows for a perpetual story)
ND/EBITDA	1.1x
ROE	13.0%

Source: Regnan.

The outlook seems brighter than the market fears

Despite the strong rally in recent weeks, we remain cautiously optimistic for the rest of the year and positive on 2023/24. The tug of war between inflation and interest rates moves will continue to drive market direction. A definite fall in inflation and a dovish pivot from the central banks will be an inflection point for equities. As the impact of previous rate rises come into effect and Covid-related supply constraints dissipate, we should see inflation pressure come down. Till then, in our view, we expect volatility to continue in the short-term as the market will be vulnerable to hawkish surprises.

We also expect the market to move from cost of capital stress to growth assessment. The first half of 2022 was about absorbing inflationary pressure and higher cost of financing. This will have an impact on demand from H2 22. We believe the market has already priced some of this impact but current valuations have not yet reflected any significant growth weakness. The market still hasn’t quantified how much growth can be at risk into 2023. Even if we were to enter a recession, we believe it is likely to be mild as corporate and household balance sheets are not stretched and most importantly, banks are much better capitalised than the financial crisis.

Having mentioned that, we see strong upside potential in the strategy based on our bottom-up estimations. It is impossible to call the bottom of the market hence staying diversified and identifying opportunities based on bottom-up fundamentals is increasingly important.

Inflation vs interest rate by country from Q4 2021 to Q4 2023

Source: Bloomberg Contributor estimates as at August 2022.
Note: EZ: Eurozone.

Why invest in the Water and Waste theme? Regnan Sustainable Water and Waste Fund

Water and Waste is a tale of civilization and economic progress

Water is essential for life on earth and is a precious resource, yet is underappreciated and undervalued. It is used in nearly all forms of economic activity including food production, industrial manufacturing and energy production.

Put simply, ‘there is no economy without water’ yet ‘there is no sustainable economy without waste management’.

The waste sector offers an array of long-term secular growth opportunities as waste generation is expected to grow at double the rate of the global population by 2050.¹

Water and Waste have the same long-term structural drivers, offer the same solutions, and work well together from an investment perspective.

¹https://datatopics.worldbank.org/what-a-waste/trends_in_solid_waste_management.html

How much water does it take to make 1 cotton shirt?

94 Litres
494 Litres
1,494 Litres
2,494 Litres

Answer: it takes
2,494 Litres of water to make 1 cotton shirt!

Helped by these long-term structural drivers, water and waste companies have outperformed the broader market in the last c.15 years¹

These companies have historically demonstrated a solid up-down capture, showing resilience during down markets and rising with the market in a rallying environment.

¹Source: Bloomberg as at 31 December 2022.

How long does a foam cup take to decompose?

1 Year
5 Years
10 Years
50 Years

Given the themes’ perpetual nature, investors are increasingly seeing water and waste as a long-term investment opportunity.

Water & Waste indices vs. MSCI All Country World Index
(Net total return)

Source: Bloomberg 19 July 2022. Waste Index represents BNP Paribas Global Waste Management Total Return Index USD, Water Index represents S&P Gb Water USD Net Total Return Index. All Indices in USD.

We believe equities in
this area offer highly visible and stable earnings and are backed by a positive regulatory and corporate environment.

Answer: it takes 50 years for a foam cup to decompose!

Why invest in our strategy? Regnan Sustainable Water and Waste Fund

The Regnan Water and Waste Strategy combines the best opportunities from the water and waste value chains.

The Fund aims to generate long-term outperformance by investing in the listed shares of sustainable companies that provide solutions to global water and/or waste related challenges.
An actively managed, high conviction, diversified portfolio with an ESG integrated process enhanced by Regnan’s proprietary ratings and engagement framework.
The team are pioneers in combining exposure to both water and waste value chains, including companies developing new technologies; this means extremely low overlap with global equity portfolios.
Benchmark: MSCI AC World Index
The use of the Index does not limit the investment decisions of the fund manager therefore the shareholdings of the Fund may differ significantly from those of the Index.
Please see the here for further details on this Fund’s sustainable objective
Please refer to the Prospectus/KIID for further information.

1. The complementary
power of water and waste integration

The combination of both water and waste themes is a differentiated proposition, and one that our investment team have pioneered. When combined, water and waste companies provide unique diversification characteristics.

2. Proven process

The team have managed strategies in this space for 8 years with a proven, robust and replicable investment process. They aim to build a high conviction portfolio with unique characteristics and extremely low overlap with global equity portfolios – providing much needed diversification away from widely held sectors such as technology, communication services, healthcare, financials and energy, whilst also offering diversification within the sustainable space (which till now has been predominantly focused on decarbonisation).

3. Portfolio purity and research

A clear focus on thematic purity ensures that all stocks in the portfolio are exposed to the water and waste theme. All stocks undergo detailed fundamental and sustainability due diligence, and the distinctive investment process enables live benchmarking of the universe in an area which remains under-researched.

The Team Regnan Sustainable Water and Waste Fund

Bertrand Lecourt

Senior Fund Manager, Head of Thematic Investments Strategies

Bertrand leads the Thematic Investing strategy at Regnan. He is a Senior Fund Manager on the Regnan Sustainable Water and Waste strategy. Previously he was a Portfolio Manager at Fidelity International, where he launched and managed the Fidelity Funds - Sustainable Water & Waste Fund. Prior to joining Fidelity International in 2018, Bertrand was a Portfolio Manager at Polar Capital and the founder and CIO of Aquilys Investment Management. Before moving to the buyside, Bertrand was Head of Equity Research, France at Deutsche Bank and a utilities analyst at Dresdner Kleinwort Benson and Goldman Sachs. He holds an MSc in International Finance from HEC School of Management, France, an MSc in Money, Banking and Finance from Birmingham University, UK, and a DEA in Monetary Economics from Orleans University, France.

Saurabh Sharma, CFA, CAIA

Fund Manager

Saurabh is part of the Thematic Investing strategy at Regnan. He is a Fund Manager on the Regnan Sustainable Water and Waste strategy. Previously, he was an Assistant Portfolio Manager on the Fidelity Sustainable Water & Waste strategy and an Investment Director in Fidelity’s equity team. Prior to joining Fidelity in 2014, he worked as an equity research analyst for Moody’s Analytics (erst Copal Amba) from 2011 to 2014 and for Global Data from 2010 to 2011. He has an MBA in Finance from IBS, Hyderabad, India, and holds a CFA (ICFAI) degree. In addition, he is a CFA and CAIA charter holder.

Disclaimer Regnan Sustainable Water and Waste Fund

Disclaimer

Professional investors only.

Issued and approved in the UK by J O Hambro Capital Management Limited (“JOHCML”) which is authorised and regulated by the Financial Conduct Authority. Registered office: Level 3, 1 St James’s Market, London SW1Y 4AH. Issued in the European Union by JOHCM Funds (Ireland) Limited (“JOHCMI”) which is authorised by the Central Bank of Ireland. Registered office: 24 Fitzwilliam Place, Dublin 2, D02 T296, Ireland.

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This is a marketing communication. Please refer to the fund prospectus and to the KIID before making any final investment decisions. These documents are available in English at www.johcm. com, and available from JOHCMI, or for UK investors JOHCML, at the addresses set out above.

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Regnan is the specialist sustainable and impact investing brand of the Australian-listed asset manager Pendal Group, which encompasses J O Hambro Capital Management, Thompson, Siegel & Walmsley and Pendal Australia. Regnan’s focus is on delivering innovative solutions for sustainable and impact investment, leaning on over 20 years of experience at the frontier of responsible investment. “Regnan” is a registered trademark of Pendal.

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Alongside the investment team is the Regnan Insight and Advisory Centre of Pendal Institutional Limited in Australia, which has a long history of providing engagement and advisory services on environmental, social and governance issues. While the investment management team will often draw on services from and collaborate with the Regnan Insight and Advisory Centre, they remain independent of the Regnan Insight and Advisory Centre and are solely responsible for the investment management of the Regnan Sustainable Water and Waste strategy.

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