PARTICIPANTS
Daniel Yungblut
Guest Host, Vice President & Head of Research, Chair of ESG Investment Committee
Eric Mencke
Vice President & Portfolio Manager
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Dan: Thank you for joining. I'm Dan Yungblut, Head of Research at Dynamic. Also, I Chair our ESG Investment Committee and help lead a lot of our ESG initiatives on sustainability. I'm here with lead Portfolio Manager of the Dynamic Sustainable Equity Fund, Eric Mencke. Eric is a VP and Portfolio Manager from our value equity team. That team oversees over 7.5 billion across North American equity and balance mandates. The Sustainable Equity Fund is part of a suite of mandates at Dynamic, that are focused on certain key sustainability themes, and we think offer unique value proposition.
We're looking forward to having Eric articulate his approach to sustainable investing today. Off the top, we wanted to address some of the negative narrative in the media around ESG and greenwashing. From our perspective, a lot of the backlash right now is actually appropriately calling out questionable practices, where certain asset managers, we think we're misrepresenting or probably overpromising on the ESG attributes of their investments. We think responsible investing is here to stay. The negative backlash is just the current reckoning, and it's healthy, and just part of maturing for the industry.
From the start at Dynamic, we've been conservative in our language around our approach to sustainable investing. We can't be all things to all people. As a fundamental active manager, we can research, identify companies we think will help solve some of the society's challenges around sustainability, and also generate strong profits while doing that. That's what we do well, and so that's our focus. With that, Eric, let's get into your approach in more detail. As a bottom-up fundamental investor, can you explain the benefits of taking an active approach to sustainable investing?
Eric: From our perspective, a lot of ESG products out there take what we consider as a passive approach, where they either one, mechanically exclude entire sectors or two, they're just going to buy the companies with the highest ESG scores. We don't believe either one of those approaches is effective in allocating capital to help solve the key challenges to society or deliver outside performance for our clients. We would argue that for one, ESG scores from rating agencies are static, they're backward looking. They do a poor job of identifying companies that are transforming, or improving, or making real change.
On top of that, if you just focus on the best ESG scores, you really end up, one, into a crowded trade and second, it ends up with a poor risk return dynamic. Lastly, you end up looking like the index. We're trying to do something different. When we've talked to our clients over the last number of years, one of the biggest pushbacks we've heard from them is that they've had a hard time in investing in sustainable products because they've been very ambiguous about their approach, and they weren't very straightforward on what they were investing in. What we are doing with our product is being fully transparent on how we're investing in sustainability.
It's in our offering documents. Our idea is we're using our bottom-up process using fundamental research, and then layering on a lens that focuses on five key sustainable themes that we believe are bringing or are going to drive key societal changes going forward. We think that using our bottom-up process, we can find a diversified group of businesses because we're using those five themes that can be a very broad group of companies.
We're not going to just end up in one or two themes or ideas. That way, we're able to provide diversification, and also find the leaders enablers in improving stories within sustainability, and generate attractive risk return for our clients as opposed to our competitors out there that are just blindly buying the index.
Dan: I mentioned, we can't be all things to all people, and you touched on some of these sustainability themes. Let's dive into that a bit more. Using that fundamental approach, what are some of the key themes that we're focusing on to drive our investment focus?
Eric: We're not relying on mechanical exclusions, what we're really wanting to do is focus on positive inclusions. We're going to use our fundamental analysis to identify companies that fit into five sustainable themes. Those themes we're inspired by the UN Sustainable Development Goals. Within these themes, what they're doing is they're doing well financially, but they're also making progress on key societal challenges. That allows us to align performance with positive outcomes for society. What we'll do is we'll break them down into the five buckets. The first one is sustainable energy generation.
In that area, think about renewable power. It could be solar, wind, onshore or offshore, battery backup power, or other innovative sources of power like hydrogen. Bucket two, efficient consumption of energy. In this bucket, think about electric vehicles or industrial companies that are upgrading and improving their infrastructure to drive efficiency or improve energy efficiency. Three, responsible consumption. Here, thinking about waste management companies that are building state-of-the-art recycling infrastructure or consumer companies that are re-engineering their products to reduce full cycle waste.
The fourth bucket, we have sustainable infrastructure. Think about telecom or cable infrastructure companies that are creating these networks, and these networks are facilitating smart technologies that are enabling us to have better, more efficient communities as well as homes. Then lastly, good health and wellbeing. Think of healthcare companies that are improving healthcare outcomes for patients, but also companies that are contributing to improving yield and the quality of our food supply. Being diversified manages the risk, but also enables us to find a good group of businesses to drive performance, which we think is a huge advantage in our approach over other passive products.
Dan: You talked about your fundamental bottom-up approach, but it's also important to mention that you do manage some other non-sustainable mandates where we don't necessarily focus on sustainability. How do you differentiate your investment process or define it for traditional versus your more sustainable focused mandates?
Eric: The process on how we go about investing in the sustainable fund is no different than how we do on our other traditional mandates. The only extra layer is we're using that lens of the five sustainable themes to narrow that pool of companies that we're looking at. We're a team of five. We invested about 7 1/2 billion of AUM in North American equities. We've worked together for about better part of 20 years. We've invested through a variety of different business cycles, and all the while we've adhered to an investment discipline that really comes down to a couple of basic rules.
One, we only invest in good companies. These are leaders in their industry, high barriers to entry that enable them to grow over the long run and generate healthy free cash flow. Two, we only invest with management teams we trust. We want management teams that have their own capital at risk in the business and who have a track record of generating shareholder value. Three, we avoid bad balance sheets as we want companies to have the maximum financial flexibility to make good long-term decisions regardless of the market environment. Lastly, we want to buy these businesses at attractive prices. We want to buy them for less than their worth, which provides us a margin of safety.
It's quality first, valuation second, but our investment process is just the first step. Now, you need to ensure that the business fits in because we want to make sure our portfolio is diversified by both idea and sector. Ideally, the best way to build a portfolio is to have a unique set of ideas, but you have to be careful of concentration risk. That is particularly important when you're talking about a fund like this. A lot of times you can get caught up in what you think might be a diversified portfolio, but they end up keying in on one or two ideas. We're really looking at providing a diversified group of businesses.
To conclude on the process, it's a high-quality bias when it comes to the businesses, concentrated portfolios, but again, diversified across sectors, no binary outcomes. Really focused on balance sheets, and really what we're trying to target is a sleep ignite experience for our unit holders. To emphasize that last point is, every name that's in a sustainable fund is a name that I've owned at one point or another in my other North American mandates over the last two to three years. I think that reiterates the point that our bottom-up quality focus with an emphasis on management teams lends well to looking for sustainable businesses. I think the key part to that is the management teams.
Management teams are the ones that are making the capital allocation decisions on these companies. The smart management teams are the ones that are looking out three to five years and going, "Okay, how can we grow and where are the risks?" In both circumstances, those management teams are realizing that investing in sustainability is one, can be a growth opportunity, but also, it also reduces their risk because if you ignore sustainability, it can be a long-term business risk to businesses.
Dan: Let's make it real. Can you share some examples of companies that you think fit into the themes and can also make money while doing it?
Eric: Absolutely. The first one is Republic Services. It's the company that comes by your place, your house once every week or two to pick up your garbage and your recycling. What's interesting about this business is this management team decided a couple of years ago to invest in plastic recycling. That's part of the byproduct that they pick up at your home. For a long period of time, it was like a loss leader that when you took the contract with your municipality for the waste, you had to take the recycling part of the business with it.
It wasn't this high margin, and they got a lot of grief from their investors on, "Why were you investing in waste recycling infrastructure for plastic when the returns were less?" Their view was, "There is going to be a growth opportunity here and we're getting ahead of it." Sure enough, where we are today, consumer product companies, I'll use Coke as an example, have set out aggressive targets to have all of their products packaged in recycling packaging by a certain period of time. For Coke, it's 2025. All of a sudden, the demand for plastic recycling or recycled plastic has exploded. Now, it's ideal for Republic in the sense that one, they've been investing in this, so they have the facilities in place, but also they're the second-largest collector of plastic, so they actually have the feed source as well. They've even escalated their investments, and are building four new plants, those plants are now sold out.
This is driving change in the organization in the sense that all of a sudden, a business that people thought was going to be a drag is actually growing faster than the rest of the business, and it's generating returns that are far superior to other parts of the business. It's improved the return profile of this company going forward, and from a business that for a long period of time, people thought was going to be in secular decline. The second example is Echolabs. This is a specialty chemical company. They're a global leader in water, hygiene, infection prevention solutions.
They were really a key supplier to almost everyone during the pandemic. If it was a hospital, a school, a train station, an airport, a corporation, these are the individuals that provided the services that kept the workers safe and the customers safe. What they provide is they have a comprehensive solution that provides advanced food safety, they maintain clean and safe working environments, they optimize water and energy use, and then really improve the operational efficiencies, and sustainability for their customers around the world. I really can put them in the pocket of being a leader in sustainability.
Then the last example is a little bit more unique, and not as well-known as Carlyle Group. They're a diversified industrial company and they focus on roofing products. There are two aspects to this, and they fit into bucket two of what I talked about are those five themes, which is energy efficiency. What they've done is they've done things both internally, as well as what their product does. Internally, they've gone out and they are upgrading all their buildings to a new environmental standard when it comes to building management systems. Essentially, a big focus on water management, power management, just efficiency in the building, waste in the building.
They are upgrading all their facilities, and that will be done in 2025. In addition, they're upgrading their entire fleet of vehicles, cars, and trucks to electric vehicles. Internally, their infrastructure inside the business, both their manufacturing side, operation side, they're making that more energy efficient. Then on top of that, their main product is a commercial roofing product. They're one of the leaders in this area.
One of the key things here is one of the biggest emitters of CO2 emissions is from HVAC, either heating or cooling coming from commercial buildings. Buildings that either install a new roof or actually replace the roof on their commercial buildings, Carlyle's product significantly improves the energy efficiency within the building when it comes to heating or cooling. That would be three examples I would touch upon.
Dan: What makes you most optimistic when it comes to sustainable investing and sustainable economy, given some of the negative narrative out there?
Eric: Really what makes me most optimistic is just seeing the sea change that's occurred in corporations in North America over the last number of years. We started the ESG Committee five to seven years ago. We started initiating conversations with corporations back then. It wasn't on their radar, it wasn't something they were really addressing, and that's something much different because in Europe, it was very top of the mind. All to say is if we go back five or seven years ago to where we are now, there's been a massive sea change. Every company we talk to now in North America is aware of sustainability, they have a plan.
Most of them have a sustainable report that's on their website that spells out what they're doing, their targets. They've hired a chief sustainable officer that is focusing on those initiatives, keeping track of those targets, going out and messaging, they're finding initiatives to actually make the business more sustainable. I don't think this is virtual signaling in the sense that these companies are putting real capital behind this because they realize that longer term, not addressing this is a business risk, and behaviors need to change.
I think what we're doing with this product, and our ability to look at those five themes, we're able to make it broad enough that we're able to come out and find those leading businesses, or enablers, or improving businesses that are driving sustainability, that give us the ability to be diversified, but also find our performance, like I use the example of Republic, where they actually had a plan in place. That's resulted in outsized returns for their investors because they thought about sustainability in their business plan.
For us, looking out on this point is that we've talked about those five themes being very impactful for society. Many of those issues relate to the environment. It's going to require positive action by every industry. While we might be in the early stages here in North America on that, I've seen real progress across multiple industries when it comes to addressing sustainability. That's probably what makes me most optimistic about this for the future.
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Dan: Thanks Eric. Look, it's a great overview of why we think our active fundamental approach adds value, but also allows us to build a diversified portfolio. Thank you for listening today.
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