Danaher, Thermo Fisher, Xylem

industry, alongside long-standing trends towards greater outsourcing. As such, Danaher and Thermo Fisher are two of the top names that help healthcare companies to research, develop and commercialise products across a wide range of end-markets. Both are geared to traditional spending as well as promising future markets (including cell and gene therapies, for example). We believe that both companies can grow annual revenues in the mid-to-high single digit range over the medium to long term, underpinned by excellent commercial execution and the aforementioned secular growth in healthcare R&D.

Splashing out

Within our “Sustainable Infrastructure” theme, the case for investment in water is quite simple: it is the finite, essential resource needed to sustain life. Further, the world needs to secure greater access to it in a useable, clean state in the face of some persistent, growing challenges. Water demand is being driven by a rising global population, coupled with climate change and the associated variability in weather patterns. In developed markets, ageing infrastructure presents a significant barrier to overcoming these issues. Across the US, for example, it is estimated that the national average age of pipes has risen from 25 to 45 years between 1970 and 2020, largely as a result of underinvestment. Creaking infrastructure not only leads to greater leakage and pollution, it is also less efficient and more costly to run than its upgraded equivalent. In emerging markets, meanwhile, water infrastructure is still non-existent in some countries and regions. The UN estimates that over four billion people lack access to basic sanitation, whilst over two billion are deprived of safely managed drinking water. Gaps in regulation around pollution, combined with a lack of adherence to existing ones, further complicate the picture. Against such a backdrop, spending on water technology must continue to grow steadily over the coming decade, to improve existing infrastructure and meet these growing challenges. This combination of solutions is what our favoured water technology companies are all about.

Biden time

However, there is also the potential for a significant separate boost in spending across developed markets from the $110bn earmarked for water infrastructure as part of President Biden’s $1.9tn proposed government spending plans. Our approach to this is nonetheless conservative – whilst we have confidence in the eventual increase in spending needed, there can be no certainty about its timing and extent beyond the headlines. Despite a growing awareness of environmental and regulatory issues, several decades of underinvestment have already passed, increasing our reluctance to assume that this time will be any different. So, rather than baking a significant step-up in spending into our forecasts, we prefer to remain circumspect. Should a significant new infrastructure replacement programme materialise in the medium term, this will likely boost our investment case. If not, the challenges facing this crucial industry will remain. Our thematic work suggests the sector will generate attractive opportunities for investors regardless. For now, our favoured way to invest is via Xylem, the world’s largest pureplay water company. With a product range spanning pumps, meters and treatment, plus data and analytics, it is geared to the replacement and upgrade cycle in hardware (mainly pumps), as well as the newest and smartest connected solutions aimed at reducing waste and improving asset efficiency. For more information on any of the companies mentioned in this note, please contact your Investment Manager. ● Killik & Co Security Risk Ratings

All research recommendations are issued with a security-specific risk rating, represented by a number between 1 and 9. Assessing the relative risk of any security (specific risk) is highly subjective and may change over time. The Killik & Co Risk Rating system uses categories which are intended as guidelines to the specific risks involved, as follows:

1. Restricted Lower Risk Securities in this category are what we believe to be lower risk investments such as cash, cash equivalents and short dated gilts, and the collective investment vehicles that invest in those instruments.

2-3. Restricted Medium Risk Securities in this category are what we believe to be medium and lower risk investments including medium and long-dated gilts, investment grade bonds and certain collective investment vehicles investing predominantly in these securities.

4-9. Unrestricted Securities in this category are what we believe to be higher risk and are drawn from across the United Kingdom and international markets. These are normally direct equity investment and collective investment vehicles which predominantly hold securities other than investment grade bonds and money market instruments. The vast majority of the Killik & Co Research recommendations are likely to fall in the unrestricted/ higher risk category (4-9) above.

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Gordon analyses the growth of “Responsible Investing” and flags some of the key considerations for fund investors.

Over the last few years, we have seen a marked increase in the formal adoption of Responsible Investment practices across the asset management industry. Fund flows into this area have been correspondingly significant, with a notable growth in the range of strategies being deployed right across the spectrum. This reflects the fact that more and more investors are seeking to either exclude less ethical areas of the market from their portfolios, or to increase their exposure to important thematic trends such as renewable energy, water sustainability and natural resource efficiency. The overall direction of travel is clear from the growing list of signatories to the UN Principles for Responsible Investment (see chart). In 2020, the number of global asset managers signed up to the principles set down by this independent body rose above 3,000, which represents over $100trn of assets worldwide. By accepting them, money managers have shown a commitment to incorporating Environmental, Social and Governance (ESG) criteria into their investment processes and recognised that a range of non-financial factors are increasingly important in identifying opportunities and risks.

As such, this is no short-term fad. Indeed, we believe that ESG could benefit for some time from a rising share of investor fund flows. There are now clear reasons why businesses with better ESG credentials can generate stronger returns. Key amongst these is the fact that they are less likely to be targeted by regulatory policy as governments around the world tackle issues such as climate change, health and inequality. Further, investor expectations for more sustainable revenue streams from such businesses should support premium valuations.

Cleaning up

Gordon Smith

Head of Fund Research

Muddying the water

Unfortunately, the terminology used to define the various elements of Responsible Investment is rarely consistent. Meanwhile, the sheer breadth of the spectrum of activities encompassed by this sector can lead to confusion. For example, some fund strategies adopt a relatively light touch when it comes to negatively screening, or excluding, the less ethical industries, such as tobacco, adult entertainment and weapons manufacturing. Others will aim to favour those firms with better ESG credentials than their peers when it comes to portfolio construction. Moving up the spectrum, there are then fund strategies underpinned by more strongly positive investment choices, which focus on businesses that are actively addressing one or more of the sustainability challenges around the world. The sector also spans mandates with a focus on social impact and philanthropy, albeit they fall outside of the scope of our research. Against this backdrop, the recently implemented Sustainable Finance Disclosure Regulation seeks to enhance the sustainability-related disclosures made in relation to financial products such as funds. It also aims to formalise the two broad groups of Responsible Investment strategies mentioned above, as part of the European Commissions’ Action Plan on Sustainable Finance. Whilst the resulting framework does not impose any changes to the way products are managed, it requires products which have met certain ESG criteria with respect to their investment process or objectives to be classified as either “Article Eight” or “Article Nine” (with the remainder being “Article Six” or “Other”). The first category captures those which consider, or actively promote, environmental and social characteristics in the ultimate pursuit of financial objectives. The second focuses on those that seek to make a positive impact on society or the environment through sustainable investment and have non-financial objectives at the core of their offering.

Treading carefully

Helpful as this is, the sheer variety of strategies that fall within the Responsible Investment category means they nonetheless come with a wide dispersion of return and risk profiles. These need to be weighed up when adding funds to portfolios. Many of the ESG or ethical strategies (i.e. Article Eight funds), which implement “negative screening” through the investment process, can still maintain a broadly diversified exposure across most of the market. For example, a wide range of ESGscreened regional exchange traded funds are available on the Londonmarket. A comparison of their strategies with the relevant, more traditional, index trackers reveals a similar volatility profile. Meanwhile, those that have adopted a greater sustainability or impact-focused investment process (i.e. Article Nine funds) will usually differ more markedly when benchmarked in this way. That is because managers who target specific environmental themes tend to invest in smaller, less