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Australian Financial Review

April 22, 2024

Top fundies list reveals turnaround for ESG, mid-cap investors


Joshua Peach

Investors who identified the increased power intensity of data centres in an AI-enabled world claimed the best returns last quarter by capitalising on one of the biggest themes shaping the sharemarket in 2024: decarbonising technology.

Returns for small-cap and environmentally conscious investment funds outpaced many of their peers in the first three months of the year, in a promising sign for two strategies that suffered throughout much of 2023.

Data covering more than 2000 Australian investment funds – compiled by Morningstar – has crowned Munro Climate Change Leaders as the best-returning equity fund of the quarter, racking up a 33.8 per cent return in the first quarter of the year.

James Tsinidis, at Munro Partners, is one of the co-leads on the Climate Leaders fund, which posted big returns. Eamon Gallagher

The fund outran Munro Partner’s Concentrated Global Growth Fund, which rode big tech exposures in Nvidia and Microsoft to post stellar returns through much of last year.

According to the Climate Leaders fund’s co-lead manager James Tsinidis, the fund aims to invest in “enablers of decarbonisation of the planet”, many of which had emerged from the February reporting season on a strong footing.

“While there have been some worries that higher interest rates would slow growth, most of the US decarbonisation enablers aren’t seeing any issues,” he said, adding that the shift in sentiment towards nuclear power this year has been the biggest surprise.

That has helped Munro’s holding in US nuclear fleet operator Constellation Energy, which the fund has owned since the stock spun out from Exelon Energy in 2022.

“The rationale for that originally was the need for reliable, clean baseload power, as the grid became more intermittent with more solar and wind,” said Mr Tsinidis.

Power-hungry data centres

An increasing demand for data centres had helped many of the Climate Leaders fund’s energy-related holdings – a theme Mr Tsinidis expects to continue over the next year.

“Data centres are now responsible for 2.5 per cent of total global emissions. This is more than the estimated contribution of the airline industry and, given AI-fuelled growth, risks becoming a bigger contributor to global warming over time,” he said.

“We are starting to look again at some of the solar and wind companies that we sold out of in 2022,” added Mr Tsinidis. “We do think some of the solar plus storage names look good, and the wind companies look better now, as they have been cleaning up their supply chain issues and working through legacy pre-COVID contracts.”

That said, the fund manager was still cautious on the electric vehicle industry, primarily because of oversupply from Chinese suppliers causing a glut.

Munro Partners wasn’t the only fund manager to chart strong returns from its ESG offering. It was a similar case for the ESG-focused team at Acadian’s Geared Sustainable Global Equity Fund, which also recorded a return of more than 30 per cent in the first quarter and was buoyed by bets on Microsoft, Nvidia and Amazon.

The strong performance arrives after a difficult couple years for ESG-themed investing, which went through a period of broad underperformance punctuated by strong outflows from investors in 2023.

Munro's Mr Tsinidis said the last few years had been hard on the sector.

“The rapid rise in interest rates throughout 2022 and the first half of 2023 led to a sharp decline for many companies in this universe. Furthermore, they were impacted by higher levels of competition in an ultra-low cost of capital environment,” he said.

“Since 2022, even many of the profitable climate-related companies witnessed substantial declines in their share price. But as rates have peaked and less mature competitors have fallen away, many of these companies with strong industry positions and sound balance sheets look better positioned.”

Small caps, big returns

Likewise, global and Australian-listed small-caps had largely lagged their larger-cap peers in the last few years, unable to match sustained rallies from big tech that have driven returns for larger-cap funds.

However, it was precisely these kinds of smaller-company bets that drove Pengana’s High Conviction Fund to a 32.1 per cent return in the first quarter. While the small- and mid-cap fund is free to invest globally, much of it is centred on Australian-listed companies, according to co-leads Jeremy Bendeich and James McDonald.

“All the holdings are internationally focused, but 75 per cent of them have an Australian domicile and 50 per cent are listed in Australia,” Mr McDonald said.

He added that the strong returns were a welcome sight after a difficult period for the global small- and mid-cap market.

Jeremy Bendeich (left) and fellow Pengana portfolio manager James McDonald rode ASX small caps to big returns in the first quarter of 2024. Peter Rae

“It’s been tough with rates rising – 2021 and 2022 was a pretty tough period for the fund, particularly small healthcare stocks. The biotech index in the US was absolutely decimated,” he said.

“Small and mid-caps have had it tough, but there’s been opportunities to find great bargains as a result.”

Mr McDonald said many of the fund’s smaller-cap ASX-listed health and biotech companies helped drive returns in the first quarter, including Clarity Pharmaceuticals and Genetic Signatures. He also noted an early holding in Telix Pharmaceutics had been a strong driver for returns since early in the fund’s inception.

“I like the fundamentals of healthcare. We’ve got an ageing society so healthcare spending is going to rise. At the same time, there’s a lot of technology differentiation that allows you to find great opportunities,” he said.

Beyond health stocks, Mr McDonald said some of the fund’s larger commodity-exposed holdings had benefited from the recent step-up in geopolitical tension around the globe.

Those included ASX-listed titanium tech developer IperionX and Gina Rinehart-backed Brazilian Rare Earths.

“With the issue of China dominating rare earths supply, there’s a great pressure to bring that production and supply chain back to the West, meaning Brazilian Rare Earths may actually benefit from geopolitical instability,” he said, adding that IperionX’s titanium technology was benefitting from efforts by the US to “near-shore” the supply chain.

Likewise, Ausbil’s Microcap fund – helmed by Andrew Peros and Arden Jennings – was the best-performing long-only Australian equity fund, while Regal’s Atlantic Absolute Return long-short strategy was the best-performer among hedge funds, returning 18.8 per cent and 22.1 per cent respectively.

Ausbil Portfolio Managers Arden Jennings (left) and Andrew Peros had big bets on retail going into reporting season. Dominic Lorrimer

Mr Peros said many of the fund’s ASX-listed retailers – including discount jewellery chain Lovisa – had come out of reporting season in a surprisingly strong position.

“We actually made a lot of money out of retail, despite the market being extremely bearish,” he said. “The concerns were really premised around cost of living pressures that still haven’t eventuated, so we really went against the herd and went long on retail quite early on – it’s certainly paid dividends.”

Beyond retailers, Mr Peros and Mr Jennings said the fund’s holding in family monitoring platform Life360 – which is up more than 70 per cent since the start of the year – had been a strong performer for the fund.

“The journey has only just begun for that company,” Mr Peros said.

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