Market Review

For the month overall, the MSCI World Index rose 1.9%.

December saw a continuation of the equity rally that began in November, fuelled by a shift in interest rate expectations following recent data showing inflation falling faster than expected in Western economies.

Interest rate-sensitive stocks, including small- to mid-cap and growth-oriented impact companies, outperformed during the month, as did some economically sensitive sectors such as semiconductors. The prospect of lower borrowing costs was also supportive for cleaner energy stocks, which tend to have growth characteristics.

Real Estate was the strongest sector over the month, followed by Industrials and Materials, while Energy remained weak, the only sector to post a negative return in the global market.

Fund Review

The fund delivered a strong return of 5.4% in December with positive contributions across sectors.

Resource Efficiency was the best performing theme over the month, with several names contributing positively to returns. The largest positive contributor was Ansys, the market leader in simulation software for product design and optimisation. There were reports that the company was an acquisition target. Silicon Labs, the semiconductor company, also performed well, as there was improving confidence on its medium-term outlook.

The Health and Environmental Services themes further helped performance, with positive contributions from names including CSL, Agilent and Thermo Fisher Scientific in the former, and Advanced Drainage Systems, TOMRA and Croda in the latter.

This was partly offset by poor performance of MSA Safety, a manufacturer and supplier of safety equipment for hazardous conditions. The share price suffered as defensive stocks fell out of favour. For the same reason, Education was the weakest theme over the month.

Outlook

Following the fall in inflation, sentiment in global equities is more positive with markets expecting that the central bank tightening phase is nearing its end. This environment should be more supportive for the generally smaller and more growth-orientated impact stocks we invest in. Our faith in the sustainability-led growth drivers and competitive advantages of the companies themselves is as strong as ever.

WHEB’s performance review of 2023

A positive but challenging year

2023 was ultimately a positive year overall for Fund, which returned 9.5%.

This final result masked a relatively high level of volatility, with the Fund hitting a peak of 15.2% in early August and trough of -4.4% in late October.

The path of this volatility matched broader equity markets where, as is often the case with short-term volatile periods, macroeconomic factors played a big part. Specifically, expectations around inflation and interest rates drove large swings in market sentiment.

This was most visible in the first half of the year when many investors expected global interest rates to start to decrease in early 2024 if not before. This supported equity markets in the first part of the year, as lower rates are generally thought to be good for equities.

By mid-year it became clear that this timetable was too ambitious, and equity markets sold off. Then, just as abruptly, confidence returned at the end of October as the US Federal Reserve signalled an end to the current rate-raising cycle prompting a rally into the end of the year.

The Fund’s benchmark, the MSCI World Index of stocks, had a stronger year than the Fund overall, returning 23.0%.  It also demonstrated less volatility than the Fund falling only 3.5% between August and October, when the Fund lost -14.5%.  One reason for this was due to some of the popular characteristics of impact stocks.  In particular, their growth orientation, and their size.

Impact stocks favour growth markets

Impact stocks tend to be growth-orientated because the underlying companies are addressing growing markets. The need for sustainability solutions provides a multi-decade runway for expansion. This can mean that the stocks look more expensive relative to short-term earnings. It also means that they are more sensitive to changes in interest rates.

Impact stocks also tend to be smaller than most of the stocks included in the mainstream indices as they are focused on sustainability solutions, rather than diversified into broad sectors. Some sustainability sectors are large and support large businesses, but most are smaller, but growing faster.

In combination, our portfolio is made up of medium-sized, growth-orientated companies which are quite sensitive to interest rate expectations. This made 2023 a difficult and volatile year for many of our stocks.

A market dominated by the “Magnificent Seven”

In addition, recent years have been especially difficult for a lot of global equity strategies, due to the strong performance of a small number of very large stocks. These so-called “Magnificent Seven” are very large US technology stocks that now dominate global equity markets (and the benchmark). As we have often communicated, we don’t consider them to offer sustainability solutions. Amongst them, only Tesla qualifies for our impact universe.

In aggregate, these companies had a strong performance in 2023 and their success helped the benchmark to return ahead of the Fund. Looking ahead, this concentration trend may well reverse, as stock markets have never before been so concentrated.

Beyond these shorter-term market headwinds, there were also some fundamental challenges to impact investing in 2023.

Current challenges to impact investing

Most visible was the political resistance to the climate change transition. Populist governments around the world painted decarbonisation as expensive and unfair. They rolled back regulations and removed policy support for green technologies. Rising interest rates also made the installation of renewables more expensive.

This hit some of our investments in our Cleaner Energy theme, such as SolarEdge and Enphase. But it also provided a broad headwind to most of our environmental themes. For example, the slowing phase-out of petrol cars was a problem for our Sustainable Transport theme. This included Aptiv, which specialises in the electrification of vehicles.

Unusually, these shorter-term headwinds in Environmental themes were matched simultaneously in the Social themes. Environmental markets are generally more economically sensitive than social ones, so the two parts of the investment strategy often tend to provide a good balance: when environmental markets are challenged by the economic cycle, the social themes have provided more defensive characteristics.

However, 2023 was notable because our largest social theme, Health, also faced strong headwinds. The pace of pharmaceutical innovation slowed as capital for early-stage research dried up. Three core investments in the life sciences tools sector are Danaher, Agilent and Thermo Fisher and all three had a difficult year as demand slowed.

The long tail of COVID disruption also played out into 2023 in healthcare systems around the world. This created challenges, for example, for the Fund’s Australian plasma specialist CSL.

Opportunities remain within testing climates

Against these headwinds, there were still some impact investment themes that prospered. One notable strong thematic area was climate change adaptation. While the political response to climate change has struggled to make progress, global temperatures continue to rise with extreme and erratic weather events becoming more commonplace.

Companies helping communities to adapt to these new conditions saw increasing demand. This included Advanced Drainage Systems, which makes flood management solutions, and efficient cooling systems maker Trane Technologies. Engineering firm Arcadis also enjoyed a growing market for its adaptation advice.

Adaptation will continue to be an important area for the Fund, but the primary emphasis remains on climate mitigation. Despite the challenges of 2023, many of the key debates in this area are now settled, and the path forward is clear.  Similarly, although the pace of healthcare innovation has temporarily slowed, the long-term push to find new and better treatments is unchanged.   We will continue to invest in high quality companies which can capture these durable long term trends.