With a long-standing philosophy of environmental, social, and governance (ESG) factors, the four-star, Bronze-rated Leith Wheeler Carbon Canadian Equity mandate offers investors zero exposure to the energy sector. By comparison, the S&P/TSX 60 Fossil Fuel Free Index has almost a 10% weighting in energy.
“Some of our clients,” says Richard Liley, a member of the investment team, “wanted a negative screen in funding the fossil-fuel industry. As a result, we decided to screen and exclude companies that derive more than 30% of their revenues from fossil fuel-related activities.” Liley is a senior analyst and portfolio manager at the independent Vancouver-based Leith Wheeler Investment Counsel Ltd., which is 100% employee owned.
Those exclusions include investments that own fossil fuel reserves, such as oil and gas producers, refiners and coal producers, pipelines, and some utility companies. “It seems a bit odd that the benchmark and some of our competitors in that space would include those investments,” says Liley.
Can’t Ignore ESG
The actively-managed approach follows the same philosophy and process as the core Canadian equity strategy. That process is based on bottom-up fundamental analysis with ESG factors integrated into stock analysis.
The team of five, including Liley, define themselves as analysts and a team of equals. During the research process, the universe of available stocks is divided into sectors. As value-based investors, with a long-term investment horizon, an emphasis on understanding the qualitative factors of management is essential.
Liley says that anyone who wants to invest in a business for 10-plus years, some for more than 20 years, needs to factor in ESG issues. “If you’re not considering all the potential risks in a business, including what would now be categorized as ESG, then you’re not doing your job,” he adds.
For investors considering the mandate, making the decision to not invest in the fossil-fuel industry may have an impact on returns. “Any time you reduce your set of opportunities you have to realize that it could, but doesn’t necessarily have to, reduce the potential return. That would be the trade-off an investor in this fund willing to make the decision to reduce the carbon footprint,” Liley explains.
‘Value’ is defined as finding companies trading at a discount to their intrinsic value, including the assessed value of future growth, discounted value, future cash flow and other forecasts. Liley says the approach is more like veteran investor Warren Buffett than deep-discount managers.
Fund Favours Financials
The fund, launched in September 2017, has an approximate 43% weighting in financials and 20% in industrials. “We really like the financials” says Liley. “We think the banks, for instance, tend to be inexpensive, they’re very diversified, and despite concerns around their balance sheets, can manage through downturns.” In the industrial sector, the team has found great businesses that produce great returns.
The mandate is concentrated in approximately 36 holdings in higher-quality businesses that are highly likely to survive and prosper over time. During the COVID-19 crisis, diligent research was done to protect the portfolio, paying a lot of attention to balance sheets. Liley says the impact on the fund was not as bad as expected and that government supports helped in some of the areas.
Canadian Stocks with an ESG Bent
“We made one fortuitous decision as the crisis started,” says Liley, “we sold all our shares in theatre operator, Cineplex (CGX).” What also helped going through the crisis was having no exposure in the travel sector.
Other initiatives included adding exposure to some companies with very clean balance sheets, as well as looking for opportunities in businesses that they thought were unfairly hit. Spin Master Corp. (TOY), a children’s entertainment company, added to the fund is one such example. “The stock, quickly went up by two-and-a-half times, validating our observations that this was unfairly hit,” Liley says. The company has a strong net cash balance sheet and when the stock quickly bounced back, some of the stock was sold.
An example of an investment, held for more than 20 years, is the top holding, Toromont Industries Ltd. (TIH), a Canadian industrial company and Caterpillar equipment dealership. “It’s a business that has the advantage of a franchise operation in their territory, with that competitive advantage, but it’s just so fantastically and efficiently run.” The company is also favoured for the recent acquisition of a Quebec Caterpillar dealer, raising their margins and returns on capital.
The holding, Sleep Country Canada (SCCAF), is another example of the long-term strategy. “It bought the largest online mattress seller in Canada,” says Liley, “It paid a very attractive price, and the company has done nothing but grow ever since.” Their competitors have been getting weaker, and the other big competitors are not focused on the category or stock supplies. “I think it’s a business that occupies a very strong position in the Canadian market, with great returns, and is still building its share,” he adds.
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