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 that 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.
