MARKET REVIEW
2024 was once again a special year. Firstly, the fight against inflation has been won, with elevated rates not leading to a recession, but deeply inverted yield curves and other traditional indicators have been poor – worrying signals for investors. Secondly, inflation fell without a material slowdown in growth, allowing for the initiation of a rate normalisation process, in turn supporting activity levels. Thirdly, economic divergences have increased – while the US has been powering ahead against expectations, China has faced ongoing challenges in relaunching its growth trajectory and dealing with its real estate and domestic demand issues; Europe is being cyclically pulled down by Germany and France, while the so-called PIGS are in great relative shape; and, finally, Japan is emerging from a decades-long economic torpor.
As the final quarter of 2024 began, the stock market bounced back from a late-summer dip and continued to reach new record highs. However, in late December, equity markets experienced a brief setback when the Federal Reserve indicated fewer rate cuts for 2025. Despite this, stocks still ended the year on a strong note overall.
On the equity front, it was again a tough year for active managers. Investors, fearful of recession, continued to focus mostly on a narrower set of large-cap companies with an a-cyclical dynamic and continued earnings growth powered by digitalisation. Interestingly, the MSCI World SMID Cap Index, the strategy's reference index, outperformed the MSCI World EqualWeight Index, illustrating the disproportionate attraction of flows towards mega-caps.
PERFORMANCE COMMENT
Despite outperforming in December, the Circular Economy strategy lagged behind its reference index (MSCI World SMID) in 2024. Approximately half of this underperformance was due to our thematic biases. For instance, we are structurally absent from Financials, the strongest sector since launch, and traditional Energy, while being structurally biased towards certain types of Materials, Industrials and Utilities. Additionally, negative stock selection within our thematic universe contributed to the rest of the underperformance. The headwinds were spread across multiple sub-themes and stocks, as cyclical concerns impacted share price performances.
Among the worst performers were our semiconductor holdings (BE Semi and SOITEC), which suffered from the prolonged electronics downturn. SEB, a leading circular domestic appliance brand, faced headwinds with Chinese and European consumers and in certain segments (e.g., professional coffee). Stora Enso’s share price declined due to an extended negative cycle in demand for pulp, mainly due to weak consumption in China coupled with growing global supply. The largest detractor, Darling Ingredients, a US producer of biodiesel from waste, suffered mostly from concerns about green policies under the Trump administration. These detractors were not sufficiently offset by positive contributors, despite strong performances from companies like Heidelberg, which benefited from structural tailwinds in sustainable cement; Smurfit Westrock, which saw a re-rating post-merger towards an appropriate valuation as a sustainable packaging provider; and Republic Services, which benefited from the shift in the US from waste disposal to resource recovery.
Zooming in on Q4 2024, the Fund’s relative performance was particularly weak, entirely driven by our thematic focus. Our biases towards Industrials, Materials and Utilities were impacted by rebounding US long-term rates, which benefited Financials, a sector from which we are absent. In Q4 2024, our main detractors were Advanced Drainage Systems, a leading US company in stormwater infrastructure solutions using recycled plastics; Andritz, an industrial manufacturer of equipment for the Pulp & Paper and Environment and Energy sectors; and Tetra Tech, a leading water solutions company. Our top contributors were Heidelberg Materials, Smurfit Westrock, Cadence Design, a provider of software for efficient electronic system design, and Descartes System, an inter-enterprise software provider for supply-chain management.
Despite lagging the market, we retained conviction in our investments, recognising the short duration of the sentiment pressures. With most of the stock-specific challenges occurring over the summer, the last quarter of the year particularly reflected our views, as the impact of thematic biases created headwinds that were offset by positive stock selection within the investable arena.
FUND ACTIVITY
During the year, we made several changes to our positions. We reshaped our Technology exposure by shifting towards strong trends in digitalising supply chains (Descartes, Kinaxis, Trimble, Daifuku) and fostering AI adoption (Cognex, BE Semiconductor). We concentrated our Materials exposure towards lower cyclicality by exiting Alcoa and Norsk Hydro, and strengthened our exposure to water technologies with new positions in Veralto, Ecolab, Kurita Water, and Beijing Enterprises. These changes reflect the accelerating innovation in circularity and resource efficiency solutions, often financed by relatively lower-conviction positions.
In the Q4 2024, we added positions in Trimble for digitalising industries, Brambles for circular distribution solutions, Guangdong for efficient water management, and Elis, a European leader in the shared economy for workwear. These additions were partially financed by exiting John Bean Tech, an animal processing equipment maker, and Weyerhauser, a forestry operator.
Our positioning aims to balance strong quality in defensive businesses with structural tailwinds for specific names or industries, alongside more cyclical exposures with well-defined secular catalysts.
OUTLOOK
In 2024, as the inflation battle seemed over, countries’ monetary policies have now moved towards a more accommodative stance, with rate cuts across key economies, with the exception of Japan. The narrative of a soft landing is starting to take shape, potentially favouring a broadening of the equity market performance into 2025, following performance having been concentrated in a narrow set of companies since 2023 and the flight away from smid-caps (i.e. the strategy's battleground). We continue to observe attractive market anomalies. Looking ahead, we anticipate that a broader equity market performance would particularly benefit stocks that lagged in 2023-24, with a specific focus on small and mid-cap companies.
In this environment, we aim to complement our portfolio's barbell approach, which balances high-quality value and growth, with idiosyncratic opportunities driven by company-specific catalysts. We have observed a growing interest and understanding among investors in circular-economy solutions, which is supportive of growth and asset valuations. Currently, our areas of focus include performance and bio-based materials, advanced manufacturing and exposure to enhanced infrastructure that promotes a sustainable future, spanning from waste and recycling to water management and environmental integrity. Both the regulatory environment and economic factors are unveiling new business models within various dimensions of our Fund's universe.
FUND STRATEGY
The Circular Economy strategy aims to capitalise on investment opportunities arising from the shift in economic models from linear to circular. This transition is centred on two main priorities: harnessing the power of nature and safeguarding natural capital.
The strategy's primary investment themes are closely tied to opportunities identified within four key revolutions associated with this transition: the circular bio-economy, resource efficiency, an outcome-oriented economy and zero waste. Across these four revolutions, the thematic investment universe encompasses over 250 companies, carefully mapped across regions and sectors. As a result, it presents a well-diversified investment universe that offers ample depth and breadth for our stock selection process.