investment viewpoints
LOIM New Food Systems marks 1 year
Last year we launched LO Funds – New Food Systems to capture equity opportunities created by the necessities of feeding a growing global population while remaining within, or helping restore, planetary boundaries. One year on, we assess the strategy’s performance against peers, profile companies aligned with our three investment themes, and describe major policy drivers supporting the investment case.
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Resilient in a challenging market
Since launching on 7 July 2022, LO Funds – New Food Systems generated a net annualised return of 3.7% compared with 12.7% for the MSCI World ACWI reference index.2 It is important to note that this benchmark represents the broad global equity universe rather than the focused theme of new food systems. Compared with a group of peers who also concentrate on this space, our strategy placed fourth out of 11 for the period (see figure 1). In the year to date, its 5.9% net annualised return delivered top-quintile performance among this group.
FIG 1. Performance vs thematic peers since inception:3 LO Funds – New Food Systems
Source: LOIM, Bloomberg as of 17 July 2023. The peer group methodology cited herein is provided for information purposes only and may be subject to change over time. No fund/benchmark/index is directly comparable to the investment objectives, strategy or universe of our fund. Returns shown net of fees. The performance of a peer group shall not be indicative of past or future performance of any fund. For illustrative purposes only. This document has been prepared by LOIM employees who are encouraged to raise assets for their strategy and may have a conflict of interest.
It has been a challenging period for equity investors in this theme. At the asset-class level, headwinds included steep interest-rate rises, investor divestment from equities and inflation’s impact on consumers. In addition, the dominance of six mega-cap technology stocks – Microsoft, Apple, Google (Alphabet), Meta, Amazon and Nvidia4 – drove the performance of the benchmark to the detriment of smaller companies that are not in the IT and communications sectors.
This weighed on our thematic universe – but has also driven valuations to extremely attractive levels relative to large caps. In our view, this provides an entry point into SMID caps exposed to secular growth drivers and supportive government policies within the sustainability transition.
Throughout the year, we remained focused on attractively valued companies that show an ability to generate excess economic return (EER) without relying on capital markets for financing. The strategy’s 16.3% return on equity – an indicator of quality – exceeds the 14.3% of the index, and its earnings per share growth of 11.5% is greater than the index’s 8.0%.5,6 Its focus on value is reflected in the 14.6x one-year forward price-to-earnings ratio of the portfolio, which compares favourably with the benchmark’s 17.3x. In essence, we believe the portfolio offers a robust, thematic, quality-growth exposure at an appealing valuation.
When researching sectors for stock ideas aligned to new food systems, we look for companies that can be overlooked but where our understanding of the transition can identify potential value. Through our integrated sustainability and investment research, we refine a universe of about 200 names from the entire index. From this, we construct a thematically pure, high-conviction portfolio of 35-45 companies aiming to deliver strong performance and some diversification from all-cap benchmarks and strategies managed against them.
System changes follow an S-shaped pattern
New Food Systems is part of our holistiQ range of sustainable equity strategies, informed by the conviction that the transition to a CLIC® economy requires transformations in the energy, land and oceans, and materials systems, plus accelerated pricing of carbon and other externalities. We believe these 3+1 systems changes will fundamentally rewire the global economy.
With current food systems driving 80% of land-use change, 90% of forest degradation and 70% of freshwater use, our strategy is aligned with the need for the land and oceans system to return 1 billion hectares of land and 30% of oceans to nature by 2030 to meet the climate and environmental goals that many of the world’s most powerful institutions have committed to.
Economic transitions – from the adoption of the steam engine to automobiles and digital technology – typically chart an S-shaped curve. Change happens slowly at first, as innovations, policy support and capital expenditure lay the groundwork for economies of scale to build. These forces lead to a tipping point, where the superior functionality, greater affordability and expanding accessibility of new solutions enable mass adoption. This drives growth and sizeable revenue pools for the companies positioned to benefit.
We see a number of solutions within the rise of new food systems approaching such tipping points, from sustainable agricultural practices to diets and enabling technologies. As the entire food value chain is reinvented, innovative companies are disrupting markets and accessing new or shifting profit pools.
FIG 2. Inflection points for selected sustainable food solutions
Source: Systemiq, LOIM analysis. For illustrative purposes only.
Case studies: investing in the future of food7
To invest in the transition to new food systems, we use three themes encompassing food production, consumption and enabling solutions. Which portfolio companies illustrate these themes and helped drive performance over the past year? We profile three from our top 10 holdings.8
The transition to new food systems will change the types of foods we consume and the way we produce them. The current system is inefficient, with livestock producing few calories and protein relative to their land use, while generating significant volumes of greenhouse gas (GHG). Diets are also unsustainable: one in five deaths is linked to high consumption of sugar, salt and processed meat.
But demand for healthier foods that are less environmentally taxing is growing. New additives and ingredients are being used to manufacture more plant-based foods in lockstep with improving technologies and shifts in consumer preferences. We expect revenues from plant-based alternatives to reach USD 140 billion by 2030, up from USD 20bn in 20219. As part of a planetary health diet aligned with environmental and human-wellbeing goals, the EAT-Lancet Commission reports that the world needs to reduce sugar consumption by 50% by 2050.
As a plant-based ingredients solutions provider, Ingredion is firmly aligned with this expected growth and stands to benefit from the growing profit pool for non-animal proteins, in our view. Specifically oriented to the company’s business, there is a USD 18 bn market for starch-based texturisers and hydrocolloids, a USD 10 bn market for alternative proteins and a USD 5 bn market for sugar reduction and specialty sweeteners.10
The company is prominent in the market for starch-based texturisers for plant-based foods, aiming to benefit from the 7% CAGR for the estimated USD 1.2 trillion plant-based protein market. For its products linked to sugar reduction and specialty sweeteners, Ingredion is benefiting from a CAGR of 14-15%. As such, we see it being well-positioned to capitalise on expanding markets for these goods.
The specialty business is highly profitable: 50% of Ingredion’s profit is tied to specialty products that typically command twice the margins of core products. Looking ahead, the company holds about 1,800 product-related patents, auguring well for its ability to maintain a strong presence in this space.
As a theme, sustainable food consumption caters to new eating habits. For Compass Group, an operator of outsourced canteens, such habits extend to ensuring that good food is eaten rather than wasted. Reducing food waste has improved its efficiency and helped grow its clientele.
Globally, about one-third of food is wasted. At a systemic level, combating food waste eases demand for agricultural land and allows it to be returned to nature, thereby supporting biodiversity, reforestation and water preservation while reducing agrochemical pollution.
Primarily an outsourced operator of canteens on corporate premises, Compass is one of the few global companies that together cater to one-quarter of the market, with local firms and internally operated canteens comprising the remainder. Benefiting from economies of scale, it can spread the cost of technology and leverage this investment across the group. One such initiative is Waste Not 2.0, a cloud-based, food-waste-tracking programme, installed to help the company achieve its target of halving its own food waste by 2030.
In its first year, the system reduced food waste by 28% in more than 2,650 sites across 28 countries. It is now being rolled out across 44 markets. Such increased efficiency, combined with Compass’s increased sourcing of sustainably produced foods and plant-based menu options, has helped it retain clients and attract new ones. The firm’s mission also extends beyond customers. In 2017 Compass founded the annual ‘Stop Food Waste Day’ to promote awareness and action. The company also partners with a range of organisations, including the UK’s Too Good to Go, to distribute surplus food from canteens at reduced prices.
In the near term, we believe Compass is benefiting from increased workplace attendance as more employees return to physical premises, increasing footfall to canteens. In H1, the group reported organic revenue growth of 25%, net new business of 5.2% with “balanced growth” across all regions, and an operating profit margin of 6.6%.11 Its scale also enables it to absorb higher input costs as inflation undermines the viability of internally operated canteens.
Longer term, we expect Compass to demonstrate resilience amid a possible recession since canteen outsourcing is a cost-saving initiative. In H1, the firm reported that 45% of its new business came from first-time outsourcers. There is also scope for the group to increase market share: with the largest outsourced-canteen operators together accounting for one quarter of the market, there is room for growth.
Enabling solutions help food producers, manufacturers and distributors embed sustainability into their operations – and by extension, across the industry value chain. These range from digital technologies powering advances in precision agriculture, to equipment for manufacturing alternative proteins, and sustainable packaging. The latter is what Graphic Packaging International, the largest folding-carton manufacturer, specialises in.
Demand for the company’s fibre-based packaging for foods, beverages and other consumer staples have seen it become one of the largest producers of paper packaging in the US and win leading market share in several key categories. The business shows evidence of growth: its Q1 net income of USD 207 million marked a 93% increase on the previous quarter and exceeded the annual total for 2021. It is almost fully integrated – right back to the eight paper mills it uses to produce packaging materials, and more than 105 converting plants that convert cardboard into finished products.
Currently, single-use plastics are widely used to protect and preserve food products. Because they are typically produced using fossil fuels and often end up as waste, the material expands the carbon footprints of foods and exacerbates already chronic pollution. With demand for food packaging expected to double by 2040, sustainable materials are a key enabling solution for new food systems.
Given the emphasis on decarbonisation and nature restoration among policymakers, businesses and consumers, switching from plastic to paper in food distribution is accelerating, driving an estimated 20% increase in the global addressable market for Graphic Packaging. More than 95% of the firm’s revenues are derived from fibre-based products or responsibly sourced, renewable virgin-tree fibres that are recyclable. By 2030, it aims to increase this to 100%.
Policy drivers for cultivated meat, food ingredients, pesticides
Influential policies that support the themes in our investment approach arise continually. Here we consider three – concerning lab-grown meat, food ingredients and pesticides – that are likely to impact exposed companies. This will affect the investment opportunity set and inform our convictions about the transition to new food systems.
Lab-grown meat approved in the US
The US fully approved lab-grown meat in June 2023. This milestone allows two companies, Good Meat and Upside Foods, to sell meat and poultry cultivated from animal cells and should presage a wide variety of new food products becoming available to US consumers in coming years, in our view.
The US approval is extremely relevant to our projections on alternative proteins, of which cultivated meat is one key technology. We expect the market for alternative proteins to grow from USD 81 billion in 2022 to USD 201 bn in 2030, and for cultivated meat to reach price parity with animal-sourced protein by 2032.12 Cultivated meat has significant capacity for growth and presents many benefits over conventional agriculture: no animal slaughter is required; production requires less use of land and water; there is no need for antibiotic treatments; and it potentially reduces greenhouse gas emissions at various stages of the supply chain.
Our sustainability analysis on the topic also meant that ahead of the approval, we researched what equipment would be needed for the cultivated-meat industry to gain scale. We found existing technology that is already being developed and applied in the pharmaceuticals sector, and took the view that these suppliers would be the leaders in providing equipment to the lab-grown meat sector. This showed us one type of ‘picks and shovels’ company that stands to benefit from growing revenue pools in this nascent area as first-movers seek scale.
Food labelling and sugar reduction
In developments impacting ingredients, policies that promote nutritional labelling and less sugar in foods have both found support. A global push to reduce sugar consumption means taxes on sugary drinks now span five continents. In Europe, the European Public Health Association is backing Nutri-Score for EU-wide implementation to help reduce the harm resulting from unhealthy diets. The labelling system grades foods according to how healthy they are, and is already used on a voluntary basis in countries including France, the Netherlands and Germany.
Once evident in supermarkets, such legislation influences consumer decisions and compels manufacturers to reformulate their products into healthier goods. After introducing a sugar tax in 2014, Mexico observed an approximate 14% decrease in sales of sweet drinks, while purchases of bottled water and beverages without added sugar increased by 4%. The 2018 UK sugar tax on soft drinks led to the stock of drinks with sugar volumes exceeding 5mg/100ml to fall from 49% to 15%. In the Netherlands, the Nutri-Score has resulted in a significant decrease of content in more than five product categories, including from bread and margarine.
EU Green Deal
The EU Green Deal targets 50% and 20% reductions in pesticide and fertilisers, respectively, by 2030. The proposal follows the EU’s Farm to Fork strategy, aiming to ensure the resilience and security of food supply by promoting practices for integrated pest management so that sustainable, biological, physical, other non-chemical methods and low risk pesticides are used to protect crops.
We see such policies as being among the primary drivers for the greater use of precision agriculture and biotechnology aimed at improving efficiency and reducing adverse environmental impacts. By 2030, such techniques could provide up to 200 million more tonnes of crops. Using more biofertilisers and biopesticides would also help to enrich soil health and increase resilience to drought and flooding, while helping to offset the negative impact of synthetic fertilisers and pesticides.
One year into a multi-decade transition
In its first year, LO Funds – New Food Systems showed resilience amid macro and market headwinds. Moving forward, we continue to apply three themes – sustainable food production, consumption and enabling solutions – to identify companies generating excess economic returns that are positioned to benefit as sustainable solutions achieve mass-market adoption.
The transition to new food systems is a long-term phenomenon. As an instrumental part of the land and oceans systems change required for a CLIC® economy, it will reshape the food value chain and help restore planetary balance. With a long-term understanding of the transformation ahead, and visibility of the innovations underway and solutions gaining scale, we invest with conviction in opportunities today.
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