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Why capital allocation can be a useful clue to business sustainability

21 Jun, 2021 | Return|

By Matt Evans, Portfolio Manager of the Ninety One UK Sustainable Equity Fund at Ninety One

“Show me where a man spends his time & money, and I'll show you his god.” Replace ‘man’ with ‘company’, and the words of theologian Martin Luther (1483 – 1546) offer a useful lesson for investors.

Capital allocation – where and how a business spends money – often reveals a lot about it, including how sustainable it is (in all senses of the word). Consequently, it is one of the key things we look at when assessing a potential investment, alongside business models and financial models.

Many an otherwise good company has blown itself up by making a poor acquisition. In contrast, great companies have a habit of reinvesting profits at attractive rates of return, typically thinking five or more years ahead when they do so.

Among other things, a company’s capital allocation often indicates its priorities. Famously, a major UK supermarket (not held in the Ninety One UK Sustainable Equity portfolio) maintained a dominant position for years by ploughing profits into keeping prices low – i.e., investing in its customers. When it began redirecting cash towards international expansion and other growth projects, it lost its way (and shoppers’ loyalty). The change in its capital allocation was a major clue that its customer-focus had slipped.

Capital allocation can also give insights into how a company treats its suppliers, which is of particular relevance in the food sector. In the best cases, food retailers invest in partnerships that allow suppliers themselves to invest and become more efficient, which is good for consumers (potentially lower prices), the environment (more sustainable food production), and their own businesses (higher customer loyalty, lower reputational and environment-related risks).

Revealing insights

Watching how companies allocate resources has been especially revealing during the pandemic. If it didn’t show companies’ ‘gods’ exactly, it certainly said a great deal about their values and attitudes towards stakeholders.

With the coronavirus accelerating the focus on sustainability, these attributes matter more than ever. We think the leading companies from a sustainability perspective – those that act responsibly, use resources efficiently and make a positive impact – have a significant opportunity to win customers and grow market share.

As Covid cases escalated, it was encouraging to see many firms move swiftly to ensure their employees were safe and equip them to continue serving customers. The better ones dedicated resources to keeping their supply chains functioning, thinking beyond the immediate crisis to safeguard the long-term viability of their businesses.

Some companies went to great lengths to help society more broadly. Examples included an industrial firm that rejigged production to make parts for ventilators; a developer that set up a fund to help vulnerable people in the communities where it manages projects; and a food-materials business that started producing hand sanitiser.

These enterprises weren’t just being altruistic. Their investments to support communities may well generate a return for them, via increased customer loyalty and goodwill, and an enhanced reputation.

In the Ninety One UK Sustainable Equity portfolio, it was notable that several companies returned furlough money to the UK government, despite being closed for periods during lockdowns. That suggests a deep understanding of their wider role and relationships with all stakeholders, which we believe will stand them in good stead.

Sustainable businesses that act sustainably

The Ninety One UK Sustainable Equity aims to achieve long-term sustainable investment returns, as well as a positive lasting impact on society and the environment. To do that, we seek companies with sustainable businesses that act sustainably – and capital allocation is one of the key lenses we use to try to identify them. We think successful and sustainable companies aren’t just good at making money. They’re good at spending it too.

To find out more, visit the Ninety One website.

All investments carry the risk of capital loss. Sustainable, impact or other sustainability focused portfolios consider specific factors related to their strategies in assessing and selecting investments. As a result, they will exclude certain industries and companies that do not meet their criteria. This may result in their portfolios being substantially different from broader benchmarks or investment universes, which could in turn result in relative investment performance deviating significantly from the performance of the broader market.

This document is being provided for informational purposes for discussion with institutional investors and financial advisors only. Circulation must be restricted accordingly. Nothing herein should be construed as an offer to enter into any contract, investment advice, a recommendation of any kind, a solicitation of clients, or an offer to invest in any particular fund, product, investment vehicle or derivative Any decision to invest in the Fund should be made after reviewing the full offering documentation, including the Prospectus, which sets out the fund specific risks. Fund prices and copies of the Prospectus, annual and semi-annual Report & Accounts, Instruments of Incorporation and the Key Investor Information Documents may be obtained from www.ninetyone.com.

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