Investing in the transition to net zero

Tim Gerrard, Portfolio Manager, Janus Henderson

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As the world moves to net zero emissions, natural resources companies will be crucial in facilitating the production and development of renewable, and low carbon energy sources. In this episode, Tim Gerrard, Portfolio Manager at Janus Henderson, shares his investment strategy for net zero emissions and provides some examples of ‘traditional’ resource companies and the positive steps they are taking towards ESG. Tim also shares his outlook for the resource sector and how the sector is responding to recent global supply chain and geopolitical events. 

 

Transcript

Paul O’Connor:

Welcome to the Netwealth Portfolio Construction Podcast series. My name is Paul O'Connor and I'm the head of investment management and research today. Tim Gerrard from Janis Henderson investors joins us who is a portfolio manager based in Sydney. Good morning, Tim, and welcome to the Netwealth Portfolio Construction Podcast.

Tim Gerrard:

Hi Paul, and thanks for the opportunity to talk to you guys.

Paul O’Connor:

Nice to have you with us this morning. Janus Henderson investors is a global asset manager offering a full suite of actively managed equities, fixed income alternatives, or multi-asset strategies. Established through the merger of Janus capital and Henderson global Investors in 2017. The history is independent investment managers stretches back to 1934. The group employ more than 340 investment professionals based in 25 regional locations and managed around 480 billion of assets, as at 31st of March, 2022.

Janus Henderson investment management teams operate autonomously with the parent company providing shared non-investment management functions, such as compliance, human resources, sales and marketing. The global natural resources team consists of five investment professionals. And as at 31 March, 2022 managed approximately one billion dollars. Tim Gerrard, joined Janus Henderson in 2015 when 90 West Asset Management was acquired. Prior to 90 West, Tim worked for Longs Sec Securities conducting cell side research targeted to the institutional market and has previously been in similar roles that InvestTech Securities and Oz Stock Securities. Before Oz Stock, Tim held a number of stockbroking positions and he started his career as a project approvals accountant with BP oil exploration, before becoming a trainee mining engineer with Hamersley Iron in Western Australia. Tim received bachelor of commerce and bachelor of mineral technology degrees from the University of Otago and later studied auditing tax trusts and estate planning at Victoria University of Wellington.

He also holds the quarry managers certificate from the department of mines, Western Australia. Tim has 42 years of financial resources experience. So he is certainly a very experienced and qualified person to be joining us today to discuss the resource sector. The Janus Henderson Global Natural Resources Fund is a specialist global resources strategy and is a long only actively managed bottom up conviction based portfolio of global resource companies across the mining energy and agricultural sub sectors in both developed and emerging markets. The fund aims to provide a diversified exposure across segments of the natural resources chain, including upstream being production and exploration, midstream being storage, transportation, and marketing of commodities and downstream being smelting, refining, and selling of processed mining energy and agricultural products to end users. There are seven Janus Henderson funds available on the Netwealth super and IDPs investment menus covering global equities, multi strategy and Australian fixed interest and including the Janus Henderson Global Natural Resources Fund that Tim works on.

The global resource sector has been subject to a lot of focus and share price volatility in recent years due in part to issues such as the growth of ESG, increasing long-term commitment to renewable resources, and of course Russia's invasion of Ukraine earlier this year. The sector is so diverse when you consider it encompasses hard commodities, energy and soft commodities, but is so fundamental and important to society given we all use commodities on a daily basis. Energy has been such a strong performer this year, mainly due to a refocus on energy security, courtesy of Europe's reliance on Russian energy. So I'll certainly be interested in Tim's views on the opportunities and the threats facing the various resource sub sectors.

With the recent rise in geopolitical risk inflation and interest rates in developed countries this year, I'm also interested to understand what impact this has on resource companies earnings, given a large amount of resource usage is independent of the economic cycle. And of course, given Australia is one of the largest producers of hard commodities, such as iron ore, the performance of the resource sector has a direct impact on the performance of the Australian economy. Tim, I know you spent the early part of your career working with BP and Hamersley Iron. So can you explain how you ended up in financial services as a portfolio manager of the global natural resources fund and what benefits do you believe actually working hands on in the resource sector provides you today as a portfolio manager?

Tim Gerrard:

Thanks Paul, for that very fulsome introduction, how did I end up to be a fund manager? The story is a slightly mandering one and there is many strands to it. But I think the start of where I've ended up is actually at a high school. It's like a boy's own boarding school. It's in Oamaru, in New Zealand, just north of Dunedin it's called Waitaki Boys. We did a lot of school work at the school, obviously. Paul, there was a lot of else besides schoolwork going on at that school. And the school was a little bit year old empire. It was kind of lots of boys had been killed in the first world war and the second world war, there was a huge hall memories and memorial to those boys killed something like 300 of them. And somehow all of that got translated into a weird thing that we did as part of our being borders, we started to dig tunnels.

We dug tunnels from one dormitory to the next. We had stolen cans of pineapple down there. We used to hang out in these tunnels that were quite deep and quite long. And somehow that's got me interested in geology. We had a geology teacher at the high school and he got me interested in geology and those two things combined suddenly I was at Otago University doing geology, then mining engineering. And then before I knew it, I was in Cobar two kilometres underground helping the miners recover copper. Now that was pretty scary for a 19 year old, but that's where it started.

Paul O’Connor:

With the tunnels you were digging at school, did the teachers understand what you were doing or was this all at the impetus of the students and the borders?

Tim Gerrard:

Yeah, this was just a boarders weird thing. I mean the first couple of years after school we'd be play tennis or golf, but by the end we are digging tunnels and know if the masters knew we'd be heavily caned.

Paul O’Connor:

I wonder if the tunnels are still there today, or if they've been filled in their Tim.

Tim Gerrard:

They could have been filled in. But Paul, the other interesting thing without dwelling on this too much, but school is very important obviously for everyone or certainly was for me in my last year at school, it wasn't so much about exams. It was about reading and doing the extra, and that's when I read about Silence Spring a book by Rachel Carson. And she was really one of the first environmentalists that brought to everyone's attention that the harm that chemical pesticides were doing. And I think when you combine that sort of love of geology with this extra reading I was doing and my rural background. And all of that came together when I had a year off just to expand a little bit more Paul, I went from Dunedin to Edinburgh, overland in 1975. And this kind of links back to my interest in sustainability right now.

You saw the environmental degradation through Asia, you saw the plastic pollution, you saw the urbanisation and the growth all in context of where I'd come from New Zealand and Australia. And when I'd put my mining engineering degree together with the BComm went into mining, went into stop picking, stop breaking and fund management. And here I am now with a good organisation that's seeked in ESG. Janus Henderson has an excellent team in London. But we know the importance of resources, but equally important is the recovery of those resources in a sustainable way. And this is how our portfolio global natural resources portfolio comes together.

Paul O’Connor:

So it sounds to me like you were born to be a global resource portfolio manager there, Tim.

Tim Gerrard:

I think that's true. I love what I do. I can't believe how lucky I am to be doing what I'm doing.

Paul O’Connor:

When many people think about resources, they think about mining or drilling for coal oil, gas, that type of thing. But as I understand it, you have a different view, Tim. So can you please talk or explain to the listeners what this view is?

Tim Gerrard:

This is our view. It's my view, and it's our team's view is that think of resources as something we just can't do without resources. And think of resources as a modern enabler to the world, human kind, being able to be warm, eat well, have shelter, have communication. And when you think of it this way, and you take the step back and you say, look, we've got to have copper, we've got to have lithium, we've got to have aluminium. All those things are absolutely critical for the renewables. As we decarbonize with increased solar, as we decarbonize with wind and with electric vehicles. And then that's almost like the metals component of what we look at, but then there's the energy component. It might have all been oil and gas. Now it's sort of transitioning to more gas and more LNG, liquified natural gas, even nuclear's back on the headlines again with good reasons.

When we think of energy, Paul, we don't think of just the fossil fuel. We think of the new energy, the LNG, the renewables and battery storage and hydrogen. And then just to round it out, our view of resources, it's got to include agriculture, natural resources like forestry, recycling of paper, recycling of metals, sustainable agriculture, alternative protein is making inroads into meat and dairy, and so you've got a multitude. When you think resources think of a basket of modern day enablers to a cleaner and healthier society.

Paul O’Connor:

Well, as I mentioned in my opening, I think we all consume resources on a daily basis and they are fundamental to our life that we live and improving the standards of living as well. So I certainly understood there, Tim. ESG themes, like climate change and natural resources seem to be an unlikely pairing, but understand you now manage a strategy aimed at net zero emissions by investing in resources. So how does that work? And I guess a general view is that it is more about advancements in green technologies that helps the planet to decarbonize rather than through natural resources.

Tim Gerrard:

Yes, you did. As the world decarbonize, it's going to electrify that involves solar, involves wind and electric vehicles. And if we wanted a pure portfolio, we could say to you, here's a low carbon portfolio, a zero carbon portfolio of all the good stuff, and let's forget everything else. That of course is not practical, it's unrealistic. We don't have solar or wind or EV unless we have copper and I'll use copper as an example, good conductivity doesn't corrode, can be recycled. And because of this move to renewables, Paul, it looks like there's another four million tonnes a year of copper required by 2030, just to meet the new demand from renewables and EVs. An electric vehicle has four times the amount of copper involved then does an internal combustion engine.

So when we look at our new strategy, it's called a J zero. It's a transition to net zero. It's an ETF it's active. And so we want to fill that portfolio with opportunities that help the world decarbonize. As I said, we can't decarbonize without copper, without steel to build the turbines, without aluminium to make lightweight vehicles. And so when we think of a basket that's eligible for our J zero strategy, which is a little bit different to the global natural resources, the J zero doesn't have any oil and gas for instance. But what it does have, it's got five buckets and one of those is sustainable energy. Like the renewables, another is mobility like the EVs and the enabling materials that enable that to be created like the copper, the lithium, the aluminium, and then we have sustainable industries. This is where the recycling fits in something I'm personally very excited about because you recycle a tonne of steel or a tonne of paper or a tonne of aluminium. You're doing that at about a quarter of the carbon emissions. And then you've got sustainable agriculture as we move more into alternative proteins, and then you've got forestry and other things. So when we look at this renewable energy world, we've created a portfolio that enables it to happen.

Paul O’Connor:

With all that in mind and given the diverse range of natural resource sub sectors, how do you think about portfolio construction? And I know you also allocate to emerging markets. So how do you also think about the additional risk associated with allocating to emerging markets in the context of overall portfolio construction?

Tim Gerrard:

When we look at our global natural resources portfolio, we have a broad benchmark there. S&P global natural resources, a third metals and mining, a third energy and a third agriculture. So that if you'd like is the starting template of a portfolio construction. And I guess all our sequel, we could have a third, a third, a third, but we try to use our expertise to pick the right third at the right time. At the moment, we're a little overweight mining and we're a little underweight agriculture, but the best way to think about the portfolio construction, it is active, it's bottom up. And it comes back to the same old important process, is management as good as what they should be? Are the costs low of the companies that we're investing in? Are they low cost providers? Do they have a long mine life? Is their debt moderate to low? Is there a good growth profile, like in a copper company? And there some near term catalyst, it could be a change in the way in which ESG ratings are perceived.

So we build the portfolio from the bottom up taking into account ESG and those things I've just talked about, and then aware of where the final waiting might be and we might balance that waiting. Now with regard to the emerging markets, we do invest in emerging markets, but I'd say at the moment, that's less than 10%. That is a little bit like a firecracker. We'll have a little bit exposed to emerging markets because it might give us an extra bank for the buck. And that could be exploration companies in Ecuador or Argentina, or a fantastic copper company in the DRC called Ivanhoe Mining. But I'd say emerging markets, Paul is a minor part of our strategy, some 55 or 60% of the portfolios in North America, 20% in Australia. And I think this is important because we are in a volatile sector, 65% of our global natural resource portfolio isn't companies with a market cap of greater than $10 billion. We want to be at the big end of town, big liquid companies in a volatile sector where we can control the risk.

Paul O’Connor:

Perhaps you could give our audience some examples of what we might think of as traditional resource companies and the positive steps they're taking towards ESG. And I guess this question's also in light of increasing, I guess, public negativity and perception towards even the likes of the BHPs and Rios of the world.

Tim Gerrard:

I think you mentioned Rio, and I think the public perception about Rio, it is just spot on, is just very, very disappointing. While I was in stockbroking, that was my favourite company for many, many years. It was ahead of the pack in terms of ESG for at least 15 years, it was a perceived leader. And then interestingly it steadily lost its way through the mid 2000s, as it concentrated on cash flow dividends only to shareholders, it became the company's mantra that shareholders were really all that it was about. And then in 2020, they destroyed the Juukan caves in the Pilborough. And that was the end of one generation of management in a way. So Rio's a good example of a company that went from top of the pack to middle of the pack. And it's now trying to fight its way back. A better example is BHP.

In my view, BHP is an ESG leader. You've seen an example recently of how they've reached their portfolio. They've spun out into Woodside, they're oil and gas assets, and there's a massive move, $15 billion where they've oil in gas assets and the selling of some thermal coal. That portfolio has been restructured with a view to BHP being a new company and taking advantage of new opportunities, primarily around decarbonization for the next 30 or 40 years. They are going to drive their strategy around decarbonization, whether it's copper or nickel or to some extent potash. And when you look at copper, they are ready to expand in copper either through existing operations or you'll see more M&A or bolt-on acquisitions. And so they're, Paul at the macro level, they're positioning for the new world, the new world is decarbonization. And on the more direct ESG, they've got very strong leadership for the last two CEOs.

They have a concept which I'm all in favour of, a lot of companies talk about social licence. You need the social licence. You need to demonstrate the goodwill and get the community on side to be permitted, to build a mine. But often that is a very transactional thing. And once the mine is built, the social licence can drift off, and it's just a little bit of motherhood. BHP's viewers, social value, they want the community, the stakeholders, they want them to embrace BHP and for BHP to be embraced within society and the community. And to do that, it's got to be fully transparent, good stuff, bad stuff. What it's plans are, how it can help the community, et cetera. Executives, their enumeration is tied to this, the power of the mine manager to make decisions and direct conjunction with the community rather than go back to London and get permission to do something. So BHP's get its portfolio positioning right, and it's got its attitude right, where it wants to be embedded in society in a positive way over the long term. I think it's capable of doing that.

Paul O’Connor:

Yeah, well, I think there's no doubt that there's strong evidence, that companies that are managed ongoing to the standards of society are the more accepted companies and successful companies over the long term. So very interesting to hear your comments about BHP and the social licence and embracing the community and trying to be positively giving to the community, I guess, are an ongoing basis there. Many resources such as iron ore often viewed as more cyclical investments. Is that still a fair comment today, later where we're at?

Tim Gerrard:

Yes and no. The answer really Paul is that commodities are cyclical, soft commodities like wheat and soybeans depend on the weather. The supply depends on lots of things out of the control of the grower. Likewise, with mining, the supply can be hit by tragedies or weather, demand can be higher or lower than expected. So all commodities are basically pretty volatile and iron ore is a good example of the volatility, but most are volatile. And Paul, when I look back nearly 90s, China was producing 90 million tonnes of steel, and so was Japan. China now produces a billion tonnes of steel and each tonne of steel needs one and a half tonnes of iron ore. So that massive, massive change to the equation from China created an iron ore price going from 20 to $200 a tonne. Then we had the GFC, it was back to $30 a tonne.

And then recently it went up to 200 again, and now it's back to below a 100. But you can almost come up with similar order of magnitude figures if you're looking at oil, for instance. So a lot of volatility iron ore is a good example of volatility right now. All I can say is we need to manage that portfolio. That's why we have our three buckets of mining, energy and agriculture. That's why we go for low cost companies with long lives and we spread the risk and we have low debt because the portfolio is designed to manage the volatility.

Paul O’Connor:

We've heard a lot more about global supply chains and geopolitical events recently. And I mentioned Russia's invasion of Ukraine in my opening and that impact on energy and I guess, energy supply, particularly across Europe. So to what extent are they impacting on the potential for natural resources?

Tim Gerrard:

Natural resources is such a broad gamut. I can give you some examples, but in the European Union, it's all of how to substitute for Russian gas. If anything, they're doing that a little bit quicker than what we might have thought possible, but that might mean building more LNG import terminals. It might mean ramping up thermal powered coal stations that had been put on care and maintenance. So more coal, more LNG, nuclear is making a comeback for good reasons. So that's got big impact for the demand for uranium oxide, which is a product that we like a lot. There's one direct change, a bit of a swing toward uranium again. The Americans their steel industry would import pig iron high grade steel products or iron products from the Ukraine and Russia. They've had to find alternatives for that. And that's including maybe importing high grade iron ore from Canada. You've got the whole issue of about security of supply countries. Like America are coming up with a list of critical minerals. They're going to increase their own domestic mine production. They'll do that with a company called Freeport-McMoRan, they'll open new copper and lithium mines in America. There's opportunities for liners and rare earths. So we are seeing this nationalisation, bringing things back home on ensuring to help even out this sort of supply chain disruption that both COVID and the China and the Russian invasion has caused.

Paul O’Connor:

Equity markets have witnessed a broad selloff on the back of rising interest rates. And clearly inflation is back and is an issue we're going to have to deal with. And even potentially the prospect of a US and Australian recession. How do you look to recession proof your portfolio?

Tim Gerrard:

I wish I had the perfect answer for that, Paul, I really do. The recession proofing, some of it comes back, in fact, a lot of it comes back to us sticking to our process. I'm sorry to labour this point, but the process has to involve companies that are low cost, are low debt, good ESG, good management. The mix of those companies insulated us from the unknowns of a recession. And remember, it's a two edge sword. There is no guarantee we could recession proof the portfolio until the cows come home. And there might only be a 30% chance that there is a recession. So we have to be very careful about going one way or the other to too much of an extreme. So that means sticking to the process is important. And it means understanding the bigger picture, like is China stimulus going to happen or not? And is it going to be positive for resources? There's an opportunity and a risk there.

What is going to be the speed of increased demand on commodities because of the renewables, because of the drive to renewables? We've got to be alert to those and the good news about commodities just at the moment. Normally, and often, if we were going into a recession, the resource sector is way overblown with too much infantry because everyone's been expanding and it's way overblown with debt. What gives us a lot of comfort, Paul, right now is that the LME stocks, the stocks of commodities like copper year on near they're down 35%. Nickel stocks in the LME down 70, aluminium down 80. So the stocks of commodities available are low and the companies we follow have low debt. So, that in a way means that we are quite well positioned in case there is a recession. We're not going to go back to the GFC where Rio Tinto had to save a massive capital injection to avoid going broke.

Paul O’Connor:

It certainly makes sense to have in your portfolio to have an exposure to resources, as we understand the importance of resources are to society, but it's a long term play as well. So certainly not a short term investment there, but it certainly makes sense that every portfolio with an equity exposure should have a significant exposure as a long term aim in the portfolio. With all that we've discussed today, such as decarbonization and net zero initiatives, even recycling. What does the future look like for resources? So can Tim Gerrard look into his crystal ball and give us some comments on new growth areas for the sector?

Tim Gerrard:

I can look into a somewhat cloudy ball and sort of see something emerging. I'm very, very positive. And the positivity it comes really from the world has to be a cleaner, better place, more sustainable. One of the ways it's going to do that is through decarbonization copper, lithium, aluminium, new technologies, they're all there in our sector. So very, very positive. Recycling is going to be changes in policies all around the world to get you to make sure you recycled your aluminium can, your cardboard box is going to be made easier to do that. And the products made from that recycled production is going to be far lower in carbon emissions. That's the big opportunity and resources forestry in order to absorb this extra carbon. Over the next 50 years, the world needs to plant about the half the size of Australia in trees. So good forestry companies that can find their land to do that and do that properly.

Hydrogen, very excited about hydrogen, that's made possible now because renewable energy is cheaper than it's ever been, and that means that hydrogen can be made greenly. And then lastly, we've got EVs, electric vehicles penetration globally as ahead of expectations. So my viewers, sure crystal balls always a bit dangerous and it's hard to get the timing dead, right. But the future for our broad basket of resources, I would say it's never looked better. And the state of the companies that we can invest in has never looked better. By the way, Paul final one, if we want to add new copper supply, it's very restricted. It takes 10 to 15 years to get a new copper mine permitted. It could be that the copper upside is just going to be massive because of this new demand.

Paul O’Connor:

No, interesting. I didn't quite appreciate the demand and the ongoing demand for copper, but certainly with the move to EV and the demand for copper and building those vehicles, it certainly makes sense. I can't let you leave the podcast without asking about your outlook on the Australian resources sector. I know you made some comments about the way BHP have been changing in the way their operations work and function and interact with society. I guess there is a view that we are a specialist in old resources. So we've been a beneficiary for over two decades now on China's growth as you articulated earlier, and their demand for iron ore because of the steel production in China and their demand for our hard commodities ultimately. But what does the future look like for Australian resources and do we have any areas that are sort of leading in ESG or clean energy or are they all more offshore examples of companies that you can think of?

Tim Gerrard:

The resource sector for Australia is Australia's very innovative. Over the years, it's invented a lot of strong technologies and copper flotation, all sorts of things. So it's innovative. We've seen the innovation and the startup sector. We've seen the innovation flow through into agriculture, into sensing, maybe some carbon soil sequestration. There's a lot of innovation in Australia. And specifically with respect to resources, I hear you comment about old, but I would prefer to say, things are in transition. Iron ore might be old, but steel is the driver of construction all around the world. And steel can be made to be a new commodity if you like by making sure it's got a low carbon footprint. And so if you're an iron ore minor in the Pilborough, Fortescu, BHP, Rio, all got initiatives on how to get more involved in renewable energy and work out ways to produce iron ore scope one or two with lower carbon emissions, and then work out ways with their customers, how to get that lower with new technology and reduce scope three.

So iron ore creates steel, all of that's long term project. In the meantime, we can get good returns from recycling of steel. But to come back directly to your question, I would think of Australia has had two decades of massive Chinese growth. Let's hope that the Chinese growth can at least stabilise and moderate rather than fall. So if there's a stability to China, then our big new opportunity comes down to new demand from renewables. And that new demand from renewables is going to help. The best iron ore mines, just is going to help the best [inaudible 00:34:52] coal mines and copper. Rio Tinto is looking at ways to get renewable electricity, to run aluminium and alumina operations in Queensland. So I would come back and say, the next generation of resource growth in Australia is all about decarbonization. It's all about renewables that will go into hydrogen and we will be a better place from all of that help and support our existing resource industry. Which is also gets added new demand from copper, lithium, and aluminium. So Australia well placed.

Paul O’Connor:

It's been a really fascinating discussion with you on your thoughts and views on the sector. And I guess as you've been talking through, it's just been on my mind that what are huge diverse sub sectors of resources exist. I feel like we've only just scratched the surface. There's so many areas of what we've discussed this morning. So I think we'll have to get you back on next year for another, maybe a deeper dive into clean energy or something of that nature there. Tim also fascinated to find out more about those tunnels that you dug back in your school days there. So I do thank you very much for joining us this morning on the podcast and certainly wish you all the best there, Tim.

Tim Gerrard:

Okay. Thanks for the opportunity.

Paul O’Connor:

To the listers, thank you very much for joining us again. I hope you've enjoyed today's discussion with Tim Gerrard from Janus Henderson. And I look forward to you joining us on the next instalment of the Netwealth Portfolio Construction Podcast.

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