Adrian Frost is someone who has delivered everything that has been asked of him as a fund manager. His Artemis Income fund has outperformed its peers and benchmark from a total return point of view over the short, medium and long term, while delivering a strong and growing payout to investors.
Performance of fund vs sector & index
Source: FE Analytics
However, the fund manager believes that very soon, this will not be enough for investors – who will demand he continues to deliver on all of the targets mentioned above, but in a “cleaner” way.
Frost (pictured) has been sceptical of the ESG (environmental, social & governance) theme in the past, as it seemed grounded more in theory than practice and had little bearing on investment performance.
More recently though, he said there has been a “dawning realisation” among his peers about the growing importance of this trend, with his own awakening taking place after a conversation with one of his six children.
“They tell me a lot, particularly in this time of change,” he said. “And a couple of really odd things happened a few years back with one of my kids. The first, which was really strange, was that he noticed I was in the room.
“The second, and it’s never too late, was that he asked me what I did.
“The rest is a cause of regret,” Frost continued, “because Angus ripped me apart. ‘Why do you own that? It does this! How can that be good?’
“So I was gutted in every way.”
Frost said societal shifts are reflected in the growing demands on the industry to allocate money in an ethical manner, whereas previously this focus was confined to a niche sector. He believes that investing in this way while also delivering the best possible return for clients will be the biggest challenge for fund managers in the coming years.
However, while this was “nigh on impossible” only relatively recently, the good news is that the way society is changing means there is a growing connection between “conscience and cash flow”.
“Quite simply, people are putting a value on companies that do things the right way,” Frost explained.
“But not only that, there will be aspects that impinge upon these companies’ supply and demand for their basic products, their cost of borrowing, their cost of compliance and their need to reinvest or to invest afresh to meet these sorts of challenges.
“These are things that are bread and butter for us when we think about medium- and long-term cash flows.
“This is much more the art of the possible for us and we are much more engaged not in the sense of asking those questions and dare I say ticking boxes, but actually rolling it into our investment rationale, our investment thesis.”
One example of how Frost is integrating an ESG focus in his investment strategy is in the disposal of Signature Aviation, previously called BBA Aviation, which provides air transport support services to aircraft. The stock surged last year on the sale of its aviation parts business Ontic; however, the manager sold out on concerns about changing attitudes to air travel.
“It looks to be a highly vulnerable area, because if you’re a business traveller, you’ve got a size-12 carbon footprint which is not something to be proud of,” the manager continued.
“The risk here is that already, there are some signs of softness in demand, contrary to the strong GDP that you’ve seen in the US. Some of this softness in demand could be to do with people’s habits and conscience.
Correlation of North American flight hours and GDP
Source: Artemis
“The fact is, it’s something that has started and none of us really know where that ends, and it could go on for a decade.
“I think you can draw your own conclusions about how damaging that would be for the share price of companies like this.”
Frost said businesses are now much happier to discuss ESG issues compared with in the past, when bringing up the subject in company meetings felt like an “ambush”.
Yet there is still cynicism that many companies are using ESG as a PR exercise and are simply telling fund managers what they want to hear. This is made more difficult with a lack of any universal quantitative rating system.
However, Frost said a simple question can give him a good idea about their commitment.
“If they have these aspirations or targets to do something by 2025, the simple question is, is that because it suits the targets or will be costly not to do it, or is it because it’s physically all they can do in that time?
“That for me is the axis to concentrate on. I think some people have put targets out there on the basis that the business can comfortably get to them.”
Data from FE Analytics shows Artemis Income has made 337.55 per cent since Frost became manager in January 2002, compared with 220.03 per cent from the IA UK Equity Income sector and 204.69 per cent from the FTSE All Share.
Performance of fund vs sector & index under manager
Source: FE Analytics
The £5.2bn fund is yielding 4.4 per cent and has ongoing charges of 0.8 per cent.