Expert: Nathan Hughes – The complexity of ESG & Three ASX stocks | Perpetual

Bryce: [00:00:15] Welcome to another episode of Equity Mates, a podcast that follows our journey of investing. Whether you're an absolute beginner or approaching Warren Buffett status, our aim is to help break down your barriers from beginning to dividend. My name is Bryce and as always, I'm joined by my equity buddy, Ren. How are you? 

Alec: [00:00:31] I'm very good, Bryce. I'm excited for this episode. We have an expert investor joining us to talk about one of the hottest topics in the Equity Mates community, ethical investing. That's it. And we get to bring back one of our favourite games that we haven't played for a while, but I'm glad we got to today. Ethical or unethical?

Bryce: [00:00:49] Yeah, you're right. We haven't. We haven't played it for a while. I'm equally as keen to get started, but it is our absolute pleasure to welcome Nathan Hughes to the Equity Mates studio. Nathan, welcome. 

Nathan Hughes: [00:01:00] Hi, guys. Thanks for having me. How you doing? 

Bryce: [00:01:01] We're very well. We're very well. So, Nathan, for those who haven't heard of you before, you're a portfolio manager of Perpetual's Ethical Fund, an income share funds with over 17 years experience in the industry. 11 of those at Perpetual Perpetual's Ethical Strike Fund is an actively managed fund targeting long term capital growth and income through investment in quality shares of Australian ethical and socially responsible companies. The Fund has just celebrated its 20 year anniversary as an unlisted fund and in November last year floated on the ASX with the ticker give v a so we're going to be unpacking all of that today and thank you to Perpetual for sponsoring this episode. But Ren, let's crack into unethical or ethical. 

Alec: [00:01:46] Yeah. Nathan, you've just joined us on the show and we want to put you on the hot seat straightaway. So we want to throw some companies out there and get your view on whether they're ethical or unethical. Now, we know there's a lot of grey area and so you don't have to make you don't have to call any company unethical if you don't want to. But we'd love to just understand how you think about even approaching this question as an ethical fund manager. So are you off applying?

Nathan Hughes: [00:02:13] Yeah, absolutely. Bring on down. Yeah. You've put me on the hot seat straight away. My warm up, guys. 

Alec: [00:02:19] That's it. That's it. We we like to go hard here at Equity Mates. But look, are you saying that we'll probably start with an easy company or a company on the easier side, ethical or unethical? Woodside Petroleum.

Nathan Hughes: [00:02:32] Look, that's that's not easy. Look, it is in one sense in the there's a very clear need to decarbonise and move away from from fossil fuels. And at the same time, we likely need gas as a transition fuel to help us get there. And the process of decarbonisation and all the infrastructure investment is actually going to require some hydrocarbons. And that's that's just an unfortunate reality of the situation we find ourselves in. However, as my phone screens, I can talk to you a little bit later on. I'd put that in the unethical category, but you make your point. You know, there are shades of grey and it's not necessarily what a lot of what is ethical or responsible sustainable can actually be quite, quite nuanced. But I'm sure we'll explore that as we go through some other stocks. 

Bryce: [00:03:16] So ethical or unethical? Crown Resorts? 

Nathan Hughes: [00:03:20] I would say unethical just in light of some of the behaviour that's gone on there and being a front for money laundering and things like that. Unethical. 

Alec: [00:03:31] Maybe we should have started with Crown. That was probably the Hazel Nathan one that we always like to ask here. Bryce used to wear green and a not employee of Woolworths and Woolworths, you know, up until last year had a big pokies business, had a big alcohol business and so that was always a controversial one. They've since merged and we haven't had the opportunity to ask a fund manager since. So we get to ask you ethical or unethical? 

Nathan Hughes: [00:03:59] Woolworths ethical. However, I would point out, even though that demerged endeavour, they still do have a small look through exposure to that. My view though is that will be sold in full course and they also do sell a lot of tobacco and in the land of ethical and responsible funds. That's something that's very much frowned upon. It's not a huge part of their sales, but it is something to keep in mind. And also, look, the reality is no company is perfect, right? And if you look hard enough at any company, I'm sure you'd be able to find some problems or things. They're not doing well. And Woollies is one of a number of companies that has had some underpayment problems and hasn't paid their staff properly and they've had to remediate that. So it is worth calling that out. But on the whole, given the changes that are made to the portfolio and some of the good things that do and still put them in the ethical terms. 

Bryce: [00:04:49] Ethical or unethical. 

Nathan Hughes: [00:04:50] Commonwealth Bank Another tricky one, you pick some really good stocks and I don't think anyone can deny again some of the challenges and problems that banks have had and some of their behaviour which obviously led to the, to the Royal Commission. But they're not all bad either. I think something that does get a lot of attention is their exposure to fossil fuels. As a general rule, I'd argue that those exposures are quite small as a total percentage of the lending book and have been coming down. At the same time, the banks have been key supporters of sustainable finance and a fund to a lot of projects in that regard as well, and renewables and things like that. So notwithstanding, again, some some flaws in the past and say CommBank is in the ethical category. 

Alec: [00:05:35] So Nathan, I'm I'm sensing a theme in the last two answers. You spoke about tobacco as a small percentage of Woolworths sales and you spoke about fossil fuel lending as a percentage of Commonwealth Bank's loan book. Will unpack your investment philosophy as we go through. But I feel like the the percentage of the the bad compared to the good probably will become a big point in today's conversation. 

Nathan Hughes: [00:06:03] Yeah, absolutely. I think I think it's just to highlight that, as I said, no one's necessarily perfect. There is a lot to consider. And when you think about ESG, I mean, I can talk about Tesla, which got removed from the S&P ESG index last week. And there some consternation about this from people like Cathie Analogue herself. But I mean, the very thing ESG itself covers a lot of different factors. Three and often is too much of a focus on anyone at the expense of the others at any one time. If you'd said to me, Tesla should be in a ESG index because they've got really high quality governance and do really well socially. Like I would have laughed. There's a big focus on electric vehicles and what that means, but we also need to think about how they source their parts and how they go about it and what they're doing environmentally in the first place to make those electric vehicles. So it's just to highlight that it's it can be quite nuanced and there are a lot of things to consider. Often there seems like a really obvious answer, but there's a lot of different things to think about. And you're right, we're trying to take a balanced view and think about things in totality rather than drilling down on any one particular thing. 

Bryce: [00:07:10] A stock that's spoken a lot about in the Equity Mates community, unethical or ethical? Zip. 

Nathan Hughes: [00:07:16] I'm probably going to disappoint some of the community. I think it's unethical and I think buy now pay later is a particular type of of lending its unsecured on argue is probably targeted at certain certain cohorts. And look I'd stop way short of using the word predatory which we see in other parts of the market. But I think I'd put that in any ethical camp. 

Alec: [00:07:38] Yeah. I don't think you are surprising to many people that a credit. Okay, it doesn't it doesn't fit in that it's obviously, you know, better than credit cards in terms of interest rate and stuff like that. But people spending beyond their means not great I. 

Nathan Hughes: [00:07:52] Think as well. All the products are slightly different. Once you're over to those late fees can become quite an imposter. And when we've thought about in terms of an equivalent interest rate, it's it's pretty prohibitive. Yeah.

Alec: [00:08:06] So Nathan, this next company we've included because they have two businesses that are quite different, I don't think either of them are particularly unethical, but I'm interested to get your views are Fortescue Yeah. 

Nathan Hughes: [00:08:20] So look, I'd say ethical. I think firstly starting off with FFI or for Pacific Industries, I mean there are some great ambitions there, but it is still early days. Look, we don't own the stock but I certainly believe in want to you Andrew Forrest is trying to achieve but it is it is a long path ahead and there's a lot to do with Fortescue as it stands today though is still predominantly an iron ore producer and as we know the scope three emissions from iron ore are quite high. But as I was saying before, there's a little bit of nuance of every day we need steel to decarbonise, we need steel for civilisation as it is today. I think the real challenge is trying to decarbonise that process and a few of the companies we look at are doing interesting things like BlueScope, for example, in how to make that less emissions intensive in the manufacturing of steel. Now look, as it stands, Fortescue have definitely put in the in the ethical category. I'd be interesting to see how FFI evolves. Overcoming is. 

Bryce: [00:09:14] If we were to say ethical or unethical on RDA group, where would you land. 

Nathan Hughes: [00:09:19] Ethical. No, I think I think I think that's pretty clear cut. Yeah. 

Alec: [00:09:23] Another tech company maybe not quite in as ethical and industry points about ethical or unethical. Oh. 

Nathan Hughes: [00:09:32] Look, I'm going to sit on the fence because I don't necessarily have a thing against wagering per say. It's obviously screened out of my son, which we can we can talk to you later. What does annoy me, it's not a specific thing. It's an interesting thing is just the level of advertising. 

Alec: [00:09:50] And you're telling me it is unbelievable. It's one of my biggest gripes. Just allow them to exist, but not to advertise.

Nathan Hughes: [00:09:57] Absolutely. I think I think it's too much. And I think I'm trying to watch the footy or the soccer with my son, who's eight and bombarded by ads, you know, just will kick off one and a half time. And it kind of drives me a little bit insane. As I said, I'm screens aside for one moment. I'm not against. Wagering per say. However, I think something's got to change in terms of the regulatory backdrop and the advertising that they do. 

Bryce: [00:10:20] Sort of close out not as a stock, but a definitely another asset class, and that is Bitcoin ethical or unethical. 

Nathan Hughes: [00:10:29] So the best to last look, I would say unethical and people probably say because you never make any money out of it. I confess to not understanding it, but from where I see it, values kind of being created out of nowhere. And I'm not really sure what sits behind that or what the longevity of that is. And as I understand it, it's quite an energy intensive process as well. So my new coins and when you're spending a lot of energy, I know some of it is powered by renewables. Now, there are a lot of firms doing that, including I think a couple listed in the US. Now when you spend a lot of energy and power to mine, something of questionable value and for me is something more akin to speculative and speculative asset class, then I just think that's probably unethical. 

Alec: [00:11:16] Yeah, it's it's it's a very divisive one. There's obviously a reason we included it in the in the run site here. Yeah. You mentioned you mentioned the the renewable energy Bitcoin miners. I think there's an Australian company that we should, I should try and remember that name and shout them out. Iris Energy that's. 

Nathan Hughes: [00:11:35] I think it's Iris Energy. 

Alec: [00:11:36] Yeah, yeah, yeah, yeah. So you love to see Australians trying to, trying to work on that problem and figure that one out. But look Nathan, we could talk crypto all day. We're not going to we're going to we want to turn, I guess to you your story and then talk about your ethical fund of perpetual. I'm sure some companies that you're you're watching in the market today. So we love to go back to how people started out as investors and hear the story of their very first investment. We generally find there's a good lesson or a good story that comes out of it. So can you tell us the story of your first investment? 

Nathan Hughes: [00:12:09] Absolutely. Yes. There was a very important lesson come out of it. I wish I didn't have to tell this story. It was early 2004 and it was in a stock called Unwired. And I think I think it made like Internet routers or something. It was sold, but evidently it didn't make any money. And I promptly dusted half of my investment. But that was in and of itself a really good lesson for me and a bit of a wake up call that I needed to actually figure out how everything worked and how businesses work and how stocks worked. If I was trying to try to make money in the future, look, I was that was one of a few investments of that stage in my life. I just had a full time job that obviously piqued my interest in the in the market. And then I went on to work in accounting and study finance at university before I found my way to Perpetual in 2010. But yeah, look, it was, it was incredibly poor investment, but it gave me the drive to actually figure it out and do some learning. And from there, obviously studies and a lot of books on investing and I've read several other over the years since, well. 

Bryce: [00:13:17] We will get to books at the end of the episode. But Nathan Ren said at the top of the show that ESG is a pretty hot topic in the Equity Mates community at the moment, and rightly so. But we're pretty interested to understand how you you have seen the focus on ethical investing evolve and change over over your 11 years at Perpetual. So you can talk us through, you know, what it used to be versus how it's kind of playing out now. 

Nathan Hughes: [00:13:42] Just for a bit of background for your listeners and yourselves, I've managed this fund for three years but have obviously been part of the organisation for nearly 12 now. And I think when I first started I wasn't as close to the equities team but it was certainly seen as a bit more. Nation is probably too strong a word, but it was certainly a satellite, if you can call satellite and portfolio construction and things like that. Now it's absolutely mainstream. So I run an ethical fund for the very notion of ESG, and thinking about companies across a whole range of factors is very much par for the course. It's integrated everywhere and gets a lot of attention. And look, there's a number of reasons for that. There's obviously a growing focus on climate giving volatility, weather patterns, to mention, one, there are regulatory changes like modern slavery and things like that. But I mean, I take a step back and I think notwithstanding the extra attention that it garners at the moment and the focus from clients and and investors as well, particularly younger generation, thinking about a company from an ESG perspective is just part of our job. We have four quality filters at Perpetual, one of those it's name quality of business. But really we're trying to think about the very nature of the company or organisation we're buying. You know, what's the competitive position of the company, what's the industry structure like, what's the culture like of the business? And when looking at a business from an ESG lens, that's really an extension of business quality in my eyes. So in one way, it's absolutely. We've seen a lot of flows into the space up until very recently, you know, performance of ESG funds had been excellent globally and a couple of Aussie funds that have done particularly well. But as I see, it's actually been cause the investment process for some time now. But definitely it's accelerated. It's one of the first questions we get from researchers or end investors. It's very much front and centre these days, which is a big change from ten years ago. 

Alec: [00:15:40] Brazil I often speak about because, you know, we've only been doing this podcast for four and a bit years now and even in that time that like the influence that ethical investing has had and the focus it has from the, you know, the Equity Mates community and the broader investment public is just crazy. Do you think there'll be a time when we stop calling them ethical funds and it's just like par for the course? Every fund, it's a consideration. It's just, you know, table stakes for companies to take. 

Nathan Hughes: [00:16:06] Yeah, absolutely. I think we're actually not that far away from that at the moment because it is. And part of it is obviously sustainability and wanting to make things better. Part of it is regulatory driven incentives. For example, in Europe, if you look at what they're doing on carbon pricing and border adjustment mechanisms, I mean, that obviously has relevance for companies all around the world. So the regulatory angle to it as well. And there's a younger demographic of investor that has a little bit of a different mindset as well and wants to invest, align with their values. And perhaps their values are no different than smaller demographics. I agree with you. I think it will become par for the course because some of the challenges, whether it's seen as an ESG or otherwise, some of these challenges like the need to decarbonise, they're just par for the course. It doesn't matter what sort of fund you're running if you're if you long an industrial utility like say an AGL, which we're not. The debate is that an ESG issue is just an existential business issue. I don't know. But I think more to go hand in hand. So I think in a roundabout way, to answer your question, I think we're not far away from that point already. 

Bryce: [00:17:10] So, Nathan, we've had a pretty long run up to this next question, so we'll just fire away. Can you explain the investment philosophy underpinning give and then perhaps following on explain some of the screening processes that you use, as you've mentioned already. 

Nathan Hughes: [00:17:26] So GIVE is a listed ETF, but it's an extension of our unlisted unit trust. In fact, it's exactly the same portfolio. The only difference is it's listed on the ASX and has a different fee structure. The unlisted funds been around for 20 years, as you guys mentioned at the start and at Perpetual, we are what we call a bottom up stock picker. So we're looking at stocks on a bottom up basis, that is stock by stock. We're not setting up our portfolios to take big macroeconomic bets or views. What we're trying to do is buy good quality companies at attractive valuations. I know it sounds really simple, but that's really what we're all about. And I think a lot of good investing is just really about discipline and sticking to that process. So we have four quality filters here at Perpetual around the quality of the business, the people running the business. We're looking for businesses that are profitable and generate recurring earnings and we're looking for conservatively good balance sheets or really strong balance sheets. We believe those four sources really protect us in times of volatility or when things go wrong, as they inevitably will. So the difference for my fund is we run two definitive screens and we call them the what and the how. And the first thing we're looking at is what a company does. So we're looking at activities of the company and some of the common things that are screened out alcohol manufacturing, distribution, tobacco gaming, fossil fuels, amongst other there. Certainly some of the bigger exclusions. And the way we assess that is that a 5% revenue materiality threshold. We look we talked about the banks early. I mean the bank's exposure to fossil fuels falls well below that threshold, as you'd expect. That's quite a small proportion of their loan book. But if a company has more than 5% of its revenue from any one of those activities, it's screened out from the first step of our screening process. So I mean a couple of examples would be BHP as it stands today, as it stands today rather with its oil and gas exposure, which it's about to dispose of, Aristocrat Leisure, something like a crown, you know, stocks of that nature excluded from the first step of the process. Then we run a second step, which is scoring a company across a whole range of ESG measures, and we're looking for a net positive score to then be eligible for the investable universe. So we try and keep a balanced score. We look at a whole different bunch of things. We look at environmental performance, safety, performance, governance, sorry, of the company. We're looking at all sorts of things to come up with a score and we're looking for net positive scores for inclusion in the universe. Then once we've passed those two filters, in addition to the full filters that are build the portfolio, there is one extra thing around give which I think is is a little bit unique and that is the way and really the reason behind the tick are so the idea behind. Is that should the fund perform? There's a performance fee component, but we're going to give a third of that performance fee to charity. And that's that's where they give comes from. So we've got a product where I think it's got a pretty competitive race fee. And I think that that alignment is important for investors, that they should only pay for certain performance rather than take an asymmetric bet. And on the flipside, if we do well, then we'll be giving a meaningful part of that to charity, which I feel pretty good about. It's only early days, but my plan is to grow that into something really meaningful over the next five or so years.

Alec: [00:20:47] Yeah, well that's great. I actually didn't, didn't realise that. So, and you know when we were prepping for this interview I didn't come across that. So Nathan, you got to get out there and shout that from the rooftops a little bit more.

Nathan Hughes: [00:20:59] So I've got to perform first. I've got to do my job through it. 

Alec: [00:21:04] Well, Nathan, speaking of performing and picking good stocks, we've asked for you to bring a couple that are on your watch list or are you keeping an eye on at the moment? And would love to turn to that and unpack them why you like them, how you think about the how ethical they are. But before we do that, we're going to take a quick break to hear from our sponsors. So, Nathan, before the break we played our favourite game, ethical or unethical, and then were introduced to you and the Perpetual Ethical Strife Fund ASX ticker. Give, give a and now we'd love to turn to how are you seeing the market at the moment and a few stocks that you're watching. So if we start broad and with the general market it's it's been a tough year for 2022 to start 2022 I think we can say that. How are you saying it and how you, I guess, positioning your portfolio to take advantage of it? 

Nathan Hughes: [00:22:01] Great question. It has has been pretty volatile, actually, hasn't it? But in terms of how how I'm seeing it, you've had a lot going on. You've had inflation. I think the dialogue around inflation becoming a little bit more in the persistent camp rather than transitory. And obviously that can be a bit of a dynamic for interest rate markets who had an invasion in Eastern Europe and the rerouting of commodities supply chains, which is, you know, thrown into chaos. Some supply chains are already experiencing see off of the back of COVID and somewhat related to the inflation, also mostly related to inflation. We've had a repricing of interest rate markets as well, which has an impact on all sorts of asset valuations, as you know. And so it's been a really interesting time in terms of positioning for the volatility. Look, we're not macro people. I'm not a macro guy. What we try and do, as I say, is build robust, diversified portfolios of good companies. So part of the prep is just really being sure of what you're buying in the first place. So making sure you've done the work around valuation and around balance sheet because it gives you that level of resilience. And then looking for opportunities, being open minded and looking for opportunities to come out of the woodwork. I think at an aggregate level, the broad 300 index is not much above zero for the financial year to date, but there is a big divergence in that where resource companies have done quite well. Industrials have have struggled, especially small industrials, they've underperformed quite materially. So we're looking in those sorts of areas and just looking to take advantage of a little bit of weakness. The last comment I make is it seems to be a lot of talk around imminent recession with rate rises and things like that. I acknowledge that unemployment, it falls probably as good as it gets. I struggle to say, Oh, I know this guy. Famous last words. I don't make macro calls, but I struggle to see how bad it can get near term. But the reason I do say that is because consumer balance sheets were boosted quite materially through October through a lot of government stimulus, and that's been evident in savings rates, which have not fully come back down. That's evident in bank system deposit growth. People were ahead of their repayments on their mortgages, has improved quite dramatically over 18 months. So there's a few good signs there that the consumer is actually starting in a reasonable position. So notwithstanding the volatility, I don't think it's time to get too bearish in aggregate. 

Alec: [00:24:23] I love that sentiment. Now you've jinxed it, so. 

Nathan Hughes: [00:24:27] It's all over. Tell us. I'm sorry. 

Alec: [00:24:30] And before we turn to your this some individual stocks, I've got to ask, has it been difficult being an ethical fund manager, watching fossil fuel stocks just absolutely rip to start the year? 

Nathan Hughes: [00:24:42] Yes, in a word. And look, I mean, kind of what attention is with Woodside, the reality is, as it stands right here, right now, so not in the psyche of on net zero where we need to be down the track, which I think we can all agree on. But as it stands today, hydrocarbons are in demand. And one of the books announcing that late I won't give it away, it talks about cycles and investment. And there hasn't been any investment in energy for some time because people have been one has been a bit of an ESG angle and there's been also a CapEx discipline angle from investors of oil companies. So it's actually not particularly surprising to see what's happened with a lack of investment and a tight market from a performance standpoint, that's been a little bit challenging. You've obviously seen oil stocks, coal stocks. Most commodity stocks have done quite well, actually, which has been a headwind for performance, no doubt. But I believe that thing comes and goes in cycles and over the long run we'll do just fine. And to be fair, performance has been okay. Not seeing that have been, which is is obviously pretty pleasing. Yeah. 

Alec: [00:25:52] And we should say like we as much as we are pretty binary in terms of, you know, fossil fuel, no fossil fuel when we speak, we say that fully recognising that even in, you know, most or almost all net zero scenarios, we still are producing oil like the world isn't going to get zero hydrocarbons like Exxon. All of them will still be around in 2050. 

Nathan Hughes: [00:26:15] Yeah, that's right. I mean, there's a lot of different paths. We're going to need some part, but we do need to change. Things have to be if we're going to get to where we are and to get to even if we're talking in 2050. And that's something that does my. A little bit. When we're looking at companies and we're talking about 2050, I think what's really important for us is the steps they're taking in the interim. So what interim targets do they have? Are we talking at Target in 23 or 2025? We need to try and hold these companies to account and make sense of what they're saying, but make sure it's not just a fake promise off in the distance if someone else has to worry about. We're looking at these companies to make sure they're taking action today because we need to start today to get on that path. 

Bryce: [00:26:55] So, Nathan, let's have a chat about some of the stocks in the portfolio. We love stocks specific shot at Equity Mates. So if possible, maybe we get through three. Yeah. If you can let us know sort of what the company does, why you like them or what's the thesis that gets them in the portfolio? And then equally, what are some of the risks that you think about and what could actually break that thesis and then how you think about this from the point of view of SGA as well. So yeah, let's kick it off. What's what stock number one? 

Nathan Hughes: [00:27:27] Absolutely. Well, look, I think it's only fair that I talk about the biggest holding in the portfolio stock number one. So that's Insurance Australia Group and the name kind of gives it away doesn't have to date right home and motor insurance and also a lot of commercial insurance, home motors, what we call their personal lines business the most recognisable brand in that business, fearless. It would be NRMA. So what they do is they, they basically take risk on for a price essentially on your home or your car. And why do I like the stock? Because there are some challenges here, but I think some of that's reflected in the price, hence why we've made the investment that we have. I think the core franchise in Australia is a very, very strong business, so it got a great market share, the receding small bits of share to the Challenger brands that have been for some time. It's a slow process and they're their shares really strong. This gives them a lot of scale and power in the market in terms of why the opportunity we always going to ask, so what's what's wrong? Was the market not like their stock? They've had a couple of particularly bad years in terms of natural perils and what we say natural perils. We're just saying bad weather, essentially. So we've had we've had bushfires. And this year, as any Sydneysider will know, we've had about ten years worth of rain in six months, and that is a problem for insurers. It drives their bad weather, drives their claims that we've had some some terrible floods up north as well. We've had a lot of challenges. Now with an insurance company, there is always going to be volatility in earnings. There are good times and bad claims. Yes, we think the market is capitalising the stock on what we'd say to be below mid-cycle earnings. So we've had a bad claims experience in recent years and the market is capitalising that into perpetuity and they do that in a few ways. They'll up their budget and perils. Costs are also up their reinsurance costs and they have a detrimental, detrimental effect on margin. These things go through cycles and it's our firm belief that the mid-cycle earnings power of this business is much higher over the medium term. The final kicker as well could be interest rates. So as an insurer, you take premiums in day one. So potentially payout claims down a track perhaps 18 months or two years later. In the case of IAG, and you can invest those reserves, what they call technical reserves, to earn an income over the interim period. And the interest rates have been obviously quite low and that's looking far more optimistic. So investment income is going to come up as well. The reasons we like it and those negativities, which we think are negatives rather than factored into the stock price, but they're also the risk to the thesis. So the risk is obviously the changing climate which the company has been doing a lot of work on and to mitigate in certain ways their reinsurance arrangements and how they price the policies with all the data that they've got a flow on effect of that is obviously reinsurance pricing as well. So the risk is that we're too optimistic on margin recovery, whereas reinsurance costs may continue to rise. The other risk I'd talk about is an adverse outcome on the business interruption insurance provision. So they've made a relatively conservative provision in my eyes, for business interruption insurance. If that was to go against them in the courts, I mean, that could be a downside risk for the stock as well. But look at a couple of reasons why we why we like it. We think a lot of the risks are well understood by the market. And it's often a case of trying to take a bit of a longer term view than a few other people. And I think the company can take through a few of these challenges over the next 12 to 18 months, and that might drive a rewrite in the stock.

Alec: [00:30:59] So, Nathan, thinking about insurance companies, I was trying to think what would it take for an insurance company to be unethical? And, you know, I was trying to apply that 5% threshold that you spoke about earlier, and I couldn't really think of anything. The best I could come up with is maybe they have a really bad policy payout ratio. And and maybe that's something where you're like, oh, they're not treating their customers that well. But like, what would I guess, what would it take for an insurance company to be unethical? 

Nathan Hughes: [00:31:28] It's worth highlighting. The idea hasn't been perfect either they had a problem with. One of the other problems they faced is they incorrectly calculated some of their pricing, which led to their customers overpaying brought in for an insurance reputational. It's not paying out claims correctly, is treating their customers poorly. It's writing policies that, you know, there is a policy there, but it doesn't actually cover news for anything because of the technical legalese. I mean, they're some of the biggest challenges, I would say, from an ethical perspective. It's really customers and integrity and how they treat their policyholders. 

Bryce: [00:32:01] So Insurance Australia Group was the first stock. Let's turn to the second. What is it, the second largest holding in the portfolio?

Nathan Hughes: [00:32:10] No, it's not. I won't bore you with another. 

Alec: [00:32:14] We laugh about that, but the biggest portfolio holdings should also be the biggest conviction. So that wouldn't be that funny if that were the topic. 

Nathan Hughes: [00:32:22] Well, I'm going to go to the fourth biggest name. So that's that's a company called Brambles, which has been in the in the papers a little bit. 

Alec: [00:32:32] This is yeah, I I'm a big fan if I were to steal your thunder. But I think anyone that can sell a couple of planks of wood painted blow that much, that's a great business. 

Nathan Hughes: [00:32:47] Look in all seriousness why it is we you think it is good business is they are an important part of supply chains they're an important part of this and CGI businesses globally moving products around. And they are actually, in all seriousness, important part in reducing wastage in supply chains like food waste and things like that is actually a big problem. And Brambles goes some way to solving that. I would call out just from an ESG standpoint straight away, that they do use a lot of timber in their products. But in a comparative sense, since some of their peers or what we call white wood pellets, which is buy and re-used brambles, operate rental tools. So there's basically a closed loop system where it goes from customer to supplier and back to Brambles through their network. So actually reusing the same stuff more often, which is obviously more environmentally friendly. And look, they are doing good things as far as their sourcing goes and also replanting to take care of wood that they use, that they're replanting stuff. So I think from a sustainability perspective it's very much focussed on a circular economy. I think we're doing good things and it's certainly a far more environmentally friendly offer than some of the what peers like in terms of why we like the company and why we've made an investment of these levels or actually a little bit higher. I'm being completely honest with you. There are three businesses geographically split with not a lot of synergy between them and very regional markets. So the iPod business, the European business and the US business, it's interesting, the US business has been problematic for some time now. It doesn't generate a lot of free cash flow and obviously with the spiking lumber price in the US that's put more pressure on cash flows in that business. So you don't see it day one through the panel because it's a CapEx cost, but it does obviously impact their free cash flow. But what we do think is the concern over that business and indeed the fear of them potentially doing a plastic pilot pool with Costco, say a lot of value off the stock price. So a point where if you look at some of the parts base is actually not paying a lot of money for the two really good businesses that do generate great returns to generate cash flows, and that's Europe. And so we think there's an opportunity there for a couple of reasons. I think Lumba would normalise some of the building there in the US eases that obviously has a beneficial impact to cash flows in the US. We think the pricing actions probably would have been got a little bit harder to recover cost inflation, but we are starting to see that come through. So you're seeing revenue improvement and we do think they've got a really strong market position at heart in the US. So I mean to us it's not a surprise. It has been a bit of corporate interest, whether it's in totality. The CBC was rumours or even for that US division and I think selling that the US division could unlock a lot of value and return some pretty meaningful capital about to shareholders.

Alec: [00:35:35] Yeah, well, Nathan, we could speak Brambles all day, but I am mindful that we're brushing up on 40 minutes here, so we should move quickly to your third one. Otherwise I'll talk about pallets until the cows come home. So briefly, do you have a third company that you're watching or that that's in the portfolio that you think is an interesting one to chat about?

Nathan Hughes: [00:35:55] I'm like, what I'm watching, but it's not in the portfolio and I'll try to be really quick. So Gravel is a company that we've been used to on here potential. I've got tons of their products in my kitchen to the point where my wife said, Why don't we own shares? And I had to try and school her in the art of valuation. But look, it's a quality company. It's growing, they make great products. The one niggle in my mind, apart from valuation, is just how much of a COVID beneficiary they were with stay at home and how much sales got pulled forward. That's tricky to figure out because they are growing quite quickly. Base level by expanding into new geographies. But it's a company I'd like to own at the right price from an ESG standpoint for them, but it really be about getting comfort in their sourcing and supply chain and making sure everything was okay in that regard. And also thinking about end of life. What can they do from a product stewardship standpoint to make things worse impactful when they no longer work? So that's one that's not in the portfolio at the moment, but is definitely on the watch list as of recently. 

Bryce: [00:36:55] Nice Will Préval is a fan favourite over here as well. The one we've talked about often on the show and Ran doesn't stop talking about his Breville coffee machine. So I can say. 

Nathan Hughes: [00:37:05] Can I ask is it which one is it? 

Alec: [00:37:08] It's I don't know what model it is, but it's the full like grind the beans. Yeah, it was my 2020 COVID lockdown purchase and I've never looked back. 

Nathan Hughes: [00:37:20] It's awesome bother your housemates. 

Alec: [00:37:21] Yeah. My my housemates of free riders on it at the moment. 

Bryce: [00:37:27] Well Nathan that does bring us to almost the close of the episode. We do have three questions that we always finish with, but I just wanted to certainly thank you for your time talking us through your approach to all your your fund's approach to ESG. A reminder that the ticker for our audience asks Give J5 a thanks to Perpetual for supporting this episode as well, and we'll put some links in the show notes to the Give website as well, if you wanted to check out more information on that. So yeah, thank you very much for your time. Nathan Bertrand We've always, always finished with the final three, so let's crack in. 

Alec: [00:38:04] That's right. Nathan, you mentioned books a couple of times and you said you were going to hold them until the end. Well, now's now's the time to to share them with us. Do you have any books that you consider a must read?

Nathan Hughes: [00:38:15] I've got a few seeking wisdom. Five. I called Peter Babylon, which is a nice all rounder from an investment standpoint. One Up on Wall Street, Peter Lynch, the one I alluded to earlier, this turns capital account and capital returns. And it's a collection of letters written by guys at Marathon Asset Management over a number of years and through market cycles. Like that's probably my favourite investment book ever read. And just again, off pace, the one book that kind of made me a bit annoyed because I'm a massive Liverpool fan. But I really enjoyed Alex Ferguson's book called Leading Just About Leadership and I was successful. That was good, right?

Alec: [00:38:52] We'll move on to the second question. Forget valuation, forget how good an investment they are today or whatever. Just purely on on what the company is and its business model, what's the best company you've ever come across? 

Nathan Hughes: [00:39:06] I'd probably say Microsoft.

Alec: [00:39:09] Yeah that is a that is a common as that is a. 

Nathan Hughes: [00:39:13] Yeah. 

Alec: [00:39:13] An unbelievable business. 

Nathan Hughes: [00:39:15] Cracking business network effects. And just like everyone uses their products right and drives you might not think that you do to productivity and value from them have been pretty successful as well expanding into cloud and switching that model from a, you know, an upfront licence to a more recurring subscription revenue model. I mean there's some great businesses over there, there's some great businesses here, but like an app or a Google would come quite overseas. But I think if you put me on the spot, I'd have to say Microsoft. 

Alec: [00:39:43] Yeah, it is an amazing business. Does it pass your HD screen?

Nathan Hughes: [00:39:48] Yes, I know, because until recently, it's been very expensive. Yeah. 

Speaker 1: [00:39:53] Yeah. 

Alec: [00:39:54] Well, look, Nathan, we've loved having you on. Would love to have you back on to talk more ethical investing. We'll do a whole episode of Brambles if we have to, but until. 

Nathan Hughes: [00:40:06] Then, you can we talk. 

Speaker 1: [00:40:06] About it? 

Alec: [00:40:09] But look, until then, we'll end with the question we always end these interviews with. If you think back to your younger self investing in Unwired for the first time, what advice would you give to your younger self? 

Nathan Hughes: [00:40:22] It's really simple. Just understand what you're buying. Make sure you can explain the investment to your kids or someone young and really simple terms. Understand exactly how the company makes money. You going to speculate? Be prepared to to take speculate, type returns. But if you're trying to be a serious investor, just understand exactly what you're buying. 

Bryce: [00:40:45] We had a similar expert finish with something along those lines quite recently. If you can't explain your investment in 30 seconds, you shouldn't be investing in it. Something along those lines. So great, great advice to finish. 

Nathan Hughes: [00:40:56] Thank you. The other thing I'd add is there's no bonus points for degree of difficulty. Yes, you can. No. Says you don't have. Yeah, you don't have to have. And this suits me cause I'm not particularly bright. But you don't have to have a 48 page Excel model or an incredibly detailed, complex thesis that makes you look and sound smarter than everyone else. You've got to figure out a few key drivers and what's going to make the stock go up and understand what you're buying but don't over complicate things. Often the greatest opportunities are staring you right in the face. 

Bryce: [00:41:30] Yeah, yeah. We're about to open a can of worms, but we do also speak about that because we find some investor letters are just overwhelmingly complicated for the purpose of trying to fool investors that they have a great thesis where in actual fact, yeah, we're in actual fact, the best ones that we often rate are just so clear. And in two sentences, you know exactly why they're investing in. Yes I think that is fantastic advice to finish on it doesn't there are no bonus points for degree of difficulty. So Nathan, thank you so much for your time. It's been an absolute pleasure chatting for those listening at home. If you want more information on perpetual, head to perpetual com dot eu, but otherwise we'll have the information in the show notes for forgive. So Nathan, good luck with it. And I hope over time the contribution to charity as well becomes meaningful and we look forward to seeing how that plays out. So thank you very much. 

Nathan Hughes: [00:42:24] Thanks very much, guys. We really appreciate you have me on have enjoyed a lot.