Expert: Velislava Dimitrova – Investing in Sustainable Resources | Fidelity

Bryce: [00:00:14] 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 said. 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 going? [00:00:29][14.8]

Alec: [00:00:30] I'm very good. Bryce Great to be with you for another episode and excited for this one because we're covering a topic that is, I think of interest to a lot of people in the Equity Mates community that is sustainable water and waste. It's definitely of interest to me. I did some work in the waste going back in the day. So very excited for this interview. [00:00:51][21.0]

Bryce: [00:00:51] Absolutely. And we have an expert joining us from Fidelity to talk us all through it. So it is our pleasure to welcome Velislava Dimitrova. Welcome. [00:00:59][8.1]

Velislava Dimitrova: [00:01:00] Thank you for having me. [00:01:01][0.9]

Bryce: [00:01:02] So Velislava is the lead portfolio manager of Fidelity Sustainable Water and Waste Fund, and if you'd like more information on what they're doing, head to the Fidelity website Fidelity dot com Dollars and thank you to Fidelity for sponsoring this episode. So Phil Slava, we'd like to start at the top with an introduction to the fund. So sustainable water and waste, what does this mean and what are some of the companies or themes that the fund invests in? [00:01:31][29.7]

Velislava Dimitrova: [00:01:32] The Water and Waste Fund invests in the food value chain of both the water and waste things. It invests in the full value chain starting from. For example, if we take water, from taking water from nature, purifying water, transporting water or storing it using for domestic purposes or industrial purposes, then again, cleaning and returning to nature in the case of waste. This is again the full value chain starting from companies providing cleaning services or waste collection, different methods of disposal. And we're talking about different types of waste as well, like commercial waste, municipalities, waste or hazardous waste, the type of companies we invest in. To give you an example, in water, for example, this can be water utilities that are maintaining the water infrastructure industrial companies making with like valves and hydrants, and followed by water treatment or purification, and in the ways that is cleaning services, but also with disposal. There are two main methods of disposing waste. Both of them are quite environmentally unfriendly, like burning waste or incineration, or burying once in the ground or selling, and because these are very polluting for the environment and very harmful to both human health and animal. And we're actually shifting the funds to more environmentally practises like recycling or extending the useful life of products. [00:03:05][92.9]

Alec: [00:03:06] So listening to that description, a lot of that makes sense in terms of, you know, we're all citizens. We all understand the importance of better resource use, better waste management, more efficient use of water. So as citizens listening to that, it makes a lot of sense. I guess the question is as investors, why is water and waste a good thematic to be exposed to? [00:03:32][25.4]

Velislava Dimitrova: [00:03:32] That's a great question, because the theme water and waste, as the name says, might not sound very exciting. But actually, it is a very exciting thematic from an investment perspective. And this is because of the extremely long duration of the theme and the great visibility we have in the growth for both the water and waste companies. And this is because water and waste is the foundation for life, but it's also the foundation for economic development, and it is the two sides of the same coin. And these two themes are driven by both the same very long term growth drivers like population growth. We know that over the next 10 years, we're likely to add about 1.2 1.3 billion to the global population, and people are still increasingly moving to cities. Yet infrastructure is not sufficient to handle those volumes. It needs to be upgraded. Consumption is still growing. We know that the growing middle class accounts for about a third of global GDP growth, and this growth is extremely water and waste intensive. For example, a cup of coffee takes 200 litres of water to make, or a pair of jeans takes a thousand theatres of water, and everything that we're consuming today becomes waste on average in a couple of years. Mm-Hmm. Another driver is ageing infrastructure cities in the developed markets. We're not built for these volumes. Just to give you an example, in the US, we have leakage rates of 20 to 40 percent. This is really unsustainable and we need to invest in this. There do more to other drivers that have probably come to our attention more recently, even though they have been around for a while. It's climate change and climate change is leading to water scarcity. He is leading to flooding to invest, to be able to maintain our current standard of living. And finally, a responsible resource consumption, this is mostly primarily changing attitudes amongst the younger population in looking for ways to have a lower burden on the environment. So it is about those very strong long term drivers that make this thing very exciting. [00:05:36][123.9]

Bryce: [00:05:39] At least 70 percent of the funds that you manage is in companies exhibiting sustainable characteristics and then 30 per cent in companies that are showing improvement or potential for improving improvement in characteristics. So let's start with the 70 percent. What are you looking for when you say, exhibiting sustainable characteristics? [00:06:01][22.0]

Velislava Dimitrova: [00:06:02] So we're looking for companies that have very high ESG ratings, and what this means is that these are companies with very good overall practises. These are a very good global citizens and these good practises are in the three buckets in environmental governance and social. When we say environmental, we mean companies where their practises are not polluting the environment. Governance means that we look at issues such as board independence and diversity, amongst other factors, and social covers how the company treats its customers, suppliers and employees and the wider community. [00:06:40][37.9]

Alec: [00:06:42] So then turning to the 30 percent. How do you engage with those companies? How do you, I guess, determine a company that is improving or has the potential for improvement? And then how do you and the team of Fidelity actually engage with these companies and try and drive that improvement? [00:06:59][16.9]

Velislava Dimitrova: [00:07:00] So the 30 percent bucket, as you mentioned, is companies that are might have low ESG rating, but they are on an improving trajectory, as judged by Fidelity analyst. And the basis for that improvement label is what practises the companies the companies are currently installing and how it is changing its practises. And if we have sufficient conviction that is going in the right direction, then we can own that company. But there are some examples where companies are not on an improving trajectory, and those are the companies that we're looking to engage with and hopefully help them improve those practises. [00:07:38][38.9]

Alec: [00:07:39] So Velislava, when we were thinking about this topic, sustainable water and waste, we really couldn't get past the overall population growth that the world is saying and what that means for resource use, the amount of waste that's produced, the amount of water that's consumed. Are we just fighting a losing battle with overall population growth? And I guess what are some of the companies that are on the forefront of fighting this battle and actually overcoming the the overall population growth that the world is saying? [00:08:09][30.1]

Velislava Dimitrova: [00:08:10] If we think about the fundamentals of the companies and whether there are great investments, the growing population is very good for them because means growing a growing volumes. But in terms of sustainability, this is clearly not sustainable. This is why within the fund, particularly within the waste bucket, we are looking to pivoting the funds to what we deem more sustainable practises. Because you're right, the burning waste releases carbon dioxide burying waste in the ground. In some regions, we don't have enough space for this. And secondly, it means chemicals ending up in water and soil, which is very harmful for humans and very harmful for animals and biodiversity. So there are, unfortunately, because of regulation and because of changing consumer attitudes. There are new, new ways of dealing with waste that are emerging that are more environmentally friendly and can hopefully help us deal with the issue of growing waste because of growing population. And these are methods to reduce the volume of waste or new recycling methods or more environmentally friendly materials. So the first bucket I mentioned reducing the volume of waste. We can achieve this by making things, by manufacturing things in a smarter way, by using industrial automation that can help us reduce defects and therefore reduce waste. Or another example is construction software. There is a company that automates construction currently that construction is done the way it was done 100 years ago, and there is a lot of error and therefore waste from those areas. Using construction software can reduce this waste by 20 to 30 percent, which is really material when you think about how much construction waste there. If it accounts for about 40 percent of all urban waste, so significant room for reducing waste. Another example is that second hand wood platforms just people buying things that have already been used, and this extends the life of the product and reduces the amount of virgin materials we need [00:10:07][117.1]

Bryce: [00:10:08] just out of interest, what's the specific construction company you're talking about? Sounds. Pretty interesting, it'd be great to get a name [00:10:14][6.4]

Velislava Dimitrova: [00:10:16] Autodesk, this is the largest provider of construction automation software. [00:10:20][3.6]

Bryce: [00:10:21] Yeah, yeah. And we know Autodesk. We've come across a couple of times on our investing journey over the years. So, yeah, good name. Let's continue the chat around waste management. Are you able to introduce the concept of a circular economy and explain what it is? [00:10:36][15.3]

Velislava Dimitrova: [00:10:37] So circular economy is just the vision. This is where we would like the economy to go into over the next years and decades, which will significantly reduce our burden environment. It is a concept of sustaining economic growth without consuming incremental resources from nature, or at least limiting that to use of virgin materials. It is managing the end stage of the life of the product in a way that materials that have gone into the product can be extracted and used as raw materials. When it comes to water, it is purifying water and reusing water rather than using water from nature. But we are in the very early stages of this. This is where regulation is likely to take us, but it is very early. [00:11:20][43.3]

Alec: [00:11:21] It seems to be the, I guess, the buzzword or like be the goal in a lot of waste companies. You know, you rate the corporate material that the investor updates, their annual reports and the circular economy is definitely mentioned a lot and it feels like more and more with, you know, the increasing focus on climate change and resource use that more and more government intervention is coming and trying to make the circular economy a thing in terms of other important trends or, I guess, emerging technologies that are emerging in the waste space. Are there any that we should be aware of as potential investors in the industry? [00:11:58][37.4]

Velislava Dimitrova: [00:11:59] Yes, there are. Actually, we have been looking at this for years now and there a lot of very exciting technologies. But like everything new, we need to be careful because not all of them are proven and to work at scale. But still, some of them are very, very exciting. An example of that will be the your previous point about circular economy, particularly within Europe. Regulation is becoming tougher increasingly, and therefore we are seeing response from the consumer goods companies. And it is getting tougher around the recyclability of plastic that companies are using in their packaging or the percentage of recycled plastic. And because of that and because of changing consumer additives as well, we're seeing companies coming to the market with new recycling technologies. So currently, penetration of recycling globally is only at around eight to nine percent, which is why we have all these articles about plastic ending up in the ocean and getting animals. And it is such a low level because the technology doesn't exist. We can recycle plastics through mechanical recycling, which is not ideal because the end product cannot be used for the same purposes as virgin plastic. It smells it. It has this ugly colour, so we need new methods to recycle. And there are companies coming to the markets that can do chemical recycling, and chemical recycling actually allows you to have a product that is very similar to the virgin plastic and used for all sorts of applications. Another example would be a very interesting company called Ren Yourself that is able to recycle cotton in clothing. Currently, this is not really recycled and clothing ends up on landfills. But this company can recycle cotton up to seven times, which materially reduces both water that's used for growing cotton and just overall volumes of new cotton as well. Another example is, as I mentioned earlier, second hand goods platforms. These are platforms that you can sell old clothes or anything, really. It would be also biodegradable plastic. There are companies that can make plastic biodegradable in the environment, not not needing industrial composting. So these are very exciting technologies, but some of them are very early stage that [00:14:05][126.7]

Bryce: [00:14:06] are global penetration of recycling was pretty alarming. Eight per cent. I thought it would have been much higher than that. But plenty of work to do, though. So let's turn our attention to the water side when when we think of water sustainability, you know, we think about water scarcity and, you know, inadequate sanitation. Are there any other issues that you think we should be aware of? [00:14:27][21.3]

Velislava Dimitrova: [00:14:28] And so in addition to water scarcity, climate change is leading to extreme flooding as well. Both of these require a significant investment in infrastructure to be able to maintain adequate supplies of water, both for domestic purposes and for industrial purposes. Water is used in in all industries speed, drug manufacturing or food manufacturing, agriculture, all industries. There's also the issue of water purification of wastewater from industrial processes, and in some countries this is not an issue, but for others it is, and volumes are also growing because of increasing use of chemicals. There's also another issue of water pollution with what we call forever chemicals. These are called forever chemicals. Because they lost extremely long time in nature. They don't biodegrade very quickly and they're found in water, they're found in soil, but also because of their broad use. It is found also in blood of people and animals all over the world. And at present, at very low level in the range of food products as well in scientific studies have actually shown that these chemicals are linked to very harmful health effects in animals and humans because of that. One of these chemicals is called pathogens, and it has garnered lots of headlines in the US. The current infrastructure bill has a provision for significant funding for cleaning up PFC contamination in land and soil. So lots of issues there. Yeah. [00:15:55][87.8]

Alec: [00:15:56] So where Bryce and I are recording from Australia and a key issue that we see when it comes to water in Australia is the balance between water scarcity, I guess, and water for agriculture. And I imagine this is a the key issue all around the world. So when you're looking at the portfolio companies, when you're looking globally, how do how do you see the world balancing the need to produce enough food for a growing population and then also the need to conserve water? [00:16:30][33.9]

Velislava Dimitrova: [00:16:31] Yes, you're right. This is increasingly becoming a challenge, and it is obvious in some regions where climate change is progressing faster and we need new solutions to solve that problem. So the solutions do exist, but similarly to previous technologies and discussion from there very early stage. So we need adoption of these very, very quickly. Given how quickly climate change is progressing and these two are, one is agriculture automation and the other is vertical farming. Now agriculture automation is probably a bit more advanced. It already has, in some regions, about 20 percent penetration. And what it means It is a more targeted application of beet chemicals or water irrigation systems that save water. Most farm is irrigated in the traditional way of flood water, just flooding the whole field with water, which is a very wasteful but targeted irrigation systems have the potential to save significant amounts of water. The second one vertical farming is probably even more promising, but it is very, very early stage. But what it can do is it can reduce the water consumption by around 80 percent. It can also reduce fertilisers fertiliser use, which is also great because it reduces leakage of fertilisers into what Ren and land. There may be hundreds of companies working on vertical farming, but it is very early stage. [00:17:55][84.7]

Bryce: [00:17:56] I think the Japanese are big in vertical farming, aren't they? Correct me if I'm wrong, they started. [00:18:00][4.1]

Velislava Dimitrova: [00:18:01] I think if I'm not mistaken, they have. I think they invented it. [00:18:05][4.0]

Bryce: [00:18:05] Yeah, there you go. They go so well. Love it! Before we turn to discussing a couple of the top holdings in your fund. We're just going to take a very short break to hear from our sponsors. So, Velislava, let's turn to company specific. Everyone loves hearing about companies here at Equity Mates, so we really want to hear from you. One water focussed stock and then one waste focussed stock from your top holdings or companies that are certainly interesting at you at the moment. So for each company, it'd be great to hear what the company does and what your investment thesis is, as well as you know, your process for discovery and and the research process to understand it. So if we want to start with the water focussed stock, that'd be great if there are any that come to mind. [00:18:55][50.4]

Velislava Dimitrova: [00:18:56] Yes, there are many great water stocks, but but one example of a very interesting and very we believe very good investment is American water works, American water works. Is it the US company? And it is the largest U.S. water utility and it is also the best in class operator. They have lower operating costs. They have better leakage performance than competitors. They have lower customer bills while enjoying higher growth. These things are all interlinked, unlike many other regulated utilities. Scale is a huge benefit to them. As in states, legislation in the US allows water utilities to spread the cost of older customers. So if you have more customers required, price increases are less. Therefore, American water works can pay more than competitors, and municipalities are likely to sell to them. There is huge runway for growth ahead of them because U.S. water networks are primarily municipality owned, 85 percent owned for water and 98 percent for wastewater. And these networks are hugely underinvested, with leakage rates of 20 to 40 percent. Therefore, municipalities are increasingly selling their assets and because of the American water works advantage, they are the most likely buyer. So very significant headroom for growth. [00:20:17][80.8]

Alec: [00:20:17] Fascinating company. Not one that I've ever really thought about American water utilities, but I'm just I'm just googling it. So it trades on the New York Stock Exchange. The ticker is IWK if people want to do some more research on it. But, if we turn to waste, are there any are there any particular waste names that are really front of mind for you at the moment? [00:20:41][23.9]

Velislava Dimitrova: [00:20:42] So waste is even more exciting because of that transformation they mentioned to these new solutions. But one I didn't mention previously was using recycled waste products into turning waste products into products, and an example of a company doing that is a company called asset. This company is making decking or composite decking from partly from waste wood and waste plastic. So Party's version but largest wastes about half its waste. Composite decking has only 20 percent share today, and it is taking share from traditional or decking because it last longer, and it because it requires less maintenance and it results in a very nice payback for customers in about three years. Isaac are the number two player in the market, but the infrastructure is very attractive and pricing is rational. And the reason we preferred to number two is because no one is significantly more expensive. The top three players have 90 percent market share. I would really like markets that are very consolidated because pricing is significantly better. Demand is very strong and capacity additions in this industry are very modular, so you can react quickly to increasing supply. You don't have the problem of flooding the market with significant supply and affecting prices, and the company has very high, very high returns on capital strategy strategies, actually to increase further the percentage of recycled content from 50 to 75 percent, which actually will increase their margins because you're paying less for for for waste basically than you're paying for virgin materials. [00:22:15][93.3]

Alec: [00:22:16] So that was AZEK. Also trades on the New York Stock Exchange, ticker AZEK. Another interesting company, [00:22:24][7.7]

Bryce: [00:22:25] Before we move to the final three questions, if you're if anyone is listening and interested in understanding more about what you're doing or the fund, head to the Fidelity website Fidelity Dot Dollars you. There is a page for the Sustainable Water and Waste Fund, and we'll include a link to that in our show notes. It's got some great research on there and info on the top holdings. [00:22:47][22.3]

Alec: [00:22:48] So yeah, I love it. The thing that I love is there's a lot of companies that I haven't heard of before in the top holdings, so a good one to go and check out if you're interested in this space. So we'll get stuck into the final couple of questions now and those one that we love to ask every expert. Forget valuation or what they're trading at now, just purely based on the company and what it does. What's the best company you've ever come across? [00:23:16][27.9]

Velislava Dimitrova: [00:23:17] That's an interesting question, because they're very interesting companies out there, and usually we find these where you have high barriers to entry bids, scale or brand or some technological advantage because if you have very strong brand, it allows you to grow at a significantly lower investment than if you are in a very capital intensive industries. If you franchise like, for example, McDonald's similar thing, you can grow with very low investment. But maybe one example it would give is a company called ounces. This is a company that makes multi physics simulation software for various applications. They're used in car production, autonomous vehicles, aviation, 5G. Many, many others and barriers to entry are extremely high and competition very low because they employ many, many, many PhDs and is a business that is extremely difficult to replicate what they have done. This means that basically they have very fast growing applications to themselves with very limited competition. We really like these type of companies because it allows you to have the volume growth, but also pricing on top of this because very often where you have strong volume growth, you have high competition pricing erosion and you don't really generate significant value. Whereas this scandal that [00:24:35][78.5]

Alec: [00:24:36] you love that never heard of that company before, but I've just googled it. It looks fascinating, so I'll definitely put it on my watch list. For those playing along at home, it trades on the Nasdaq ticker AMSS. And then final question? Well, Velislava, though we'd like to end every interview with if you think back to your younger self when you were just starting out in the world of finance and investing. What advice would you give to your younger self? [00:25:02][25.9]

Velislava Dimitrova: [00:25:02] Oh, I would think very hard about what you're good at and what you're also passionate about, because if you can integrate these to in what you're doing for a living, combining work and passion means that you will be fulfilled every day. But also, I have a second one, I guess, and it's start investing early, start investing your thing very early. The power of compounding is hugely underestimated. If you start in your twenties, it's significant difference as compared to just starting your forties. Yeah, so start investing early. Yeah, I love that. [00:25:36][34.0]

Bryce: [00:25:37] It's not surprising how many experts say that that is the piece of advice that they would give their younger self just get in the markets, get in the markets as soon as possible. I think it's a great message to finish on. So thank you so much for your time. Well, Slava, as I said, it's a very important and in-demand topic is sustainability, and you've certainly provided us with some interesting companies that not all of us had heard of before. So I appreciate your time and all the best. [00:26:03][26.5]

Velislava Dimitrova: [00:26:03] Thank you. Thank you for having me. [00:26:05][1.4]

Bryce: [00:26:06] Hey, thanks for listening to this episode of Equity Mates. We love hearing from you, so drop us a line at contact@equitymates.com or even better, go to your podcast player and leave a five star review. Also, a reminder that the Equity Mates content train doesn't stop when you've run out of episodes to binge. We've got a brand new website, a Facebook discussion group where on Instagram, YouTube and slowly making our way as an influencer on Tik-tok. Well, that's Ren. So come and say hello and join the community. We'd love to welcome you. Until next time. [00:26:06][0.0]

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