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Future Quality Insights
The path to clean, secure and affordable energy
Investment Insights from the Global Equity Team: Today’s choices and tomorrow’s returns

By Johnny Russell
January 2023

Source: Shutterstock

The changing seasons are nature’s way of reminding us that time moves on. And it is the same in the Russell
household, where my youngest is approaching 18 and his late weekend nights are his way of telling me change isarriving in our home too. There is a dawning that I am heading into a new stage of life. It is exciting, but after 20 yearsof bringing up a family, I also admit to being a little scared of what the next chapter will bring. In markets we often
get obsessed with short-term changes but it can be the slow structural moves—such as a child leaving the home—which can have a more profound longer-term impact.
Bear markets exist for a purpose. They expose the heavy misallocation of capital that in this bear market happened
because finance was too easy. While capital is now more rationed, energy too can no longer be taken for granted. Of
course management teams of energy companies have been aware of this for some time, as they have witnessed theirown cost of capital rise as the shale revolution unwound and climate change took hold.
In bear markets time horizons are compressed and dreams are often shelved as rising costs force management teams
to make difficult choices. These choices impact different stakeholders, often over different time horizons, which
explains why companies adopting a stakeholder approach with purpose could be better equipped to navigate their
way through difficult times and eventually, when the next bull market begins, may be better placed to solve thesignificant challenges facing society over the coming decades.

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Choice One: Energy affordability versus long-term energy transition
Energy markets and policies have changed as a result of Russia’s invasion of Ukraine, not just for the time being, but
likely for decades to come. The environmental case for clean energy needed no reinforcement, but the economic
arguments in favour of cost-competitive and affordable clean technologies are now stronger—and so too is theenergy security case. But solving for clean, secure and affordable energy is not straight forward.
Energy is an input to making substantively everything in the modern world. So when we have shortages—as we do
now—the rising costs of everything acts like a tax on consumption. Primary energy costs at the start of the last century
were about 4% of the global GDP. Today, primary energy accounts for about 12% of total GDP, which is similar to that
achieved in the two oil shocks in the 1970s. 1
Direct energy makes up about 45% of European inflation (Chart 1). However, we also know that 10%–15% of all
primary energy goes into making food for the world’s population—which adds to the inflationary pressure. If otherassociated links to energy are added, we can estimate that approximately 75% 2 of inflation is driven directly andindirectly by energy costs. Our current energy crisis is a core element of today’s inflation and until we solve energy’s
supply problems, we expect inflation to remain stubbornly above most central banks’ 2% targets.
Chart 1: Headline inflation rate with component contributions - Eurozone

Source: Aurora Energy Research, GOV.UK, Eurostat, U.S. Bureau of Labor Statistics, MarketWatch

Today, for every US dollar (USD) spent globally on fossil fuels, USD 1.5 is spent on clean energy technologies. But by
2030, under the net-zero emissions by 2050 scenario, every dollar spent on fossil fuels will be outmatched by USD 5
on clean energy supply and another USD 4 on efficiency and end-uses. 3
If clean energy investment does not accelerate, higher investment in oil and gas will be needed to avoid further fuelprice volatility, while also putting the 1.5 degrees Celsius goal in jeopardy. But if we accelerate clean energy today atthe expense of fossil fuels, we will only exacerbate our energy shortages, given the short-term draw on valuable
energy sources made by solar and wind. These are long-term versus short-term choices that even the experts havedifficulty reconciling (Exhibit 1):
Exhibit 1: IEA illustrates the challenge between short-term affordability and long-term energy transition
International Energy Agency (IEA) executive director Fatih Birol: “If governments are serious about the climate
crisis, there can be no new investments in oil, gas and coal, from now – from this year”. (“No new oil, gas orcoal development if world is to reach net zero by 2050, says world energy body”, The Guardian, 18 May 2021)
IEA’s 2022 outlook: “A huge increase in energy investment is essential to reduce the risks of future price spikes
and volatility, and to get on track for net zero emissions by 2050… an average of almost USD 650 billion peryear ‘will be’ spent on upstream oil and natural gas investment to 2030, a rise of more than 50% comparedwith recent years”. (IEA “World Energy Outlook 2022”, November 2022)

The most suitable near-term solutions include projects with short lead times that bring oil and gas to market quickly,
but also includes areas such as capturing some of the 260 billion cubic metres of gas that is wasted each year throughflaring and methane leaks 4 to the atmosphere—a key driver of our investment in Emerson.
Reference to individual stocks is for illustration purpose only and does not guarantee their continued inclusion in the strategy’s
portfolio, nor constitute a recommendation to buy or sell.
1 Thunder Said Energy, “Energy Shortage: fear in a handful of dust?”, November 2022
2 Nikko AM estimates
3 IEA, “World Energy Outlook 2022”, November 2022
4 IEA, “World Energy Outlook 2022”, November 2022

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2Demand efficiency and productivity could also be key and in this field, there has been significant progress. A recent
German IFO survey suggested that most companies—in this case 75% of those that use gas as a primary energy
source in their production—have found ways to reduce gas usage in the last six months while still meeting production
targets (Chart 2).
Chart 2: Reduction of natural gas consumption in the production process (%)

Source: IFO Business survey, October 2022

In fact energy efficiency is the number one place to look for solutions to this energy crisis. While energy costs soar,
CEOs are expected to look at ways to make their businesses more resilient and reduce their energy burden. Paybacks
on energy efficient investments will be very high, in our view, and are unlikely to be shelved if and when a recession
starts. We see this providing tailwinds for long-term holding companies such as Schneider and opportunities within
the energy services companies, where cash flow returns could accelerate to double-digit levels. This is certainly asignificant part of the reason for our more recent investments in Worley & Schlumberger.

Choice two: ESG recession versus stakeholder capitalism
Recent market history suggests that commodity prices will correct with a recession and if central banks have theirway, a recession is exactly what we may get. Our own experience tells us that we should prepare for where the cutsmight be. Some are obvious—such as advertising and marketing. These cuts have already started as can be seen by
the demise of Google or Meta. For many others their earnings recession is just starting.
Corporates are also expected to cut capital projects and the following June 2022 Gartner poll provides some insight
into where these might be (Chart 3). The results are not surprising—but significant reductions in investment for
improved sustainability and environmental impact is worth raising.
Chart 3: Investment categories to be cut first—surveys

Source: Gartner, July 2022

Reference to individual stocks is for illustration purpose only and does not guarantee their continued inclusion in the strategy’s
portfolio, nor constitute a recommendation to buy or sell.
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3While corporates may sharpen the knife on sustainability, what is surprising to many is the backbone behind policychanges in Europe and the US (among others) which instead of accelerating fossil energy supply, are expanding
incentives and targets for alternatives, such as wind, solar and hydrogen. The REPowerEU Plan was launched by theEuropean Commission earlier in 2022 to reduce the European Union’s (EU) dependence on Russian fossil fuels in a
direct response to the Ukraine invasion. The plan calls for the EU to consume 20 million tonnes (mT) of hydrogen by
2030, instead of the 5mT target previously quoted in the Fit For 55 policy announced just a few months before, as an
example. If we feared a clash between decarbonisation and short-term energy needs, decarbonisation seems toremain society’s number one target.
The bull market for ESG data and integration has been stratospheric. Changing demographics, rising inequality, therise in the importance of externalities such as nature and increased influence of the state through regulation all havea part to play. But as was the case in prior recessions, we should expect ESG to be less of a focus for management
teams as they divert their attention to short-term challenges or for some simply staying afloat (Chart 4). In our view,
expensive virtue signalling does not perform well during recessions (e.g. Tesla).
Chart 4: Long-term bull market for ESG—with a few blips

Source: Bernstein research and Bloomberg, October 2022

In terms of energy shortages, we may play out the 1970s again. We also appear to have returned to that decade toquestion the role of shareholder primacy, with both business leaders and politicians (e.g. business round tables andthe Davos Manifesto), suggesting we are on the verge of a fundamental reshaping of society. This slow, structuralchange is of course not new and ESG is a key cog if stakeholder capitalism is to work.
Given the shift to stakeholder capitalism is such an ideological shift, it shouldn’t surprise anyone that we are now
seeing an ESG backlash, the most vigorous of which is targeted at greenwashing. Survey evidence aroundsustainability suggests trust is low. For example, three out of four institutional investors do not trust companies toachieve their sustainability targets and commitments. 5 And of course, the measurement of ESG data is fraught withdifficulty; while credit ratings correlate 99%, the correlation of external ESG ratings ranges between 38% and 71% . 6
For some, ESG is leading to a significant misallocation of capital and is morally bankrupt. 7 8 The situation has
prompted some regulators, such those in the predominantly Republican US states, to try and alter the direction of
travel and ban ESG investing altogether.
Yet, many companies today are making major decisions, such as discontinuing operations in Russia and protecting
employees in at-risk countries. They also continue to commit to science-based targets and to define and executeplans for realising these commitments. This indicates that ESG considerations are becoming more—not less—important in companies’ long term decision making.
In fact, at Nikko Asset Management we believe companies should adopt a stakeholder approach. Companies must
approach externalities as a core strategic challenge, not only to help future-proof their organisations but to deliver
meaningful impact over the long term. Some companies that have already built purpose into their business models
and are demonstrating they benefit multiple stakeholders are already showing success, such as Microsoft or lesser
known companies, such as Compass Group.
Reference to individual stocks is for illustration purpose only and does not guarantee their continued inclusion in the strategy’s
portfolio, nor constitute a recommendation to buy or sell.
5 Edelman, “2021 Trust Barometer Special report: Institutional investors”, November 2021
6 Florian Berg, Julian Kölbel and Roberto Rigobon, “Aggregate confusion: The divergence of ESG ratings”, Review of Finance, forthcoming, updated
26 April 2022
7 Bérengère Sim, “Ukraine war ‘bankrupts’ ESG case, says BlackRock’s former sustainable investing boss”, Financial News, 14 March 2022
8 Steve Johnson, “ESG outperformance narrative ‘is flawed,’ new research shows”, Financial Times, 3 May 2021

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In recent years, boards of directors have become increasingly focused on corporate purpose. This is partly driven by
a sense that purpose drives corporate culture, helps attract and retain talent and is increasingly a differentiator whenit comes to customers and suppliers.
External pressure on corporate boards to define purpose better has come from investors, who are themselves being
asked to justify their own investments on the basis of ESG as well as financial considerations.
A single, clearly marked path that every business should follow does not exist. Strong corporate leaders recognisethat social expectations constantly evolve and we believe that it is the company’s purpose that guides management,
fund managers and owners through difficult times.
A recent Mckinsey study developed a framework for summarising key ESG approaches. This highlights characteristicsof those at the forefront of stakeholder capitalism, fully integrating ESG into strategy and operations—listed as “NextLevel Practices”. Companies adopting stakeholder capitalism are seen to be enhancing their company’s competitive
positioning. They have purpose and can articulate why stakeholder capitalism is creating a competitive edge (Exhibit
2).
Exhibit 2: Corporate approach to ESG and stakeholder capitalism

Source: “How to Make ESG Real”, McKinsey, August 2022

They are a more attractive place to work for their employees—retention rates are higher than peers—successfully
fighting the war for talent, while some are discovering new solutions needed to solve many of our current problems,such as climate change.
We can already see success in many of our own holdings—such as Danaher, Sony, John Deere or Rentokil to namea few. These companies are creating their very own superpowers, enhancing their franchise and management
qualities and creating value (Exhibit 3).
Exhibit 3: Examples of Future Quality purpose statement“Helping realize life’s potential” (Danaher)“Fill the world with emotion, through the power of creativity and technology”. (Sony)“We must act with urgency today to make the lives of our customers, workforce, and all those we
serve better tomorrow”. (John Deere)“To protect people and enhance lives” (Rentokil)
Reference to individual stocks is for illustration purpose only and does not guarantee their continued inclusion in the strategy’s
portfolio, nor constitute a recommendation to buy or sell.
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5Our own experience is supported by academic research. Work by Ariel Babcock et al. titled “Walking the Talk: Valuing
a multi-stakeholder strategy” links the importance of stakeholders and stronger operating performance across anumber of metrics. 9
These management teams are committed, empathetic and demonstrate with full and transparent disclosure of datathat they are on a journey of continuous improvement. They invest with a long term investment horizon and areprepared to make difficult decisions, some with potential trade-offs across different time periods. But when backed
by a clear purpose statement that creates value for all key stakeholders, these management teams can “walk the talk”.
Remuneration and incentive schemes are linked to measurable ESG targets and integrated reporting—such as
diversity targets or emission reduction targets. And they are preparing themselves for further regulation such as theintroduction of separate ESG reporting under what is known as “Double Materiality”.

Conclusion
In conclusion clean, secure and affordable energy is likely to be one of the major challenges of this decade. Given weneed abundant energy to complete the energy transition, we believe fossil fuel companies that are actively enablingtransition to low carbon society can be part of the solution. They often understand how to deliver global energy at
scale and have the balance sheets capable of enabling the transition to clean energy.
We also believe companies adopting a stakeholder approach will be better equipped to solve the significant
challenges facing society over the coming years, and that a clearly defined purpose will help guide management
teams through the challenges and choices they will have to make.
After all, it is the choices made today that will define the Future Quality returns of tomorrow.

9 Ariel Babcock et al., “Walking the talk: Valuing a multi-stakeholder strategy”, FCLTGlobal, 17 January 2022

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Source: MSCI ESG Research, September 2022* Underlying score is the MSCI ESG Quality Score. Carbon Footprint is
Weighted Average Carbon Intensity Fund is a representative account of the Nikko AM Global Equity Strategy.
Benchmark is the MSCI ACWI.

Global Equity strategy composite performance to November 2022
190%
170%

Nikko AM Global Equity Composite – Cumulative Returns
October 14 – November 2022
138.1%

150%
130%
110%
76.5%

90%
70%
50%
30%
10%

Sep-14
Nov-14Jan-15Mar-15May-15
Jul-15
Sep-15
Nov-15Jan-16
Mar-16May-16
Jul-16
Sep-16
Nov-16
Jan-17Mar-17May-17
Jul-17
Sep-17
Nov-17Jan-18Mar-18May-18
Jul-18
Sep-18
Nov-18Jan-19Mar-19
May-19Jul-19Sep-19
Nov-19Jan-20Mar-20May-20Jul-20
Sep-20Nov-20Jan-21
Mar-21
May-21
Jul-21
Sep-21
Nov-21
Jan-22Mar-22
May-22
Jul-22
Sep-22
Nov-22-10%

Nikko AM Global Equity

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All Countries World Index *7

Nikko AM Gross Annualised Returns(USD) %
Global Equity Strategy Composite

1 year
-13.682 years
1.81

3 years
9.50

5 years
10.65

Since
Inception
11.21

All Countries World Index*-11.62

2.67

6.63

6.41

7.21

Excess Return

-2.06

-0.86

2.87

4.23

4.00

*The benchmark for this composite is MSCI All Countries World Index. The benchmark was the MSCI All Countries World
Index ex AU since inception of the composite to 31 March 2016. Inception date for the composite is 01 October 2014. Returns
are based on Nikko AM’s (hereafter referred to as the “Firm”) Global Equity Strategy Composite returns. Returns for periods
in excess of 1 year are annualised. The Firm claims compliance with the Global Investment Performance Standards (GIPS ®)and has prepared and presented this report in compliance with the GIPS. GIPS® is a registered trademark of CFA Institute.
CFA Institute does not endorse or promote this organization, nor does it warrant the accuracy or quality of the content
contained herein. Returns are US Dollar based and are calculated gross of advisory and management fees, custodial fees
and withholding taxes, but are net of transaction costs and include reinvestment of dividends and interest. Copyright ©
MSCI Inc. The copyright and intellectual rights to the index displayed above are the sole property of the index provider. Anycomparison to reference index or benchmark may have material inherent limitations and therefore should not be relied
upon. To obtain a GIPS Composite Report, please contact GIPS_inquiry@nikkoam.com. Data as of 30 November 2022.

Nikko AM Global Equity: Capability profile and available funds (as at
November 2022)
Available strategies

Global ACWI, Global EAFE, Global Developed, Global ex specific country, Sharia,
Dividend

Available vehicles

UCITS-SICAV, Country domiciled mutual funds, unit trusts, investment trusts andsegregated accounts

Key Features of Global
ACWI

Current Positioning

Investment Objective

Guidelines+3% vs MSCI AC World

No. of holdings

44

40-50

Active share

91.8%

90-95%

Cash

1.18%

0-3%

Target return is an expected level of return based on certain assumptions and/or simulations taking into account thestrategy’s risk components. There can be no assurance that any stated investment objective, including target return, will beachieved and therefore should not be relied upon. Any comparison to a reference index or benchmark may have material
inherent limitations and therefore should not be relied upon.
Past performance is not indicative of future performance. This is provided as supplementary information to theperformance reports prepared and presented in compliance with the Global Investment Performance Standards (GIPS®).
GIPS® is a registered trademark of CFA Institute. Nikko AM Representative Global Equity account. Source: Nikko AM, FactSet.

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Nikko AM Global Equity Team

This Edinburgh based team provides solutions for clients seeking global exposure. Their unique approach, acombination of Experience, Future Quality and Execution, means they are continually “joining the dots” acrossgeographies, sectors and companies, to find the opportunities that others simply don’t see.

Experience
Our five portfolio managers have an average of 25 years’ industry experience and have worked together as a Global
Equity team for eight years. In 2019, two portfolio analysts, Michael Chen and Ellie Stephenson joined the teamfollowed by Finn Stewart in 2022, they are the first in a new generation of talent on the path to becoming portfolio
managers. The team’s deliberate flat structure fosters individual accountability and collective responsibility. It is
designed to take advantage of the diversity of backgrounds and areas of specialisation to ensure the team can findthe investment opportunities others don’t.

Future Quality
The team’s philosophy is based on the belief that investing in a portfolio of Future Quality companies will lead tooutperformance over the long term. They define Future Quality as a business that can generate sustained growth incash flow and improving returns on investment. They believe the rewards are greatest where these qualities are
sustainable and the valuation is attractive. This concept underpins everything the team does.

Execution
Effective execution is essential to fully harness Future Quality ideas in portfolios. We combine a differentiated processwith a highly collaborative culture to achieve our goal: high conviction portfolios delivering the best outcome forclients. It is this combination of extensive experience, Future Quality style and effective execution that offers acompelling and differentiated outcome for our clients.

About Nikko Asset Management
With USD 186.3 billion* under management, Nikko Asset Management is one of Asia’s largest asset managers,
providing high-conviction, active fund management across a range of Equity, Fixed Income, Multi-Asset andAlternative strategies. In addition, its complementary range of passive strategies covers more than 20 indices andincludes some of Asia’s largest exchange-traded funds (ETFs).
*Consolidated assets under management and sub-advisory of Nikko Asset Management and its subsidiaries as of 30
September 2022.

Risks
Emerging markets risk - the risk arising from political and institutional factors which make investments in emerging
markets less liquid and subject to potential difficulties in dealing, settlement, accounting and custody.
Currency risk - this exists when the strategy invests in assets denominated in a different currency. A devaluation of
the asset's currency relative to the currency of the Sub-Fund will lead to a reduction in the value of the strategy.

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9Operational risk - due to issues such as natural disasters, technical problems and fraud.
Liquidity risk - investments that could have a lower level of liquidity due to (extreme) market conditions or issuerspecific factors and or large redemptions of shareholders. Liquidity risk is the risk that a position in the portfolio
cannot be sold, liquidated or closed at limited cost in an adequately short time frame as required to meet liabilities of
the Strategy.

Contact us
EMEA – Nikko Asset Management Europe Ltd.
Level 5, City Tower, 40 Basinghall Street, London EC2V 5DE, U.K.
Phone:
Email:+44 (0) 20 7796 9866
EMEAenquiries@nikkoam.com

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