The commentary appearing in this document represents excerpts taken from selected semi-annual and annual reports published by sustainable mutual funds and exchange-traded funds (ETFs). The intention of the Spotlight is to track relevant commentary and performance results provided by funds that pursue sustainable strategies across varying sectors and asset classes in an effort to better understand how such strategies are directly affecting the fund’s positioning and performance results achieved during the covered reporting periods and also to tease out any information regarding positive societal outcomes achieved through the implementation of these sustainable strategies. These are juxtaposed against the fund’s sustainable investing strategy. Interested readers should consult the referenced fund’s annual and semi-annual reports for the complete text of management’s discussions of investment results, fund positioning, fund performance and outlook. 

Fund Name:  Putnam Sustainable Future Fund (Formerly Putnam Multi-Cap Value Fund)
Investment Management Firm: Putnam Investment Management
Annual Report: May 1, 2017 – April 30, 2018, filed June 29, 2018

Sustainable Research and Analysis Observations:
Effective March 21, 2018, the Putnam Multi-Cap Value Fund changed its name to the Putnam Sustainable Future Fund. While the fund retrained its research-oriented investment process, the emphasis of the fund shifted to focus on sustainability and growth.  The fund’s Russell Midcap Growth Index replaced the Russell 3000 Value Index as the primary benchmark for the fund. Its too early to evaluate the fund’s performance results given its new focus, however, the fund’s historical performance has been sub-par:  the fund’s various share classes only outperformed the fund’s previous benchmark in 5 of 24 (21%) time intervals over the last 1-year, 3, 5 and 10-year intervals.  As for disclosure and transparency regarding stock selection and impact, Putnam offers some examples in this report, but here too, it’s still very early days and it remains to be seen how ESG outcomes or positive impacts are measured and disclosed with regard to clean energy, carbon emissions, improved water quality, good health and well-being, to mention just a few.

Principal Sustainable Investment Strategy:
Putnam believes that companies whose products and services produce positive environmental, social and economic development impact also often demonstrate strong financial growth and profitability. Accordingly, in selecting investments, Putnam considers the extent to which a company’s products or services may provide solutions that directly impact sustainable environmental, social and economic development. Environmental impact may include, for example, reduction of carbon emissions and improved water quality. Social impact may include, for example, fair labor practices and responsible supply chain management. Economic development may include, for example, stakeholder analysis and shared value approaches to business practices. It is likely that the metrics and measurements that Putnam uses to evaluate environmental, social and economic development impacts will continue to evolve over time.

Putnam believes that companies that exhibit leadership in sustainable business practice also often exhibit more profitable, durable financial returns with lower risk profiles. Accordingly, in selecting investments, Putnam focuses on companies that the firm believes have a demonstrated commitment to sustainable business practices. This commitment may be reflected through environmental, social and/or corporate governance (ESG) policies, practices or outcomes.

Annual Report Commentary[1]:
According to the fund’s annual report, Putnam Sustainable Future Fund brings a new dimension to investing in stocks of U.S. companies. The fund’s managers look for companies that offer durable, long-term growth potential for investors, and they also bring expertise in identifying businesses focused on sustainability in their products and services. The fund’s management and research teams seek companies that directly demonstrate positive impact in social, environmental, or economic development.

An emerging discipline
Sustainable investing is an area where the interests of investors are aligning with active money managers seeking to build more resilient portfolios. It is increasingly important for fund managers to evaluate how a company conducts business and the broader impact of its operations beyond financial statements. Recent research on investment performance indicates that companies adopting better corporate practices can achieve better stock performance as well.

Targeting growing companies making a positive impact
Fund Managers Katherine Collins and Stephanie Henderson seek to identify innovative companies that are at the forefront of addressing unmet needs and solving pressing challenges. They also look at ESG (environmental, social, and governance) data to analyze a company’s impact in a range of areas. Examples of positive impact they consider include reduction of carbon emissions, improved water quality, fair labor practices, and responsible supply chain management.

Rigorous analysis of company financial strength
With the goal of delivering capital appreciation for investors over time, the fund’s managers focus on companies with the potential to produce strong financial performance. They consider factors such as the stock’s valuation and the company’s financial strength, growth potential, competitive position, future earnings, and cash flows.

Katherine, the fund has a new investment approach and management team. What can you tell us about the changes?
In December 2017, I assumed management of the fund. On March 19, 2018, the fund became Putnam Sustainable Future Fund and Stephanie Henderson became Assistant Portfolio Manager. We continue to invest in stocks of U.S. companies for investors seeking long-term capital appreciation. Our research-intensive investment process has been a strength for the fund historically, and we do not expect it to change.

What has changed is our emphasis on sustainability and growth. Beyond looking for financially strong companies with growth potential, we want companies that are at the forefront of addressing unmet needs and solving pressing challenges. The companies we choose for the fund are those that we believe are making a positive impact in social, environmental, or economic development. Our process requires both strong sustainability characteristics and strong fundamental prospects.

What are some examples of positive impact?
We analyze a company’s products or services to determine if they may provide solutions that directly impact sustainable environmental, social, and economic development. From an environmental perspective, it could mean improved water quality or the reduction of carbon emissions. Positive social impact could mean fair labor practices and responsible supply chain management — monitoring the standards and practices of suppliers, manufacturers, or other partners. Our investing approach also involves setting explicit goals for both financial return and social or environmental benefit.

Let’s turn to the fiscal year we are covering in this report. How was the investing environment for U.S. stocks?
Conditions for the U.S. stock market overall were generally positive for most of the 12-month period. From the start of the period in May 2017 through the end of the 2017 calendar year, we saw very little volatility in the market and stocks advanced despite a number of political and economic uncertainties that could have disrupted the market’s momentum.

Stocks were boosted further in the final weeks of 2017, when Congress finalized an agreement and passed a $1.4 trillion tax reform bill. For the 2017 calendar year, all three major U.S. stock indexes had their best annual returns since 2013. The Dow Jones Industrial Average, the S&P 500 Index, and the Nasdaq Composite Index all posted dozens of record closes throughout 2017.

The strong performance for the stock market continued into January 2018, but soon after, market volatility increased sharply. In early February, a series of declines pushed the U.S. market into correction territory. This was followed by a number of turbulent sessions that, combined with fears of a trade war, resulted in a more difficult environment for investors. Although stocks managed to post healthy gains for the 12-month period, the final four months were more challenging for stock performance.

For most of the period, the fund focused on value-style stocks. How did they perform?
One persistent theme that defined the U.S. stock market during the period was the outperformance of growth stocks over value stocks, which was a reversal of what we saw in 2016. While it is not unusual for these two investing styles to diverge, it suggests that growth-related factors, such as earnings momentum and improving business fundamentals, drove stock performance, rather than valuations. After leading performance in 2016, stocks of small and midsize companies did not perform as well as those of large companies.

What were some holdings that contributed to performance during the period?
The top contributor to performance was our investment in DXC Technology, an information technology company. Formerly known as CSC, the company merged with Hewlett Packard’s services business in March 2017 to create DXC. We think the merger has great potential in terms of improved earnings power that is not yet fully reflected in DXC’s stock price. Also, in our view, the company has a solid core business and a strong management team, and the stock offers a reasonable valuation given its growth potential.

DXC also aligns with our sustainability focus. The nature of its business is improving efficiency and effectiveness for its customers. An important theme for us is the elimination of waste — whether in terms of time, material, or products — and DXC’s business model exemplifies this theme. In addition, DXC Technology has been recognized for responsible business practices, and shortly after the close of the period, it was named one of the top 20 companies on Corporate Responsibility Magazine’s 100 Best Corporate Citizens List.

Another performance highlight was the stock of Chipotle Mexican Grill, a company that also offers an attractive sustainability profile, in our view. Chipotle is focused on offering fresh ingredients that are sourced in sustainable ways, and the company is committed to reducing food and packaging waste. Chipotle has made great strides with food safety measures following outbreaks of foodbourne illness linked to its restaurants in 2015. Investors have been encouraged by the appointment of the company’s new CEO, and in April, Chipotle reported better-than-expected first-quarter results. This stock was a relatively new position for the fund, and it remained in the portfolio at the close of the period.

A strategy worth noting was our decision to avoid the stock of General Electric, which was one of the worst-performing large-company U.S. stocks in 2017. The company has struggled with a number of issues, including fundamental pressures in key business units and continued concerns about its balance sheet health. The strategy of keeping this stock out of the portfolio made a considerable positive contribution to fund performance for the period.

What were some holdings that detracted from fund performance?
The top detractor for the period was the fund’s investment in Allergan, a pharmaceutical company. This stock declined largely due to investor concerns about increased generic competition as the company lost exclusivity for several of its patented drugs. This stock did not offer the characteristics we seek for Putnam Sustainable Future Fund, and we had sold the position by period-end.

Although our investment in Applied Materials dampened performance for the period, it remained in the portfolio at period-end, and we increased its weighting. The stock of this semiconductor equipment company declined mainly due to concerns about supply and demand in the semiconductor industry as a whole. Investors were worried that semiconductor equipment volumes may have reached a peak. However, we believe this is a fundamentally strong company that continues to offer attractive long-term growth potential. From a sustainability standpoint, we believe

Applied Materials has a record of excellent capital management, which reflects solid governance. In addition, growth potential remains robust in many of the markets served by Applied Materials, including semiconductor applications that improve energy efficiency and increase connectivity in both consumer and industrial applications.

What are your thoughts about positioning and strategy as the fund begins a new fiscal year?
At Putnam, we see potential to use our fundamental research strength to identify innovative companies that are at the forefront of addressing unmet needs and solving pressing challenges. This fund focuses on these solutions-oriented investments, and it is exciting to play a role in pursuing these goals.

Our research teams and portfolio managers have already benefited from more actively using ESG data and sustainability analysis in our company research, and we believe this context-specific analytical focus has the potential to benefit investors, our communities, and our planet for many years to come.

[1] Excludes any graphs and charts that are displayed in the annual report.