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Schroders

PRI reporting framework 2019

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Outputs and outcomes

LEI 12. How ESG incorporation has influenced portfolio composition (Private)


LEI 13. Examples of ESG issues that affected your investment view / performance

13.1. Provide examples of ESG issues that affected your investment view and/or performance during the reporting year.

ESG factor and explanation

Concerns over customer privacy and human rights.

Our emerging markets analyst was looking at potential investment in a Chinese manufacturer of surveillance cameras. Surveillance cameras can be controversial. While they help with public and private security, customers may abuse them by violating privacy. For this particular manufacturer, the Chinese government is the largest client and an indirect shareholder. The higher level of technology in surveillance cameras, such as facial recognition, makes people feel uncomfortable, although it is likely to become increasingly prevalent with competitors producing cameras with similar technology.

ESG incorporation strategy applied Integration

Impact on investment decision or performance

There were accusations by the US government that the company was complicit in a Chinese detention camp for Muslims. The US government also threatened the company with sanctions. Although these did not materialise, they have caused bad publicity and we were mindful that corporate and government clients outside of China may refrain from using the company’s products as a result. The portfolio manager decided not to buy the stock given potential human rights and privacy risks.

ESG factor and explanation

Governance concerns.

Our Swiss Equity team identified some issues with the governance structure of a Swiss manufacturer of floor coverings. First of all, the presence of a large shareholder (who is also a member of the Board) with 30% of the votes is a potential concern regarding the treatment of minorities. The company also has an executive Chairman and weak Board composition, with many members having a tenure exceeding 10 years.

ESG incorporation strategy applied Integration

Impact on investment decision or performance

While the team acknowledged the governance risks, the large shareholder and executive Chairman had an excellent track record, having turned around the company during their time there. The Chairman was paid solely in company shares, effectively aligning interests with shareholders. In addition, the company has an excellent environmental footprint as its products are made of waste material and can be fully recycled. It has put strong emphasis on the sustainability of its product offering. This warranted a positive ESG rating in our view, in sharp contradiction with a 3P ESG assessment. With the company scoring highly in terms of quality and upside potential as well, the team decided to invest.

ESG factor and explanation

​Cyber risk.

Digital data has grown exponentially in recent years, spurred by increased penetration of mobile devices and consumption of online services. The rapid expansion in the volume of data companies store, many of which are relatively new to data management and security, has attracted cyber criminals employing increasingly sophisticated tools and techniques. Cyber crime costs global companies around 60% more than it did only five years ago, whilst in the US, that number has risen by over 80%.

Cyber is an increasingly critical source of business risk, especially for companies with important intangible assets such as brands, customer relationships or technology. The negative impact a data breach can have on a brand link straight to companies’ competitiveness, future revenues and future cash flows. Data breaches often uncover poor governance practices and weak management; changing people or policies is quick but re-establishing market and customer trust take much longer.

Our International Small Cap Equity team were concerned about potential cyber security risks at an Asian software company held in the portfolio. The team engaged with the company to better understand how it is prepared to deal with cyber threats.

ESG incorporation strategy applied Integration

Impact on investment decision or performance

The company provided details about annual and quarterly audits in accordance with the government’s data centre licensing rules and advised it has taken out cyber security-related insurance. External consultants are also consulted from time to time. The company has active processes in place, including 24 hour real-time monitoring, and are dealing with 200-300 attempts on a daily basis without breach. The International Small Cap Equity team were satisfied that the company was proactively addressing potential cyber threats and as a result, adjusted their ESG risk score downwards and continued to maintain their position.

ESG factor and explanation

Supply chain management practices

Our Global Equities team identified some concerns with the sourcing practices of a European global materials technology company. Despite the company demonstrating strong ESG characteristics across most aspects of its operations, management and governance, there were concerns around weak controls for sourcing material and the chequered history of parties involved resulted in heightened risks regarding the integrity of their supply chain.

The Sustainable Investment team and Global Equities team engaged with the company to discuss our concerns.

ESG incorporation strategy applied Integration

Impact on investment decision or performance

Management adequately demonstrated that the company was striving to improve standards and reduce risk (no artisanal mining, chemical fingerprinting and 3rd party audits). It also served to strengthen our perception of the company’s ethical standards more broadly both from an absolute perspective and relative to peers.

That said, heightened risk within the supply chain and ongoing concerns about greenwashing have resulted in a downgrade in the Global Equity team’s ESG rating for the company. Position sizes across our global equity portfolios were re-evaluated and adjusted in light of a change in the risk-adjusted return potential of the stock.

ESG factor and explanation

Environmental risk

Our Global Value Equities team were concerned about the environmental impact of a European chemical company. While a certain level of environmental risk is to be expected due to the bi-products of the chemical production process, this particular company seemed to be at greater risk than peers.  The local government has imposed regulation, forcing companies to pay for the environmental externalities they create from the production of chemicals.

ESG incorporation strategy applied Integration

Impact on investment decision or performance

While the company is currently paying for the environmental impact as required, it’s difficult to assess whether the current payment is an accurate reflection of the true environmental impact of their activities.  As a result, the team felt there was greater risk associated with this company versus other operators and increased the risk score, which affected position sizing.

13.2. Additional information.[Optional]


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