Federated Hermes (aka Federated) is committed to ESG integration across all asset classes on a firm-wide basis. Our equity teams predominantly follow a bottom-up fundamental research process that integrates both quantitative and qualitative metrics. We view the incorporation of ESG factors as a natural extension of our primary research providing unique insights into a company's long-term strategic direction and a more comprehensive view of the risks and opportunities inherent in a security. To us a long-term responsible investment approach needs to assess material ESG issues to better inform investment decisions and enhance sustainable value.
When Federated acquired Hermes Investment Management, a globally recognized pioneer in ESG integration and advocacy, the partnership created an opportunity for Federated to accelerate its incorporation of ESG factors and engagement into the DNA of all of our investment strategies. In collaboration with Hermes, Federated has advanced a more systematic and formal approach to ESG integration in our equity strategies which we believe strengthens our commitment to our clients to be stewards of their financial assets, seek superior, risk-adjusted returns and create sustainable wealth.
Governance issues, because they affect all stakeholders and provide insights into management quality, have consistently been a factor which is part of Federated's fundamental research when evaluating and owning portfolio companies. Empirical evidence from Hermes has shown that companies with strong corporate governance and improving social characteristics tend to relatively outperform their industry peers. We believe the integration of ESG factors and active engagement into the investment framework, both during the research process, and as owners, provides an important lens to understand material risk and opportunity over the long-term.
Our proprietary ESG toolkit is three-pronged and focuses on data, materiality and engagement as the means by which ESG factors are integrated into our investment research and ownership processes.
Data Analytics - Federated Hermes has developed a full suite of company-level and portfolio-level ESG analytical tools which serve as a cornerstone of ESG integration in our equity strategies.
For company-level research, our investment teams use proprietary ESG Dashboards and Governance tools to evaluate corporate issuer ESG exposure and momentum. Our ESG Dashboard provides a concise digest of ESG data, incorporating research from 10 leading ESG providers such as MSCI, Sustainalytics, Trucost, Bloomberg, ISS and CDP, and it includes EOS at Federated Hermes ("EOS") voting and engagement information. A valuable component of the Dashboard is the QESG score, a proprietary ranking developed by the Hermes Global Equity Team over a decade ago covering over 12,000 global securities. The score captures how well a company manages ESG risk versus its peers and monitors ESG rating momentum, showing the trajectory of progress in managing those risks. The QESG score can act as an early indicator of improving or deteriorating ESG risks. Investment teams can use the proprietary rating, both the overall composite QESG score as well as individual E, S, or G pillar scores, to go deeper into a particular E, S, or G risk which may be increasing or decreasing in its impact to the company. Our Governance Tool is multidimensional, assessing a company across measurable governance metrics and flagging outliers and discrepancies. Investment teams find these governance analytics as highly complementary to their company ESG diligence by allowing them to focus on areas where a firm falls short on governance expectations and industry best practices.
In addition to the ESG Dashboard which aids in company-specific due diligence, investment teams are equipped with multiple portfolio-level ESG analytics. Our suite of proprietary portfolio tools includes a Portfolio Snapshot, Carbon Footprint, and Engagement measurement. Collectively, these tools allow investment teams to quantify ESG momentum, identify and assess climate-related carbon risk and measure portfolio-level engagement coverage by EOS within portfolios.
Materiality - Research is focused on financially material ESG risks and opportunities in each industry. An in-house materiality assessment is especially important for strategies with limited or low quality ESG data coverage such as small capitalization. Identifying financially material factors requires both primary fundamental research and external sources such as sell-side research and industry-specific sources. In 2018 Federated joined the Sustainability Accounting Standards Board (SASB). SASB has developed a complete set of standards for 77 industries, focusing on ESG and sustainability risks that are financially material to each industry sector. All of our Investment teams have access to SASB materiality maps through a centralized ESG hub that houses SASB materiality matrices, proprietary ESG portfolio tools, ESG third party data and EOS corporate engagement database.
Engagement - Investment teams have access to unique ESG insights about a specific issuer through dedicated engagers within EOS. These corporate engagement specialists have deep knowledge of industry sectors, the companies they cover, and material ESG priorities, providing meaningful insight into an issuer's willingness to managing their ESG risks within the context of an enterprise's long-term strategic plan. This perspective on long-term ESG risks can impact an investment team's assessment of company valuations. Direct engagement with issuers is not only important to obtain additional insights into a company's ESG practices, it can also serve as a mechanism to improve issuer's ESG profiles and thereby reduce risks over the longer term. Each of our equity investment teams adopts a customized approach to incorporating ESG factors and engagement into their individual workflow and framework. While all teams have full access to the proprietary data, resources and expertise highlighted above, Portfolio Managers tailor the various ESG tools to meet their security selection and portfolio construction frameworks.
Our integration strategy is combined with other approaches when responding to client mandates and in our themed investment product:
- Negative screening or exclusionary strategies are used primarily within separate accounts for those clients whose values-based investment policies prohibit specific securities, industries or sectors. Federated will exclude the securities expressly prohibited by the client and construct the balance of the portfolio using the firm's bottom-up fundamental research process.
- A thematic SDG Engagement Equity fund was introduced in 2019. This fund uses the SDGs as a framework for engaging with companies to create more impactful and financially successful enterprises.