We have developed an internal framework for assessing the relevance of ESG integration through the varying stages of the investment process. This framework enables us to apply a consistent approach to integration analysis and allows our investment teams to develop their own unique approach to ESG. We have outlined below how we integrate ESG considerations into the investment processes of our main Equity investment teams.
The investment framework follows an active bottom-up strategy which, we believe, marries the best from traditional financial analysis along with behavioural factors. Understanding ESG concerns is an important component of 4Factor’s bottom-up analysis as we believe it helps us gain a better understanding of a company’s strategy, one of the four key attributes of our investment philosophy.
On an ongoing basis we are working to enhance the integration of ESG considerations at various stages of the process. Arguably the most important stage of integration within the 4Factor investment process is in fundamental analysis; where many of the most subjective aspects of ESG understanding can be appraised and incorporated into the fundamental investment case. Each of our research notes includes a formal section that allows for discussion of ESG issues. Our external ESG research provider, MSCI, helps these discussions by providing us with products such as ESG ratings, controversy scores and business activities screens
Beyond the research and investment stages of the process, another area we feel is key to our ESG efforts is that of engagement; acting as responsible shareholders on behalf of our clients. The investment team initiates engagements based on their investment research and priorities. We also have a dedicated team of ESG professionals split between our offices in the UK and South Africa. The ESG team work closely with the investment team to provide a supporting engagement strategy which targets specific holdings and material ESG themes that are significant to the firm, the investment team, and our clients.
‘Quality’ can be described as an investment approach that assesses the qualitative attributes of a company such as management credibility, business strategy, governance standards, as well as quantifiable characteristics such as balance sheet stability and persistently high levels of profitability. We favour companies with exceptional financial strength and which have a leading market position in an industry that offers sustained growth potential.
Our rigorous research process enables us to understand the impact of the company on its various internal and external stakeholders, which inherently highlights issues of an ESG nature that can then be factored into the decision-making process.
We assess the ESG risks and opportunities that can affect the sustainability of a company’s business model; we assess the quality of accounting policies when considering a company’s financial model; and we assess governance issues such as risk management, board balance, audit, remuneration and shareholder rights, that can affect a management team’s ability to allocate capital in line with shareholders’ interests. We use third party ESG/IVA ratings, ESG Controversy Flags and Governance Ratings as appropriate to help with our analysis. Our assessment of these factors is reflected in the valuation we ascribe to a stock, and the risk/reward trade-off of a stock that determines inclusion in the portfolio and position sizing. Ninety One’s dedicated global ESG team provides additional support in terms of ESG integration, ESG research and engagement efforts.
The Value investment team employs a disciplined investment process seeking to make long-term investments in cheap, out-of-favour companies with appropriate balance sheets. It is an inherent characteristic of value investing to look at any upside, including ESG considerations, which could benefit a company to bring it up from its current low valuation. Many times, this would involve some issue related to governance or management.
We use the ESG research available from various external providers to identify any material issues identified for a specific sector and/or company. We can then take a view to determine to what degree we agree with that research and also whether we have any additional concerns. Any material ESG issues identified will be incorporated into our final analysis, and any impact that these issues may have on valuation will be considered. These material issues will also be considered on an ongoing basis as we continue to monitor stocks which we currently own or are considering purchasing in the future. However, ESG issues themselves do not inform our screening process or portfolio construction.
As leading active managers in a carbon-intensive sector, we are acutely aware of our responsibility around ESG and sustainability considerations. We believe that bad ESG practice in the natural resources sector clearly damages corporate performance and also the physical environment.
ESG is integrated throughout the investment process, from screening for investment ideas through to engagement with companies.
In the initial stage of the process, we screen for ideas based on a number of valuation, returns and ESG/Sustainability metrics.
In the fundamental analysis section of the process, we undertake deep analysis of the most material ESG issues, such as carbon emissions, water usage and safety. We also adjust the Weighted Average Cost of Capital (WACC) of the company under analysis based on the Natural Resources Sustainability score. The WACC is decreased for the top scorers and increased for the bottom scorers. In this way, companies with poor ESG performance will have reduced upside in the equity model.
Our engagement work with companies is often focussed on ESG issues. We believe that through systematic engagement with resources companies we can enable positive change. We engage in two different ways. We meet our portfolio companies on a regular basis and use a systematic programme of engagement goals to ensure that progress can be measured and monitored. We also believe that there is strength in collaborating with other leading shareholders.
We believe that this combination of quantitative scoring, qualitative analysis and judgment based on deep knowledge of the companies under review, and systematic engagement can not only improve our investment performance but can also enable positive change in the sector.