Our investments are responsible as we incorporate ESG factors into our investment process in order to generate deeper insights and help deliver sustainable, long-term returns.
This is differentiated from “sustainable investing”, “impact investing” or ‘”socially responsible investing”, which may set financial returns as a secondary consideration, subordinate to social or environmental goals.
We actively support the principles enshrined in the UN Global Compact. Through focusing management attention on all stakeholders and the risks and rewards, we are supporting the actualization of the Compact’s principles into business practice.
ESG issues have the potential to create and destroy long-term shareholder value, presenting risks across a company’s entire value chain, from supply disruptions and labour disputes, to large scale industrial accidents and product safety concerns. Moreover, these insights offer a broader, often less-scrutinised perspective into management behaviour and efficiency.
We believe that a focus on corporate governance and minority shareholders is representative of a more efficient business, able to adapt more successfully to economic, environmental and technological changes.
We therefore expect such firms to trade at higher multiples and create greater value for all stakeholders over the long-term. Conversely, those companies that pollute or pillage their environment do not have long-term sustainable business models, and thus are more likely to destroy shareholder value over time.
Of equal importance, we consider that detailed, forward-looking ESG analysis enables us to identify early signs of internal changes in a company. This is ahead of the impact on earnings and identification by other investors, and thus ahead of a share price re-rating or de-rating. It is therefore the momentum in these factors, as well as the absolute standards, which drive our allocations.
MSCI describe ESG issues as “quiet storms that reconfigure the financial landscape when they hit landfall”. This is an accurate premise; detailed analysis of ESG factors enables us to discover potential problems that may be submerged for many years, before suddenly erupting and destroying value.
By successfully avoiding companies with high ESG risks, we expect to generate lower volatility for investors. This is because those companies that are demonstrably resistant to ESG shocks can better mitigate the downside risks, both short and long-term. This makes disclosure on how companies manage their ESG risks all the more critical, because it can help capture investor interest and establish the long-term value of ESG management.
By focusing on firms with tangible evidence of appropriate values and judgement, we can generate greater conviction and trust.
This allows us to invest earlier, and to better assess the interaction between firm level and macro level dynamics.
ESG IN THE INVESTMENT PROCESS
We do not use forward-looking ESG analysis as a pre, post or ad-hoc screening. Rather, it is a fundamental and fully integrated part of our investment process, carried out alongside macro and financial analysis by our investment team.
At the macro level, we consider the quality and potential for change in governments and institutions. This is because whatever the underlying development, cyclical and company-specific forces; effective and inclusive policy and legal frameworks play an important role.
Our ESG analysis, however, is centred at the corporate level. Given our investment approach is conviction based, we have to understand the ability of management to execute on their business plan, monetise opportunity and correctly manage risk through the cycle. It also means there must be sufficient transparency and disclosure to analyse the company in full.
Specifically, we look at behaviours and practices across the firm in the context of global and regional best practice.
Following this analysis, our overall view on the quality of ESG on a forward-looking basis is then summarised on a scale from A (excellent) to E (fail). Our portfolios only include stocks graded A-C. To be clear, this means that we will only invest in firms where there is satisfactory quality and alignment of management.
LINK TO COMPANY VALUATION
Our forward-looking ESG and material non-financial analysis provides a holistic view of the company’s current position and future prospects that purely financial analysis cannot provide. This informs our valuation of the company and our conviction on the likelihood of the company being able to monetize future opportunities and manage business risks.
To make a contribution to the firm valuation, the ESG/Non-financial factor must have a tangible impact on a core business function. Either improving its efficacy or reducing its cost so that the business generates greater revenues and profits. The two most common examples we see are:
1. Reducing risk: increased confidence in management capability and behaviour helps reduce the uncertainty with delivery of future profits allowing us to assign a higher valuation than that of the wider market.
2. Increasing growth: In many of the markets we invest, structural growth drivers and cyclical positioning can mean certain sectors can grow exponentially. Our goal here is to find the companies that will capture this growth ahead of their competition. Non-financial factors playing out through attributes such as company reputation, staff skills and service or product quality enable companies to capture more customers, retain them longer or sell at higher prices.
COMPANY ENGAGEMENT AND VOTING
Our active engagement policy supports a continuous improvement culture within our holdings. This not only promotes progress in line with the UN Global Compact and UN Sustainable Development Goals but, from our experience, leads to material improvement in business performance and long-term investment returns.
Our approach is pragmatic, and so is best reflected through the real examples we have provided, showing how we work with companies to improve their ESG behaviour.
We use the services of ISS to implement our active voting policy. They provide a recommendation for each voting item, at each meeting for each company and an explanation of their view. We review these, and undertake further research or engagement with the company if necessary. We then instruct ISS to vote in line with the decision we have reached