At Sparinvest, our responsible investment approach is built on our conviction that environmental, social and governance opportunities and risks can have a major impact on long-term returns, and that it is therefore an essential part of our duty to clients to consider ESG issues in our investment processes.
With EU legislation set to ensure that ESG considerations are introduced into all parts of the financial system, interest in the area of responsible investment is growing significantly, and we now receive notably more enquiries about our approach.
Sparinvest’s Responsible Investment Review aims to answer some of the questions and to keep investors updated about responsible investment topics and practices. In the latest edition, we describe how we believe investors can best judge the way asset managers work with responsible investments and whether external ratings systems are valuable. The Review also gives examples of ESG Integration in the investment process and looks at how Sparinvest has bolstered its approach to voting with the introduction of a new custom policy.
External ratings: PRI gives the best picture
At Sparinvest we prefer ratings systems that give a more holistic view of how an asset manager’s responsible investment beliefs and active ownership practices can influence portfolios rather than ratings that focus purely on the underlying ESG scores of portfolio holdings.
Fund manager process-focused ratings (of which the PRI Assessments are the best-known example) consider how asset managers tackle ESG opportunities and risks in their investment processes, and how they work with investee companies - through voting and engagement – to help them to exploit their ESG opportunities and mitigate risks, with the aim of creating long term value for investors.
Fund level rating systems (of which the Morningstar sustainability globes are the best-known example) ignore the fund managers’ processes. Instead they focus on fund content, giving each holding in a portfolio an ESG score, and then amalgamating those scores to give a ‘fund ESG score’.
From Sparinvest’s viewpoint the main criticism is that the holdings-based approach says nothing about the Fund Manager’s process in implementing responsible investment. Morningstar has said that if they can’t get independent proof that engagement is happening, and effective, they can’t put it into an indicator. Therefore Fund Managers get no credit for the degree of active ownership that they exercise to encourage improvement in companies with poorer ESG profiles.
ESG Integration in stocks and credit – three examples
Before investing in stocks or bonds Sparinvest analyses each company in depth to gain a full understanding of its long term value/ability to repay investors. This means a careful consideration of all the risks and opportunities faced by the company – including those related to ESG issues. In the RI Review, we describe three concrete examples of how ESG issues can impact on investment decisions.
1) A tyre company looked interesting as a value investment until our in-depth analysis revealed past quality issues. This, plus some ongoing lawsuits regarding accidents involving vehicles using their tyres made us decide not to invest in the company.
2) Product safety was also an issue at an Indian maker of generic pharmaceuticals that we analysed for potential investment. The fact that the company had previously experienced issues - albeit responding very well to those issues - were among the factors we considered in our valuation calculations, and led us to apply discount rates and valuation multiples towards the more conservative end of the considered range.
3) In late 2017 we participated in a new bond issue for an agricultural company from Asia Pacific.
Our analysis revealed that there were certain gaps in the company's environmental risk management policies and processes that – once integrated in the analysis – led to a lower recommended exposure to the company. To get a better understanding of the company's plans to mitigate these risks, we decided to engage with the company.
Stronger approach to voting
The three pillars of our approach to responsible investment are the integration of ESG considerations into our investment processes, stewardship, and using exclusions (to a greater or lesser extent in different strategies) to avoid certain investments. Stewardship consists of our voting and engagement programmes. We continually look to develop our practices further, and have recently bolstered our approach to voting in two ways. Firstly, we have updated our voting principles and secondly, based on our voting principles, we have implemented a new custom voting policy at proxy voting service provider, ISS. This means that when ISS provide us with research on upcoming corporate AGMs, their input is based on our independent criteria. This input is used to inform voting in our quant and index funds.
As always, in our value equity funds (which are actively managed, fundamental stock picking funds), our investment team reviews all voting agendas, as well as the input from ISS, and then the team makes voting decisions based on our voting principles and in the interest of long-term corporate value.
Voting for board diversity
As investors, we believe that it is important to promote strong corporate governance. We like to see well-functioning and diverse boards that work in the best long-term interests of our investee companies. Diversity can be viewed in terms of age, gender, ethnicity etc. but for voting purposes, the most readily available data is on gender diversity - it is easy to see the number of women appointed to boards. Here, as a first step towards encouraging broader diversity, we will typically vote against the chair of the nominations committee – or the chair of the board - if a company fails to appoint at least one woman board member. If a board hasn’t managed to appoint a single woman, then this may be an indication that this board doesn’t consider diversity seriously. The goal is overall diversity, and this is one tool to achieve that.
We would also add that we see voting on its own as a fairly blunt instrument. Our aim is discuss these issues with the companies, and work with them, hopefully to boost long- term corporate value.
Other topics in Responsible Investment Review:
- Sparinvest receives A+ for Strategy & Governance from PRI
- Ethical bond fund gets a LuxFLAG ESG label and is listed at the Luxembourg Green Exchange
- Direct engagement on carbon footprint in all ethical portfolios – both stocks and bonds
Read the full review here