ESG

Please see the below article from Jupiter Asset Management received late yesterday afternoon:

Abbie Llewellyn-Waters, Freddie Woolfe, and Jenna Zegleman of Jupiter’s Global Sustainable Equity strategy, set out the progress they would like to see in 2022 and in years ahead on climate change, inequality and biodiversity.

This decade is key if we are to achieve the necessary progress in tackling the multi-decade challenges facing the planet we live on and the people we coexist with. In 2021, financial markets were largely driven by short-term considerations, but for long term economic prosperity we need to look beyond the near term to address vital issues. For this reason, we focus on companies leading the transition to a more sustainable world. This requires a long-term outlook, in line with solving vital issues facing climate change, inequality and biodiversity. The imperative for sustainable investing has never been greater.

Action on climate change

COP26, the intergovernmental climate change conference that took place in Glasgow in November 2021, was a milestone in the acceleration of policy change to address emissions reduction and biodiversity decline. While the outcome of the conference could have gone further, the direction of travel is clear. We have held the view for some time that there needs to be global collaboration around carbon pricing and there was positive momentum from COP26 around these policy measures. Governments pledged to revisit and strengthen their 2030 targets to align with the Paris Agreement goal of limiting global warming to 1.5 degrees Celsius above pre-industrial levels. We are hopeful that the ambition gap will be addressed. We expect to see greater collaboration, led by the reiteration of joint commitment from the US and China, and that there will be a rapid but just transition to a low carbon future.

As investors, we need to see clear actionability and irreversibility from companies as they move to decarbonise their processes. Companies able to tangibly reduce carbon emissions, rather than offset, will be better positioned to deliver sustainable returns as increasingly we see externalised costs becoming an internalised cost of doing business.

In 2022, we except to see further policy acceleration to address the current mispricing of the use of nature. It is vital that companies move to live within planetary bounds and mitigate their environmental impact, both from a resilience perspective but also from a financial one.

This also applies to our own company, of course. Jupiter is a signatory to the Net Zero Asset Managers Initiative and has committed itself to align its operations and its investments with net zero emissions by 2050 or sooner.

It is important that the transition to a low carbon future is a just transition, uniting climate change with social justice. At COP26, for the first time the Just Transition was core to the agreement, acknowledging the importance of fairness in how the burden of addressing climate change is borne. Compensating vulnerable nations for loss and damage caused by climate change has also started to enter the dialogue and sets a trajectory for commitments on financing by richer nations to lower-income countries. The developed world has enjoyed more than a century of unprecedented economic growth at significant environmental cost. It is imperative for the global climate action success that developing nations avoid a similar environmental crisis.

Action on inequality

In addition to investing in companies leading the transition to a more sustainable world, we also seek companies which are driving a transition to a more inclusive world. Covid has exacerbated and revealed social inequalities. The economic shock caused by Covid-related closures has fallen disproportionately on vulnerable groups. In the US, the unemployment rate skyrocketed at the start of Covid, across the board, but the impact was significantly greater for those individuals with less than a high school diploma. Similarly, during the pandemic when children were unable to attend school, access to technology became imperative for the continuance of education, again disproportionately impacting those with more limited resources.

Covid has led to the increased vulnerability of many women, particularly in terms of financial independence, and to many exiting the job market altogether. Worldwide, women’s labour force participation has rapidly declined. This has a wider reaching social impact, as there is a correlation between female underemployment and children living in poverty. We look for improved wage transparency, and higher participation of women in the work force as an indicator of high-quality businesses.

Action on biodiversity

Addressing the loss of biodiversity is increasingly becoming a key topic for policy makers. Half of the world’s GDP depends on biodiversity, yet we continue to use natural resources at an alarming rate. COP15, the intergovernmental conference on biological diversity, started in Kunming, China, in October 2021, and will continue there in April 2022. Our hope is that lessons learned from climate change will be usefully applied to the urgent need to reverse loss of biodiversity. Companies’ impact on nature will increasingly be re-evaluated as a cost – just as has happened with carbon.

Just as with carbon, the internalising of externalities around biodiversity will present both opportunities and risks. While companies have been producing carbon data for a long time, the measurement of companies’ impact on nature is nascent. There are already frameworks coming into force in the next few years to improve standardisation of disclosure, notably the Taskforce on Nature-related Financial Disclosures (TNFD). This is a positive step but one that needs to be followed with clear actionability and irreversibility from companies. Addressing these challenges is of enormous importance now, both for our society, and for our long-term capital growth objective. The imperative for sustainable investing could not be greater.

Keep checking back for more ESG related content and our usual market commentary from some of the world’s leading fund management houses.

Andrew Lloyd DipPFS

07/12/2021

Please see the below article from JP Morgan received yesterday morning:

Environmental, social and governance (ESG) factors have all grown in importance for investors in recent years. But the S in ESG – the social factor – has, until recently, often played second fiddle to environmental considerations.

This neglect is understandable, because what makes up the social factor – how well companies treat their employees, suppliers and customers – is harder to measure than performance on the environment or in governance. Nonetheless, failing to pay heed to the social factor is a mistake because there appears to be some correlation between social performance and share price performance.

The benefits of happy employees

One way to measure this correlation is by looking at Glassdoor, the website where employees anonymously rate employers. Over the past 10 years, the share prices of companies ranked in the top fifth in Glassdoor ratings have outperformed companies ranked in the bottom fifth by over 6%. Glassdoor provides useful quantitative and qualitative evidence, so it can help open the door to engagement with management on social issues. We used Glassdoor, for example, to start a conversation with a management team about issues employees were raising on the platform. This prompted a productive discussion with senior executives about what they thought they could do to address these issues.

Exhibit 1: Glassdoor versus returns

This glassdoor model is a proprietary neural network, which was trained to forecast future financial performance from content in Glassdoor reviews. The model was trained in an expanding window manner, using 5 million reviews from more than 5,000 unique publicly-traded companies, covering the time period from 2008 to present. For more information please refer to footnote.

Another example of how employee satisfaction can contribute to a better company is Rentokil Initial, a British pest-control and hygiene company. The company has a strong culture of listening to employees; this has likely contributed to its high employee retention rate of 85%. Importantly, customer retention is equally high at 86%, supporting the idea that happier employees produce more satisfied customers because the workers tend do their jobs better.

The value of customer service

Treating customers well is another social factor that can also have an impact on company performance, as evidenced by the recent issue of travel refunds thrown up by the pandemic. Customers who booked directly with a hotel or airline found it easier to secure a refund than if they had booked through a third party. We believe that this may translate into an increase in direct bookings, which allows us to try to capture and quantify the differences in customer service by feeding these expected new booking trends into our earnings growth estimates.

Diversity in focus

Treating employees and customers well is one way companies are taking the social factor more seriously. The corporate sector, as a whole, also seems to be paying more attention to social factors. For example, since early 2020 there has been a sharp rise in the number of management mentions of diversity and inclusion in the earnings calls of companies in the MSCI All Country World Index.

Exhibit 2: The importance of social issues in ESG investing

Corporate mentions of “diversity”/“inclusion” in earnings calls

Number of mentions for MSCI ACWI companies, four-quarter moving average

Studies have started to examine the impact diversity on corporate performance. A 2018 study by McKinsey found that companies in the top quartile for gender diversity on executive teams were 21% more likely to outperform on profitability and 27% more likely to have superior value creation, while companies in the top quartile for ethnic/cultural diversity on executive teams were 33% more likely to have industry-leading profitability.

Conclusion

We believe increased corporate focus on social factors will ultimately be good for productivity, economic growth and – in the long term – corporate profits and share prices. We see much for investors to celebrate in the future if the social factor is good for share prices.

Comment

Its an interesting area to improve businesses in the UK. For large corporates like Rentokil Initial, you can see how they can drive change through the business. Is this more challenging for smaller companies?

Keep checking back for our usual market updates, insights and ESG related content.

Andrew Lloyd DipPFS

12/10/2021

Please see the below article from JP Morgan received this morning:

China’s ESG reporting is on an improving trend, but investors still need to do their own work and fill in the gaps left by third-party providers to get the full picture.

Data is critical in any investment decision process. For sustainable investing, the requirement goes beyond financial statements – we need specific and comparable ESG data. However, the availability and quality of such data is a major challenge for investors, particularly those investing in emerging markets, including China.

Third-party ESG data providers tend to take a broad-brush approach in emerging markets, and don’t always apply local nuance. In particular, they can lack local language skills and focus on data and information published in English, often leading to significant information gaps. Even more than in developed markets, it is necessary for investors to lead with their own analysis rather than with third-party ESG research. Standards are often better than many foreign investors suspect – but it’s necessary to do the fundamental work and to be selective.

Chinese companies do report information related to ESG, and the trend of ESG reporting is positive. In 2020, 1,021 A-share companies issued ESG reports, representing 27% of all. This number is much higher for bigger companies, with 86% of CSI 300 constituents producing ESG reports in 2020, up from 49% in 2010.1 However, the content of ESG reports in China is highly qualitative. Quantifiable metrics, which are vital for investment analysis, are limited. The transparency of the methodology and the consistency of disclosure are additional concerns for investors. As with third-party providers, overseas investors without local language resources may sometimes struggle to get the full picture as companies listed only on the onshore market tend to report only in Chinese.

Looking at E, S and G data separately, the quality and availability of governance data stands out in relation to the other two, as in other parts of the world. This makes sense as governance has been subject to investor scrutiny for much longer. Measurable and comparable environmental data is also increasingly available, helped by the strengthening of regulatory requirements and commitments made by the authorities. In 2020, China made a surprise pledge prior to COP 26 to reach carbon neutrality before 2060, which should further drive the introduction of policies supporting the transition to a low carbon economy. Social data is more limited, but here too we expect regulation to help.

Exchanges and regulators are major stakeholders that the investment community is looking to for help in uplifting ESG reporting. Hong Kong Exchange is among the exchanges in Asia actively promoting ESG reporting and has introduced mandatory disclosure requirements. In the domestic markets, the China Securities Regulatory Commission (CSRC) also plans to introduce new rules that could require more compulsory reporting of ESG data.

Environmental

Rapid development since China opened up and reformed its economy in 1978 has resulted in economic prosperity but also the environmental challenges we are seeing today. The authorities recognise the need to control pollution and to preserve the environment for a more sustainable economy. This has been underpinned by proactive measures on environmental protection over the past five to six years. The refinement of the Environmental Protection Law stated the responsibilities of companies and their reporting requirements related to matters such as emissions and discharge of certain pollutants. These mandatory reporting regulations help not only the China government but also investors to assess the environmental protection efforts of local companies. While the amount of mandatory environmental disclosure is relatively limited in terms of both breadth and depth, the content is comparable with global standards.

Following the carbon commitments made by China last year, investors are clearly expecting follow-through actions by the central government. Among the expectations for public companies is an uplift in the disclosure requirements of regulators and stock exchanges. Currently, the Shenzhen and Shanghai exchanges do not make environmental disclosure mandatory for all companies. With the global demand for higher standards of climate reporting, which is at the front and centre of environmental reporting, we see a trend towards more exchanges and regulators making certain climate data disclosures compulsory. While not every piece of data is material and relevant to all companies, investors are looking for some critical data points, including Scope 1 and 2 emissions, which are comparable and necessary for measuring the environmental performance achieved by companies. More importantly, China needs greenhouse gas emission data from all companies to track the national roadmap to peak carbon by 2030 and carbon neutral by 2060. On the back of the water crisis that China and many other countries are facing, investors are also looking for greater transparency in water data.

We want accurate static data about environmental footprint, but what we need even more is forward-looking commitments and action plans. We believe that the risks and opportunities related to climate change can have a financially material impact. Today, disclosure on strategies, risks and targets for climate management are uncommon in China. When we engage with companies, we encourage them to align their reporting to an internationally recognised framework, such as the Task Force on Climate-related Financial Disclosures (TCFD). We are looking for expansive adoption of the framework in China.

Social

The Chinese authorities increasingly recognise that robust ESG disclosures and practices are necessary. As a result, they are increasingly implementing regulation, not only on environmental issues, but also related to areas such as labour rights, product safety and diversity – although enforcement still varies by sector and by region.

One element of the motivation for this increased focus is to attract overseas investors to the market. As China’s markets continue to open up, these overseas investors are demanding increasing levels of transparency and positive engagement: a virtuous circle. A major internet company came under scrutiny in January this year following the deaths of two employees – one sudden cardiac death and one suicide. The company is a classic tech stock with a highly driven work culture and long working hours – 9am-9pm, six days a week, is the standard in the sector in China. The company issued its first ESG report in November 2020, which was welcome progress. However, as a result of the increased investor engagement, it has now committed to further improvements in its disclosures, as well as to an action plan on working conditions, including health checks and the establishment of a transparent communication channel for employees to register problems.

Disclosure standards on social issues for some Chinese companies may also be driven to a significant extent by the companies they supply. In sectors including tech and retail, large western companies are closely scrutinised for labour practices in their supply chains, and have therefore pushed for increased transparency on these issues in China. Simply being aware that a local manufacturer forms part of the supply chain for a western organisation with rigorous practices is not a replacement for detailed analysis by investors; however, such an awareness can contribute both reassurance and another potential source of information.

Among domestic investors, too, there is a rising awareness of ESG issues, and although such issues are generally not currently driving investment decisions, we expect them to play more of a role in the future.

Governance

For investors, governance is a foundational precept that underpins public markets. China presents investors with a large economy, in which the state is an active actor. State-owned enterprises (SOEs) offer investors a wide range of options, but are commonly subject to different governance norms and priorities versus privately owned enterprises. This dissonance requires a nuanced approach to mitigate potential risks. In some cases, privately owned onshore enterprises lag their state-owned counterparts around disclosure standards, especially around related party transactions. However SOEs are also not free of potential governance concerns: senior management positions are largely appointed by the Chinese government, with crossover between government officials and SOE boards implicitly raising risk of conflict with investor and creditor interest. The Chinese government has begun to make progress around SOE reform, introducing more professional management, but the scale of the challenge makes progress appear small, albeit determined. We note an increasing number of independent board directors, especially in listed SOEs, where awareness of external rating assessments are more pronounced.

In the private sector, Chinese regulators have been investigating accounting issues and forcing enhanced disclosure, with more public sanctions following evidence of wrongdoing. As a result, the depth of financial disclosure has improved. In response to the negative cost of capital impacts that follow scandal, Chinese family businesses are also showing improvement, through the hiring of professional management or other steps to reduce key employee risk.

We would still like to see increased transparency from both state and privately owned enterprises, including greater clarity around segregation of duties and evidence of awareness of ESG issues. We welcome companies and issuers making greater efforts around investor education, particularly those that make senior executive time available to investors. Overall, we note an improving governance framework evolving in China, with increased investor interaction an area of improvement. The overall standard remains lower than US companies, though improvements on the China side are narrowing the gap.

Conclusion

Overall, we consider ESG data disclosed by Chinese companies still to be insufficient. But this should not rule out sustainable investing in Chinese companies. With the help of on-the-ground fundamental analysis and alternative data, and through active corporate engagement, investment managers can still integrate ESG factors into investment research and create value for their investors.

With a stronger push from regulators, exchanges and investors, we expect Chinese companies to disclose more, better ESG data over time. Higher transparency through the ESG lens would allow investors to better understand the risks and opportunities of companies they invest in. This is critical in driving sustainable investing to the mainstream in China.

1 An Evolving Process: Analysis of China A-share ESG Ratings 2020 by SynTao Green Finance

Our Comment

The above article is interesting as accurate data is one of the key components for our ESG due diligence process.

The article highlights issues with China’s ESG data, but looking at the bigger picture, the rest of the world also has a way to go when it comes to data.

We have to watch out for ‘greenwashing’ which we have written about before, and make sure that the investment providers are doing what they say.

One of the key ways we avoid these data issues is by using multi asset or discretionary fund managers for our ESG offerings.

This makes sure that the investments we recommend are actively managed and that the investments have a strong ESG process built in, which is done by specific and experienced teams of fund managers.

This also helps us to reduce any concentration risk in one market sector and diversify an overall portfolio.

We have an ongoing dialogue with these fund managers and our due diligence is a constant ongoing process which helps us to ensure that the investments we recommend are managed exactly as the fund managers say they are.

As ESG stays under the spotlight and becomes an integral part of investing, the more accurate and reliable data reporting will become. ESG data reporting is in its infancy.

Keep an eye out for more ESG related content from us.

Andrew Lloyd DipPFS

16/08/2021

Please see the below article from Invesco:

Investors are focusing too much on certain sustainability areas, without paying attention to the broader – or even counterproductive – effects. Invesco partnered with The Economist to explore the topic in more depth in their ‘The art of the possible’ series.

Sustainability is the new investment ‘must-have’. It’s estimated that about 20% of investments are badged environmental, social and governance (ESG) of one form or another, and that proportion grows continually. That’s a lot of money: about $20trn and counting.

This has generated a ‘green rush’—what’s now the largest trend in investment. But it isn’t a silver bullet to make money and do good. Although the positive aspects are very real, there are also challenges: how the benefits and costs of such investments are apportioned—indeed, even down to how they are calculated.

There is, for instance, a persistent disparity between where environmental investments are going—largely towards established technologies such as wind and solar—and integral parts of the sustainability puzzle that remain underinvested. A recent survey of large investors globally conducted by The Economist Intelligence Unit found that electricity and heat generation, followed by industry-related investments, represent the lion’s share of sustainable investments. Jason Tu, cofounder and CEO of ESG analytics company MioTech, is seeing a lot of investor interest in “energy generation, transmission or storage, or usage such as electric vehicles”. He also cites farming technology as a particularly hot topic among investors.

Conversely, buildings, transport and agriculture, despite being major sources of greenhouse gases (GHG), have relatively low uptake.

How useful is ESG?

“The starting point for ESG is flawed,” argues Aswath Damodaran, professor of finance at New York University’s Stern School of Business. “We’re trying to substitute company behaviour for laws we should be passing as a society.”

However, others object that pushing this back onto society or the individual is a distraction from the role large corporations play—and sometimes an intentional distraction at that.

“Professor Damodaran is quite wrong to think that anyone in ESG actually thinks voluntary action is a good substitute for good laws,” says Mark Campanale, founder and executive chairman of the Carbon Tracker Initiative. “Quite the opposite. What ESG does however recognise is that the law is a minimum and we should all aspire to higher standards. When governments abrogate their responsibilities—for example by allowing themselves to be lobbied by powerful business interests to block certain standards—then shareholders can step in and take action.” He points to the recent removal of senior executives at Rio Tinto over the mining violation of indigenous Australians’ historical sites as a good example of this.

Technology is playing an increasing role in exposing these sorts of abuses. Mr Tu cites the use of satellite imagery “to see whether there’s any decrease in greeneries at the plantation, or any kind of signs of pollutants around a 30 km radius of a factory”.

This helps investors ensure that their sustainable projects are actually doing good—and choosing projects where they care about their success is exactly how Professor Damodaran suggests approaching green investing. “My advice to investors is pick your dimension of goodness,” he says. “Each of us has something we think is most critical to us, and invest based on that dimension, which means ESG scores are completely useless.”

How well does a company perform on gender diversity, water usage, emissions and so on? Distilling all these factors and more to one ESG number is obviously problematic. Some investors want as low fossil fuel exposure as possible—while others will intentionally be targeting more carbon-intensive companies—to finance a transition from the brown to green economy. ESG scores cannot resolve this; it’s only the starting point.

Mr Campanale takes a different approach: “ESG scoring is neither an investment thesis nor a strategy. What’s more compelling is to find areas that can demonstrate a valuable impact on society, for example investing in the clean energy revolution, or medical technologies. ESG-led investment research strategies that allow you to invest in a spread of high social impact enterprises is really at the heart of responsible finance.”

Pedal to the metal

Such strategies can’t be summed up in one number. A single ESG score—one number encompassing diverse factors—arguably doesn’t tell you much. A fund or stock can have a high ESG score by being in an industry with a low carbon footprint, such as finance, for example, or simply by reporting on lots of metrics that ESG ratings agencies score on. Some large oil companies, for example, score well on transparency, compensating low E with high G.

A positive impact in one area, earning a good ESG score, can also have a negative impact in other areas, which may not be highlighted by some ESG metrics, and so asset owners may be unaware of important consequences of some of their investments. One example of this is the knock-on effect of low-carbon technologies on metal extraction. These technologies use much larger amounts of metal than fossil fuel-based systems, creating an exponentially rising demand. An electric car typically contains 80 kg of copper, four times as much as a petrol-fuelled one. Both wind and solar power plants contain more copper than their fossil fuel equivalents: a typical solar plant contains about 5 kg of copper per kilowatt versus 2 kg per kilowatt for a coal-fired power station, points out economist Frances Coppola.

“It’s surface level ESG, because you think about carbon footprint, you think people who produce gas cars create this huge carbon footprint,” says Professor Damodaran. “If you create electric cars, you’re good. But electric cars create their own costs. And if you start digging into those costs, the question you have to ask is, are we really trading one devil for another?”

Given the reliance of the green energy transition on poorly regulated mining in these regions, does this not risk minimising the S in ESG? And is this not creating wilful blind spots to other forms of environmental degradation? It leads to the accusation, expressed pointedly by charity War on Want, that this green rush threatens a “new form of green colonialism that will continue to sacrifice the people of the global south to maintain our broken economic model”.

That the developed world has used the available resources, then pulled up the ladder to the global south, is echoed by Invesco’s The 21st Century Portfolio report, authored by Paul Jackson, which notes “the developed world has got rich by using up the CO2-absorbing capacity of the atmosphere, leaving little room for the rest of the world to develop”.

For Professor Damodaran, addressing the issue cannot rest at the door of the corporation: “Much of the ESG literature starts with an almost perfunctory dismissal of [founder of monetarism] Milton Friedman’s thesis that companies should focus on delivering profits and value to their shareholders, rather than play the role of social policymakers,” he says.

This article highlights one of our key points about ESG which we have repeatedly stated over the past year throughout our ESG related content, that ESG is a journey.

It isn’t a ‘one size fits all solution’, its about aspiring to do better.

As the ESG trend continues to grow, fund managers and investors alike, are learning more and more every day. Companies are having to adapt to the increasing ESG standards that are set.

Whilst a company may only score well on one aspect of ESG, it may be lacking in others, however over the next few years, ESG isn’t going away so it’s important to remember that every company will have a starting point and should continue on their journeys to improve in all aspects. If they don’t, they will be held accountable by their clients and fall behind the rest who will be actively trying to improve their ESG ratings.

Keep checking back for our usual market updates, insights and ESG related content.

Andrew Lloyd DipPFS

23/06/2021

Please see the below article from Royal London received over the weekend:

The majority of our assets just over 90% – are invested with Royal London Asset Management (RLAM), and their responsible investment team is doing great work to help drive the move to a low carbon economy and leading the way on the Just Transition.

What is the Just Transition?

Just Transition ensures that social issues are taken into account in moving to a low carbon economy. Rapid climate action that limits global warming to below 1.5ºC prevents the worst human and economic costs of climate change. A Just Transition ensures this climate action also supports an inclusive economy and avoids exacerbating existing injustices or creating new ones.

We care about Just Transition in the industry, because without adequate considerations of the social impacts of accelerating the path to Net Zero, there is a risk that people will not be willing to make the hard choices we need in order to limit the impacts of climate change. This can lead to policy delays and uncertainty. Companies that acknowledge this challenge and plan for a Just Transition, will be more likely to deliver on their commitment to low-carbon growth. We believe energy utility companies should develop formal Just Transition strategies to manage social risk and ensure they continue to deliver good value for society and their investors.

A just transition for Scottish and Southern Energy (SSE)

SSE is an energy utility company that helps produce and distribute gas and electricity to our homes. It is one of the largest producers of wind power in the UK and has committed to become ‘net zero by 2050’ – which means that by 2050 the amount of greenhouse gas emissions produced by SSE will be equal to the amount it removes from the atmosphere.

RLAM’s responsible investment team has been champions of SSE’s strategy to move to wind power and reduce its reliance on coal and gas, which will have a big benefit for our climate. However, they’ve also been talking to SSE about the Just Transition – what the company is doing to ensure that its transition to lower carbon energy also considers any negative social consequences like significant job losses or making energy bills unaffordable. Solving the climate crisis is not straightforward, and the responsible investment team is asking companies to take a more holistic view and look at both the social and environmental consequences of taking action.

Please continue to check back for a range of blog content, from ESG focused pieces like this one to market updates and insights from a variety of the worlds’ leading investment houses.

Andrew Lloyd DipPFS

07/06/2021