Environmental Social Governance Investing

Integration in practise

A robust ESG Investment framework seeks to integrate environmental, social and governance data into the broader investment screening process. To better understand the process we need to improve our understanding of how assets are generally selected for inclusion. For instance certain industry stocks are included in a portfolio based upon a set of standardised screening tiers including valuation, momentum, management performance, strategy, market competitiveness etc. The ESG components are just another set of data inputs used to justify inclusion or removal from the portfolio. From its early origins of the late nineties the BMO Stewardship Ethical fund has sought to influence corporate culture through targeted engagement. At the beginning, this interaction was viewed as a niche activity and has gradually moved into mainstream practise over the past 20 years. Engagement today has become much more collaborative in nature and strategic in design. Company disclosure and reporting has been replaced by the integration of sustainability issues into core business strategies. This transition has emerged from the realization that the key decision-makers were central to any meaningful engagement. Finally, outcomes are measured and their impact monitored to ensure the sustainability of the changes. A benchmark is required and 79% of BMO GAM engagement linked to UN sustainable Development Goals. BMO realized that real, lasting engagement around positive ethically focussed targets is more likely to succeed if companies themselves champion the process.

Engagement

I thought it would be useful to provide some practical examples of the lived experiences of senior executives in their engagement with shareholders like BMO. The asset manager recently held their 2021 Responsible Investing conference virtually. All three of the executives below spoke to the intensification of the types of engagements that are now taking place. There appears to have been a shift in late 2018 which saw more generalist portfolio managers seeking much heightened due diligence reporting on the commitment of companies to sustainable practises. There follows a brief summary of the type of engagement that takes place between the BMO Stewardship investment team and companies including Smurfit Kappa, the Clicks Group and BHP.

Clicks Group

  • South African listed corporate health & beauty retailer
  • 7th Largest health & beauty retailer
  • Largest pharmacy chain in South Africa

The Clicks group has consistently been included in the FTSE4good index and the FTSE Responsible Investing index. The company is strategically focussed on reducing their carbon & climate footprints. The Clicks group is one of the founding members of the SA Plastics pact – A network of national or regional initiatives working towards a circular economy for plastics. The Clicks group promotes strong advocacy particularly in the realm of affordable health care policies. The social component of ESG investing focussing lots of attention on social justice issues including racial equality. The company promotes bio-diversity and water management programmes. South Africa experienced terrible droughts in 2018 with water becoming a scarce commodity. The company ranks highly in terms of gender-empowerment and employee wellness rankings. On a recent platform hosting the 2021 BMO Ethical investing conference, Group Corporate Affairs Director Bertina Engelbrecht highlighted the tight correlation between top quartile financial performance and their sustainability metrics.  She also pointed to the intensification of engagement with their shareholders on ESG issues, ESG Linked compensation and independence of the board leading to stronger oversight. There has been much more concentration in South Africa on issues of climate change, water management and sustainability. The level of follow-up and request for discussion at board level has also increased. This in turn improves the level of the discussions within the company as well as the degree of accountability and commitment.

Smurfit Kappa

  • One of the world’s largest paper-based packaging companies
  • Smurfit Kappa have operations in 36 countries across Europe & North/ South America
  • Each year the company recycles over 6 million tonnes of paper waste
  • Largest paper recycler in Europe
  • Over 64,000 customers

Smurfit Kappa is in the business of packaging consumer goods. The cardboard boxes that the company uses are renewable, recyclable and biodegradable. Garrett Quinn, Head of Investor relations spoke about the rapid increase in the volume of ESG queries the company has received. He spoke about a heightened enthusiasm around ESG policy and an “encouragement to be more ambitious” type approach. The latent message in all of this is that investors and asset managers now require action.

BHP

  • Global mining company
  • Operate the world’s largest copper mine
  • One of the world’s largest producers of Nickel

BHP is an interesting company in so far as it has a mixture of commodity products that are expected to perform very well [copper/nickel] in the energy transformation and those that will struggle for obvious reasons [fossil fuels]. ESG is fundamental to the company’s strategy. Group ESG Officer for BHP, Geof Stapledon spoke of the importance of copper as an input to the electrification of vehicles. An average electric vehicle will have 4 x times as much copper in it versus an internal combustion engine. The type of engagement was also discussed ranging from very large shareholder including BMO to individuals with small holdings.

Where to from here?

It is clear that ESG investing is gathering momentum. It is instructive to try and understand what is driving this energy. Research carried out by the UK firm Boring Money surveyed some of the main stakeholders and their results are interesting. Investors may be very simply split into two sub-groups. Investor group 1 are driven by their own personal motivations and genuine desires to support active ethical investing strategies. Their research revealed that 35% of those surveyed aged under 55 said that an ESG type investment approach was fundamentally important for future investment choices. Interestingly, women appear to be much more active and vocal in this group. Investor Group 2 is focussed instead on personal gain and bases their asset allocation on the investment returns in 2019 & 2020. They recognise that momentum and enthusiasm is building for this approach and would like to take personal advantage. The governance aspect of ECG is of particular importance here. Robust oversight and independence at board level is seen as critical in avoiding scandals such as Enron. The greatest shift towards ESG adoption has been at the advice level with more and more advisors focussing on the benefits to their clients of ESG investing. The research is useful also in confirming the environmental concerns remain the dominant concern for retail investors. The regulatory background has also driven the institutional interest in this sector.

In March 2021 the EU began the implementation of the first phase of the Sustainable Finance Disclosure Regulation. The SFDR regulations have now require investment houses to:

  1. Disclose how they integrate sustainability into their investment processes
  2. Disclosure on these strategies are implemented at the product level
  3. Publish sustainable policy papers
  4. Categorise products in terms of sustainability [Article 8/9]

The regulations are not without their challenges however including huge divergence across jurisdictions and incomplete regulatory system. The interpretation of so-called “light” and “green” funds has also been problematic for investment houses. The 2015 Paris Climate change agreement created the architecture and the determination to achieve net zero and the 1.5 degrees commitment. COP26 is the next milestone of collective ambition to increase national capacity and climate reform targets. Politics matter. President Joe Biden should quickly re-commit to the Paris accords following four years of controversial denials from his predecessor.

It is clear that the BMO Stewardship Ethical fund has a robust framework of engagement and influence with the companies in its fund. ESG related policy goals are not just inspirational. They are hard-wired into the engagement processes as evident from the contributions made here. This should provide investors with confidence that modern day ESG integration is much more sophisticated than playing lip-service to environmental concerns. It is in fact a catalyst for important change.

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