ESG: coming into the mainstream
April 2017
ESG and related types of investing are slowly but surely coming into
the mainstream. Socially responsible investing (SRI), which involves
screening out investments based on certain criteria, has been available
for decades but investors are increasingly moving to a more nuanced
approach of integrating qualitative ESG considerations into investment
analysis. The ESG approach aims to accurately identify the intrinsic
risks and opportunities that an asset has to offer.
This note defines the many terms in this space and explains what has
driven the rise of ESG and SRI. The second part outlines Aberdeen's
process for integrating ESG factors into our investment analysis across
asset classes-a key element of our stewardship approach.
Defining terms
According to the United Nations, responsible investment is an
approach that aims to incorporate environmental, social and
governance (ESG) factors into investment decisions, to better manage
risk and generate sustainable, long‑term returns.
ESG is the identification of environmental, social and governance
factors that have the ability to materially impact the financial
prospects of an investment. When considered alongside standard
financial metrics, ESG forms part of a holistic understanding of an
asset’s true value.
ESG issues cover a broad range of areas, some of which are:
Environmental
Carbon emissions, energy efficiency, biodiversity and land use, toxic
waste and emissions, clean technology and renewable energy
Social
Treatment of stakeholders, supply chain, employee training,
talent retention, health & safety, product safety and privacy
and data security
Governance
Company ownership, board structure and independence, executive
compensation, business ethics and corporate culture
“To ignore ESG factors is to ignore risks and
opportunities that have a material effect on the
returns delivered to clients and beneficiaries.”
Principles for Responsible Investment (PRI)
ESG analysis differs from SRI, which aims to generate financial returns
without compromising the investor’s personal values and preferences.
With SRI, the investor typically specifies screens that exclude
companies, sectors or funds that are deemed controversial or unethical.
Such negative screening can exclude companies involved in areas
including munitions, alcohol and tobacco production, for example.
Positive (or best-in-class) screening is also possible where investors
actively seek out companies that exhibit leadership in environmental
conservation, employee policies, business ethics and other areas.
Impact investing aims to have a measurable and defined social or
environmental benefit, alongside financial returns. It is based on the
idea that the private sector can provide much needed innovation
and resources to help efforts to solve global environmental and
social challenges. Thematic investing focuses on a particular theme,
like renewable energy, or social housing.
Green investing meanwhile seeks to invest in environmentally
conscious companies or business practices. The term is usually used
in relation to bonds. For example, governments can issue green bonds
that generate revenue for funding conservation of natural resources,
development of renewable energy sources or clean air and water
projects. The market for green bonds is expanding rapidly – issuance in
2016 was c$93 billion, double that of 2015.
Why all the fuss?
ESG and SRI have been gaining international prominence in recent
years. According to the Global Sustainable Investment Alliance
(GSIA), assets invested in funds integrating ESG factors and applying
SRI screens rose to $22.89 trillion globally at the beginning of 2016,
up 25% from the start of 2014. In the US, assets under management
in SRI funds grew to $8.7 trillion, up 33% since 2014.
Recent news stories underline the growth of ESG and SRI:
• “Over 95% of private equity investors believe their company
portfolios contain significant untapped ESG opportunities,
according to a recent survey by global environmental
consultancy ERM.” Environmental Resources Management (ERM),
March 2017
• “The Swiss responsible investment association, SVVK-ASIR, has
identified 15 arms companies its members – major Swiss pension
funds – should not invest in.” Investment & Pensions Europe,
March 2017
• “The HSBC Bank UK Pension Scheme has selected a multi-factor
fund with a tilt towards low-carbon businesses as the equity
component of its default offering, a switch that will see £1.85bn
of defined contribution savers’ money invested in line with
green principles.” Pensions Expert, November 2016
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ESG: coming into the mainstream - April 2017
Concurrently, awareness of social and environmental issues is gaining
traction for various reasons. The United Nations’ 17 Sustainable
Development Goals to be met by 2030 agenda define global
development priorities and aspirations. The establishment of the
PRI was instrumental in underlining the importance of integrating
ESG principles in investment management. The 2015 Paris climate
agreement (COP21) helped to unite the global response to the threat
of climate change and will lead to significant reduction in carbon
emissions. This sets a challenging regulatory backdrop for businesses
around the world to adhere to.
National regulators and governments are increasingly focussing on
how appropriate and transparent governance structures can support
a higher degree of integrity and ethical behaviour. In some countries
(particularly in Europe), an increasing focus on corporate stewardship
is a central part of the public policy agenda. Corporate governance
failures (like the Volkswagen emissions scandal) and concerns about
rising inequality in executive pay have driven ESG issues further up
the agenda.
There is also growing acceptance that incorporating ESG factors is a
key element of investment analysis and therefore an integral aspect
of investment managers' fiduciary duty to clients. Funds increasingly
need to actively integrate ESG considerations into the investment
process to be considered for pensions mandates, particularly in Europe.
Many investment managers are marketing their knowledge of ESG
factors and launching funds for competitive advantage. So to stay
competitive, asset managers have to respond to this trend.
Aberdeen’s stewardship approach
Scandinavia has historically led the way in ESG integration and SRI
investing, followed by Australia, the UK and Canada. The US and Asia
are also starting to integrate ESG into investment decisions and apply
SRI type criteria, but it will take time to fully develop in these regions.
From an investor perspective, millennials (the generation born between
1982 and 2004) and women are driving much of the demand for ESG
and SRI. Women already control over 50% of US household wealth and
the proportion is increasing, while millennials are set to inherit trillions
of dollars in the coming decades.
The rising prominence of ESG analysis is good for investors – it allows
a better appreciation of the risks and opportunities of a company,
and may even improve performance. For example, a 2014 study by
Harvard Business School and London Business School found that ‘highsustainability’ companiesA significantly outperform their counterparts
in the stock market over the long-term. And analysis from HSBC shows
ESG improvement drives share price outperformance, especially in
emerging markets.
ESG, SRI and thematic investing all sit within Aberdeen’s stewardship
approach, which outlines the fiduciary role that we play as guardians
of clients’ money. ESG is a key element in stewardship (which also
includes engagement and proxy voting). ESG integration focuses
holistically on the intrinsic risks and opportunities of our investments
and thereby helps us to better understand the quality of an asset,
along with its key concerns.
We may find that an asset has material risks with regards to
governance, cybersecurity, labour standards, or even bribery and
corruption issues. By considering all the risks and opportunities that
an asset offers, we can better understand its true quality, how much
we should pay for it, how much of it we should put in our portfolios,
and where to focus our long-term engagement on.
We also offer a variety of screened portfolios which help clients avoid
investment in certain areas, such as tobacco, alcohol, weapons, child
labour or animal testing. Finally, we have the capability to create
thematic portfolios tailored to clients’ needs. For example, if an
investor wishes to focus their investments in a specific theme, such as
renewable energy or invest in companies that have a lower carbon
footprint, then we can create bespoke products to meet these needs.
Aberdeen’s stewardship capabilities by asset class
ESG
Thematic
Optional
Fixed income
Fundamental - focused Blends multiple sources
of value to diversify risk
on identifying highquality companies
Disciplined approach to
Contrarian – disciplined determining fair value
on price
Avoiding losers
as important as
Active – act as coowners of businesses, picking winners
not traders
SRI screens
Integrated
Active equities
Property
Bottom-up approach
focussed on asset
quality, not regional or
sector allocations
Risk-focused
Local presence in all
markets in which we
are invested
Active management
Alternatives
Multi-asset
Quant
Primarily via external
manager allocations
Unconstrained, openarchitecture universe
Fundamental analysis
to find best-in-class
hedge funds, PE and real
asset managers
Combines longterm strategy with
short-term tactical
opportunities
Systematic investments
across traditional
beta, smart beta and
active quant
Aims for consistent
returns through
the cycle
Top-down and
bottom-up analysis
ESG fully integrated
into systematic
investment processes
at both universe
ESG based on
construction
underlying funds’ and
and portfolio
managers’ ESG policies
construction stages
Tailoring of portfolios
to meet client
ESG requirements
ESG is a key element of ESG analysis embedded
in fundamental in-house
all analysis
credit research
Holistic company risk
assessment carried out, ESG risks categorised
including ESG factors according to severity,
allowing them to be
Engagement with
priced appropriately
management on risks,
alongside other
improvement and
credit risks
opportunities
ESG factors a part of the Due diligence of
underlying managers’
investment process
ESG considerations
Holistic risk assessment,
ESG metrics feed
including ESG factors
decision-making
Engagement with
key stakeholders on
risks, improvement
and opportunities
Value or ethicallydriven exclusions
Not applicable
Screens in underlying
Screening based on
third party ESG dataset products can be
incorporated according
can be offered
to client needs
Funds or mandates can
be weighted towards
specific sectors or issues,
according to client needs
Specific themes /
sectors/issues in
underlying products
can be incorporated
according to
client needs
Screening available
across a wide range of
criteria according to
client needs
Thematic investing can Thematic investing can
be offered in line with be offered according to
client needs
client demand
Focus on carbon
exposure and climate risk
Focus on efficient
portfolio construction,
disciplined rebalancing
and risk management
Engagement on
governance issues
through proxy voting
Specific themes /
sectors/issues in
underlying products
can be incorporated
according to
client needs
Controversial weapons
and companies with
severe controversies*
excluded from
investable universe
SMARTER Beta™
capability includes ESG
Multifactor Equity Index
family, comprised of
multifactor ESG indices
for global, regional and
local markets
Source: Aberdeen Asset Management.
A
Defined as companies with a substantial number of environmental and social policies adopted for a significant
number of years (since the early to mid-1990s).
ESG: coming into the mainstream - April 2017
3
Active equities
For our active equity business, our bottom-up stock selection process
is long-established. With general average holding periods of eight
years or more, we actively prioritise long-term value for potential and
ongoing investments. We are committed to the very active role we play,
behaving as owners of our investee companies.
Our approach to stewardship is focused on materiality and
understanding the specific risks and opportunities a company faces –
both financial and ESG – prior to making any investment decision and
then in our on-going due diligence.
Portfolios are managed on a team basis, with investment managers
doing their own research and analysis. Each team has a responsible
investment analyst that sits within the team, who carries responsible
for carrying out a holistic risk assessment of a company, and engages
Positive engagement at a mining company
We engaged extensively with an international mining group
with operations in Latin America and Asia. The group has
experienced a number of material ESG-related risks over
the past 18 months, including an increasing fatality rate,
severe health and safety related accidents which have
impacted local communities, and a failure to reduce its
GHG emissions. The issues we discussed constituted key,
material concerns for the company. Our conversations
focused on reasons for the worsening safety record and we
recommended steps the company can undertake to improve
its record. We also discussed at length the company’s
management of its individual sites and suggested ways to
improve how risk assessments are undertaken at its locations.
We pushed for greater oversight on material health and safety
concerns and, importantly, stressed the need for the group
to link its ESG-related targets to executive remuneration.
We believe the best way to ensure progress in these areas is
for remuneration to be linked to the progress being made.
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ESG: coming into the mainstream - April 2017
with them directly on any issues that appear to pose a material risk.
Desks operate independently but each has a model portfolio that
contains its best ideas, and forms the basis for portfolios, be they
retail or institutional. All ideas are shared via formal committees and
common databases, with desk heads enforcing consistency across
the Group.
Corporate engagement
A hallmark of our approach is ongoing engagement. We aim to visit
companies in our core portfolios at least once before investing with
an aim to revisit annually. This means we can respond pragmatically
to their individual needs and seek to consider what is in the best
interests of the company and its shareholders at the relevant stage
of its development.
Invest in good quality companies at a sensible price
Proactive company engagement
We invest for the long term – and only in companies that we believe
that we understand and can value
Ensures our holdings remain or become better companies
Company visit note
Step 1: Quality
Pass or fail?
Aberdeen universe
of stocks
Revisit
Step 2: Valuation
Cheap or expensive?
Watch list
• Ownership structure
• Business strategy
• Management
• Financials
• ESG
• Price/earnings
• Price to cash flow
• Price to book
• ROE
• Dividend Yield
Frequent dialogue
• Frequent dialogue
• Senior executives
• Board members
• Site visits
On-going due-diligence
• Business performance
• Company’s financials
• Corporate governance
• Company’s key risks
and opportunities
Step 3:
Portfolio
construction
Monitor
• Risk controls
• Model portfolio
• Portfolio ‘balance’
Exercise rights
• Always voteB
• Explain voting decisions
• Attend AGM/EGMs
as required
Consider all options
• Buy, Sell or Fight
• Seek to collaborate
• Legal action, if necessary
Source: Aberdeen Asset Management.
Source: Aberdeen Asset Management.
“In 2016 we held more than 4,600 meetings
with the companies in which we invest and
voted at more than 4,400 shareholder
meetings worldwide.”
Devan Kaloo,
Global Head of Equities
Fixed income
Within fixed income, the material risks of an investment are examined
across a spectrum of issues, including traditional financial metrics,
governance issues, country and industry specific considerations,
and environmental and social risks. These are all taken into
consideration, using information from many different sources before an
investment decision is made on behalf of clients.
Our ESG approach is to examine factors which have a potential,
material impact on the credit risk of the underlying investment. We
assess how they are managed and mitigated, as well as the
opportunities they create for the issuer and therefore the investor.
As with our equity holdings, we look to engage actively where we
believe this can add value.
Aberdeen also offer clients SRI screening, which excludes or
includes certain issuers based on client-determined values or
norms, and thematic bespoke solutions to suit specific client ESG
requirements. These customised capabilities include ESG-score
based products, benchmark comparisons, such as a comparison of
issuers’ carbon footprint in relation to an index, and impact investing,
in which an investor may target a specific issue or sector.
Two-level research process
Level I
Integration
All Credit mandates
ESG Integration
ESG risk assessments are included in our credit
research process
Engagement
Our Stewardship Centre coordinates our
engagement across asset classes
Negative Lists
Exclusion list
No controversial weapons
Norm-based exclusions
Global Compact compliance
No violation of Principle 2: working against corruption
Score-based inclusions
Best-in-class
Only the top 50% of companies by ESG score
Benchmark comparison
150 tons of CO2 per USDM of revenue vs 500 tons
in the benchmark
Use of proceeds
Targeting outperformance in health and safety
Preparedness
Investment strategy designed to mitigate energy
transition risks
Credit research
Stewardship center
Level II
Screening and
thematic investment
Footprinting
Customised
Thematic investment
universe definition
Climate risk management
B
Shareblocking in Germany and Switzerland can prevent us from voting.
ESG: coming into the mainstream - April 2017
5
Aberdeen Low Carbon Fund
Interest in carbon approaches by countries, companies, individuals
and wider stakeholders is increasing. To meet this demand, we are
able to provide clients with portfolios which have a lower carbon
footprint than the benchmark, both in terms of carbon output and
intensity. In this way, we can offer a solution which enables clients
to capitalise on the trend towards a low carbon world. We currently
manage over £1 billion in a low carbon fixed income portfolio.
Property
If both direct and indirect environmental and societal impacts are well
managed, the portfolio risk of our property investments can be reduced,
with higher rental growth and occupancy rates achieved.
In our property division, the consideration of ESG factors is integrated
into each and every stage of our investment process – from allocation
to selection and management.
“Our approach is not just about saving carbon
and energy; it is about managing our risks and
increasingly operational efficiencies to the
longer term benefit of building occupiers and
ultimately our investors.”
Dan Grandage,
Head of Responsible Property Investment
In addition to the full integration of ESG factors into the investment
process, we also offer thematic solutions to clients’ ESG needs in which
portfolios can be weighted towards specific sectors or issues.
Building a renewable data centre
We have worked with key stakeholders, Nokia and the city of
Tampere to build a world leading data centre in Tampere, Finland,
which minimises energy consumption and monetises waste.
The data centre will buy its energy from the nearby Tammerkoski
hydroelectric power plant and, coupled with solar panels on the roof,
this will produce 10% of the energy required to power the plant.
The cooling is solely powered by renewable energy sources through
district cooling. Rather than considering the resultant heated
water as waste, the plant will enable it to be sold back to the city
of Tampere for district heating of homes and hospitals. Nokia has
calculated that if all such centres around the world worked as
efficiently as their facility in Tampere, the global energy savings
would be equal to the amount of power produced by 100 nuclear
power plants.
Alternatives
For our indirect investment teams, our first step is to understand
how external asset managers integrate ESG considerations into their
investment analysis and decision making. Integrating ESG factors
into this process can provide additional insight into the quality of
a company’s management, its culture and risk profile as well as
identifying opportunities for growth and improvement. It is therefore
important not only for value protection but also for value creation.
In some cases ESG issues will have a limited impact on the potential
risks or opportunities of an investment. However, particularly for less
liquid private markets and our investments in less developed markets,
these issues can be meaningful in our assessment. This means that we
have, and will, make decisions incorporating metrics other than just
financial ones, including not progressing with an investment on ESG
grounds even when on financial metrics alone we would have chosen
to proceed.
In private equity, research and due diligence is carried out to
identify all material risks and opportunities – financial and ESG.
We actively engage with General Partners (GPs) of underlying funds
and ESG questionnaires are issued to all GPs. We are refining our
process to incorporate ESG key performance indicators and crisis
escalation processes.
Within hedge funds, our new manager due diligence process
incorporates strict governance standards across a range of issues.
There is ongoing engagement with approved managers on further ESG
adoption and ESG risk assessment. We can also customise strategies to
incorporate clients’ ESG requirements.
In our property fund of funds process, ESG issues of underlying
property funds are assessed via data from GRESBC, an investor-driven
organisation committed to assessing the integration of ESG factors in
investment processes and stock selection of real assets globally.
ESG within infrastructure differs from that of other alternative
teams. Aberdeen Infrastructure Funds (AIF) focus on Greenfield social
infrastructure (relating to schools, hospitals, water treatment facilities,
roads and rail), rather than wider economic infrastructure (e.g. airports,
ports, and utilities). When bidding for Greenfield projects as part of
consortia, ESG policies and practices are part of the assessment criteria
used by a government to select bidders that it would be willing to
award contracts to.
AIF currently have no formal negative investment restrictions relating
to ESG, however governance is a key consideration in the investment
process and any environmental issues likely to impact value are
evaluated. Aberdeen has the ability to influence ESG outcomes because
it takes substantial direct equity positions and appoints directors on
investee company boards. When it comes to managing investments
infrastructure seeks to ensure that governance has an appropriate level
of priority within the policies and strategies of its investee companies.
C
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ESG: coming into the mainstream - April 2017
Global Real Estate Sustainability Benchmark.
Integrating ESG in private equity
In 2016, Aberdeen completed a co-investment into Ethypharm,
an integrated pharmaceutical company providing complex generic
and speciality pharma products across the globe, alongside PanEuropean sponsor, PAI Partners. Given the nature of the business
and its global reach, ESG was an important consideration for
management and incoming investors from PAI and Aberdeen.
Quantitative investments
Multi-asset
At Aberdeen, our quantitative investment team build bottom-up
equity portfolios targeting factors which predict out performance.
Our systematic investment process allows the integration of any
ESG factor into a client’s portfolio. This can include a customised
implementation targeting a positive exposure to any desired ESG factor
at the portfolio level versus the benchmark, for example overall ESG
score, carbon profile or gender diversity.
Our multi asset funds are built around a clear philosophy of
diversification and utilising the team’s expertise in managing the
market risks of traditional and alternative assets. Aberdeen Solutions
offer genuinely bespoke solutions to our clients, including tailored
approaches to ESG integration according to clients’ ESG needs.
The team can also offer SRI-screened strategies.
The team also offer the more standard exclusion methodology (SRI
screening) of not holding stocks and industries which do not meet
the client’s requirements. Both controversial weapons (cluster bombs,
landmines, depleted uranium weapons and chemical/ biological
weapons) and companies with severe controversies (Level 5
controversies based on ratings from the Sustainalytics agency)
are excluded from our investable universe.
Finally, we have a thematic offering – SMARTER Beta™. Our capability
includes an ESG Multifactor Equity Index family, comprised of
multifactor ESG indices for global markets, developed markets,
emerging markets, Europe ex-UK, UK, Asia ex-Japan, Japan,
and Australia.
ESG: coming into the mainstream - April 2017
7
Important Information
The value of investments, and the income from them, can go down as well as up and you may get back less than the amount invested. Past performance is not a guide to
future results. Tax treatment depends on the individual circumstances of each investor and may be subject to change in the future.
Further details
For more information on ESG, SRI and Aberdeen’s stewardship capabilities, please e-mail the [email protected] mailbox.
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