Our Global Long-Term Unconstrained ESG integration

20 January 2020

GLTUESGIntegrationHighlight

We consider environmental, social and governance (ESG) factors to be key indicators of a company’s ability to generate sustainable returns.

For us, ESG is part of our focus on Stewardship, which goes hand in hand with sustainable investing. ESG risks can ultimately detrimentally impact the fair value of a stock. Assessing these is an essential part of ensuring that we capture and understand all risks to an investment case.

To capture these risks, we integrate ESG analysis from end to end in the investment process combining three elements:

  • Fundamental research
  • Active ownership
  • Portfolio analytics

Fundamental Research

Stewardship goes hand in hand with sustainable investing and within our fundamental research, analysis of ESG factors are captured through:

  • Early stage analysis in the ‘Long-Term Unconstrained checklist’,
  • Integration into our research templates
  • Our proprietary ESG risk assessment

Long-Term Unconstrained checklist

The Long-Term Unconstrained checklist is our first stage of fundamental analysis looking at eight key factors: growth drivers, industry analysis, returns, financial strength, accounting, corporate ethos and ESG. The purpose here is to examine the sustainability and quality of the business in broad terms before launching into deeper analysis.

Our ESG analysis at this stage is our first take. We will consider the MSCI ESG scores versus the company, assess remuneration and transparency of governance. This also complements our work on corporate ethos and the examination of the firm’s culture and management quality.

ESG analysis is integral to the GLTU strategy, employed throughout the investment process. It forms part of the decision to take a deeper dive on a company, is seamlessly integrated into our fundamental research, guides our engagement agenda and ultimately impacts our overall portfolio shape.

Integration into our research templates

Our research templates have multiple areas covering ESG analysis. It scores each company’s risk against four categories – one of which is Governance and Sustainability, as shown below. These scores are the output of the analyst’s overall ESG assessment of the target firm.

ESG Scoring charts 1a

ESG Scoring charts 1b

Feeding into this overall score, our research template has a qualitative summary and our proprietary ESG scoring system (covered in the next section). The qualitative ESG analysis is a written assessment of the company’s specific approach to, and potential impacts from ESG factors. To assess their impact the analyst will detail the:

  • ESG integration into the business model,
  • the impact of ESG factors on the analyst’s forecasted returns
  • what areas require engagement with management and;
  • the progress the firm has made since we began researching the stock.

The written thesis is a key part of how we build the investment case for the stock and allows for effective peer review.

Proprietary ESG risk assessment

Our proprietary ESG risk scoring template is shown below. We built the risk scoring system to capture the complexity of the ESG risks facing a company’s long-term outlook and sustainability – the categories reflecting what we believe are the most universal material factors. The scores of 1-5, reflect the level of risk we estimate from each factor, 1 is the lowest risk and 5 the highest. By scoring each factor, the team can then identify what material risks a company is potentially vulnerable to and what areas require more work. The analyst will score each area as they conduct their fundamental analysis on a company and the risk scores are discussed by the team at their stock discussions.

It is important to highlight here that a lower score in a specific category would not necessarily rule out investing in the firm. Rather it is an acknowledgement of an area where we have identified a potential risk. We would follow up in our engagement with management in order to understand further and gauge our level of conviction, or indeed look to engage with a view to guiding the company to improve in that specific field.

This is divided into two sections; Governance and Sustainability factors. Governance focuses on the board, management, remuneration and culture, while Sustainability covers, environmental & social factors, their integration and what we classify as systematic or ‘common factors’. These include climate change, cyber security and customer areas that can have significant impact on both the brand and long-term value of the target firm. Among the 11 high-level categories shown at the top of the template ‘Stake vs Shareholder conflict’, ‘Governance Momentum’ and ‘Sustainability Momentum’ are standalone factors. The latter two capture the momentum of change at the firm in addressing governance and sustainability risks, because it is important for us to assess the degree of change and improvement. Overall, we have approximately 50 parameters across both sections that our analysts assess on a consistent basis.

We built the risk scoring system to capture the complexity of the ESG risks facing a company’s long-term outlook and sustainability – the categories reflecting what we believe are the most universal material factors.

Proprietary ESG risk assessment (cont)

The ESG risk assessment framework ensures that we are thorough and systematic in assessing all the fields relevant to both the Governance and the Sustainability side. As part of that, we identify which fields are material for any given company, and then engage on these with a view to guiding companies towards driving improvement.

GLTUESGAssessment

Active Ownership

We believe monitoring and engagement are an essential part of being a long-term shareholder in a company. It allows us to improve our understanding of investee companies and their governance structures, so that our voting decisions may be better informed. In addition, it enables us to understand to what extent companies have identified material ESG risks and how they are managing these. The materiality and immediacy of a given issue will generally determine the level of our engagement.

Our ambition is to engage with companies on important ESG matters and guide them on areas of improvement towards being best in class to make the business more sustainable in the long-term.

Our practice is to engage not only with the management of companies, but also with a range of other stakeholders for each business. These include government agencies focusing on areas that are material to a particular region or company. Similarly, the investment team meets on a daily basis with a focus on read-across from one company to another – this ensures that lessons learned from any engagement on a particular issue are disseminated quickly and effectively to the broader team. Our internal research portal also ensures that all company-level research and contact is made available for the whole investment team.

The main objectives of our engagement activities are:

  • to enhance our conviction in investee companies
  • to understand management incentives
  • to identify and share best practice
  • and ultimately to improve corporate practice

Our process on tracking engagement is overseen by David Sheasby, our Head of Stewardship and ESG. We disclose engagement details and examples in both our annual stewardship report and client reports.

In addition, it enables us to understand to what extent companies have identified material ESG risks and how they are managing these.

Portfolio Analytics

Managing a high-conviction, unconstrained portfolio places increased emphasis on portfolio construction and we consider this with equal importance to the research process. Our ESG research is an integral part of our fundamental research and feeds through into our portfolio analytics alongside our analysis of geographic revenues/profits, company classifications and thematic exposures.

The output is shown in an ESG dashboard on our in-house portfolio application, shown below:

ESG Scoring charts 2a

ES Scoring charts 2b

The dashboard is structured as follows:

Governance and sustainability risk scores

We have split the overall number of 1-5 scores by governance and sustainability. Where we have scored a stock a 4 or 5, it is important we understand the risk behind the score on each factor before investing in the stock. An increase of 4-5 scores would be a trigger to investigate what stocks are causing this and potentially either adjust the portfolio weighting or reassess the individual investment cases.

Percentiles

The percentile score plot shows each stock in the portfolio scored by its governance versus its sustainability score. This provides a visual overview of each stock’s overall risk contribution to the portfolio, allowing us to identify any outliers and analyse diversification.

Scores breakdown

The scores breakdown decomposes the portfolio’s overall ESG score as per our 11 high-level categories from our proprietary template, with the dots representing the sub categories. For example, under ‘Culture’ the dots represent the scores for; Corporate culture, Sustainability focus, Diversity, Integrity & ethics and Relationships with stakeholders. Again, this will highlight areas where we need to do more work or potential vulnerabilities.

Overall, this analysis both helps measure our effectiveness in integrating ESG factors and complements our other portfolio analytics on geographic revenues/profits, company classifications and thematic exposures. It is an integral element of our work on achieving good diversification and understanding the risks to the portfolio.

A focus on continual improvement

ESG analysis is integral to the GLTU strategy, employed throughout the investment process. It forms part of the decision to take a deeper dive on a company, is seamlessly integrated into our fundamental research, guides our engagement agenda and ultimately impacts our overall portfolio shape.

We are always looking at continual improvement within our investment processes. Going forward, we will be placing further emphasis on measuring and reporting on the outcome and impact of our engagement. We want to assess how driving a change agenda to improve ESG at target firms has improved performance (both on share price and operationally).

We go beyond integration into fundamental research, employing our ESG analysis within the portfolio construction process. From this perspective, the real value comes from being able to drill down and examine our overall exposures and identify any areas of potential risk. It provides feedback on the effectiveness of our ESG integration and that can be reflected back into research and portfolio positioning. Overall, this allows us to build robust, diversified portfolios capable of delivering on our client’s long-term objectives.

We want to assess how driving a change agenda to improve ESG at target firms has improved performance (both on share price and operationally).


Important information

This information is issued and approved by Martin Currie Investment Management Limited (‘MCIM’). It does not constitute investment advice.

The analysis of Environmental, Social and Governance (ESG) factors form an important part of the investment process and helps inform investment decisions. The strategy does not necessarily target particular sustainability outcomes.

Market and currency movements may cause the capital value of shares, and the income from them, to fall as well as rise and you may get back less than you invested.
The opinions contained in this document are those of the named manager(s). They may not necessarily represent the views of other Martin Currie managers, strategies or funds.
The information provided should not be considered a recommendation to purchase or sell any particular security. It should not be assumed that any of the security transactions discussed here were or will prove to be profitable.