Investment Magazine » Environmental; Social & Governance

We’re all stakeholders, says Hermes CEO

Amal Awad — Mon, 06 May 2013 06:14:12 +0000

It’s not common to sit in an industry seminar and hear a chief executive utter the words, “Firstly, let me appeal to your hearts”, yet this was the central currency to Hermes CEO Saker Nusseibeh’s keynote at last week’s environmental, social and governance-themed ACSI conference.

Addressing a diverse industry crowd, with several major fund CEOs and CIOs in attendance, as well as numerous asset managers, Nusseibeh’s point was clear: the industry should be changing its emphasis to focus on stakeholders rather than individual members.

In other words, we should be paying greater attention to the impact investments have on wider society and consider adjusting them accordingly.

Increasing the savings pots of members is important, but with the rise of the environmental, social and governance conscience, investment extends beyond the individual.

This is about creation – asking what kind of world we’ll be inhabiting in 20 or 30 years if we’re not conscious of how our investments can affect and be affected by externalities – politics, business ethics, environment and infrastructure, to name a few.

All of us have a stake in all of our savings

It might seem easy to devalue this proposition given the not-insignificant responsibility of a fund to deliver the best outcomes to its members, but Nusseibeh is hardly naïve on the role of a super fund. That and it’s a space he’s highly attuned to given he chairs the 300 Club, which is focused on the impacts market behaviours have on investment. Hermes is also owned by the BT Pension Scheme, which also oversees Hermes Equity Ownership Services, an advisory service with a focus on responsible investment.

As Nusseibeh notes, the onus on industry stewards to grow member savings is, arguably, a duty to attract growth for wider society.

“It ultimately means that all of us have a stake in all of our savings. It’s about more stakeholders than simply those who individually own the assets as individuals within the scheme,” he suggests.

And there is some agency in taking on a longer term consideration of investment, with closer thought to how asset allocations impact the world, this human and earthly collective.

Perhaps a primary issue is the terminology. Have, as Nusseibeh argues, these notions of a “collective” or “stakeholder” society become dirty words since the Reagan-Thatcher rise of Milton Friedman economics in the late 1970s?

If so, and if oil-spills, pollution and a weak economy aren’t enough of a contention for funds, Nusseibeh goes on to appeal to the almighty wallet.

“What happens to our investments if don’t take a long-term governance, environmental and social issues into consideration? What is the result of that on the prices of the assets that we invest in? On the cash flow that these assets generate, because it’s that cash flow that’s going to pay out the pensions at the end of the day?

“I would say it’s a disaster.”

No to near slavery

This taps into a wider issue of industry engagement, not just governance but, as Nusseibeh points out, investors should be holding companies they invest in accountable for risk and operational standards, otherwise they’ll feel it in the share price.

“We’re all rushing into cheap overseas production. Just think about what we’re doing. We’re creating factories around the world that have people in near-slavery conditions.”

This sort of situation has political impact, Nusseibeh says – think, the rise of extreme politics globally – and the end investor will also feel the pain.

It’s a thinking that was canvassed throughout the day. Richard Brandweiner, who has just joined First State Super as director of investment services, argued similarly that a tunnel-vision approach to investment could mean crucial longer term returns get sacrificed in the desire to deliver short-term returns for investors.

Indeed, anxious investors are nothing new, but perhaps the ESG theme is becoming a far greater consideration for an industry having to reshape its approach to how people live.

Nusseibeh argues that there needs to be a different kind of relationship between individual asset managers and their clients.

“The relationship has to be one of fiduciary care with a small ‘f’,” he said.

“We can no longer afford to simply say, for the sake of an example, I’m an asset manager and I’m selling you global equities, that’s all I’m selling you.”

Similarly, funds should be taking a wider, longer term view to how they engage with the world. As Nusseibeh told delegates, a widely integrated approach to ESG investing is doable and not that difficult.

LGS strengthens ESG suit with Hermes mandate

Lachlan Colquhoun — Mon, 12 Nov 2012 06:01:49 +0000

Hermes Fund Managers has been awarded a $90-million environmental, social and governance mandate by Local Government Super for a developed-world equities fund.

Hermes director, Ian Manton-Hall, told IM Online that the fund was similar to another of the firm’s funds for core investor, the BT Pension Scheme, but with some particular overlays specifically for Local Government Super.

How it works

“We have an ESG input into our quant team, and we know there are some things Local Government wants to exclude – such as tobacco, alcohol and gambling – and we do that screening in the quant process and then apply our active management over the top of that,” said Manton-Hall.

“We’ve known Local Government Super for a long time and we’ve been talking to them about a portfolio that had some positive ESG components to suit them, and which will deliver good returns going forward.”

Local Government Super chief executive Peter Lambert told IM Online that working with Hermes, which has $116 billion in assets under management worldwide, was an effective way of running the fund’s ESG filter on the portfolio. ”We run and overlay and often the difficult is that when you deal with global stocks you then up with small holdings and an unbalanced portfolio,” Lambert said.

“This way we can work with Hermes to run an ESG filter on their existing fund, which has an ESG dashboard, and it enables us to do this at a manager level.”

The portfolio is benchmarked against the MSCI World (excluding Australia) Index in a universe of around 250 stocks “which takes on Local Government Super’s exclusions.”

The Hermes mandate is a second significant ESG move by the $6-billion Local Government Super this year, coming after a mandate to Omega for a global bond fund that invests in bonds issued by nations judged on their ESG records.

The analysts look at 90 nations through up to 70 ESG filters and the fund also has a 15-per-cent allocation to climate-themed or so-called green bonds.

In May, Local Government Super joined with several other funds alongside shareholder activist group, Regnan, to push for raising the operating standards in the global coal-seam gas industry.

Room for diversity

Amanda White — Mon, 10 Sep 2012 07:31:04 +0000

Australian supernnuation-fund boards suffer from “similarity selection bias” in selecting trustees and by doing so limit their opportunities to act, according to human-capital partner at Deloitte, Juliet Bourke.

Bourke, who leads the national diversity and inclusion practice at Deloitte, says people are attracted to other people who are fundamentally the same as themselves.

“We need to reset the mindset to help them understand that is the comfort zone but that’s not the best way of doing business,” she says.

Bourke, who works with corporations including Westpac and BHP on their diversity programs, says the collective intelligence of 10 people around a boardroom table will “cap out” if there is lack of diversity of perspective.

She says shifting the thinking on diversity can only be done by experiential learning and she works with corporates to go through unconscious bias training.

“We give them the opportunity to learn by experience, our workshops help leaders experience the information in a different way, and we look at inclusive behaviours.”

She believes that board diversity extends beyond gender diversity and to a difference of life experience and skill.

“Questions to the board are large and complex so diversity of thinking is essential,” she says.

“There are so few cues to check the measure of a boards’ success, the lack of demography is one measure.”

Women make up 20 per cent of board positions on Australian superannuation funds. On the boards of ASX-listed companies, that number is only 14 per cent.

The September issue of Investment Magazine looks at diversity on superannuation fund boards in Australia.

Papers on gender diversity mentioned in the cover story include and articles of interest on the topic include:

https://infocus.credit-suisse.com/data/_product_documents/_shop/360145/csri_
gender_diversity_and_corporate_performance.pdf

http://www.womenonboards.org.au/pubs/articles/

http://www.themonthly.com.au/do-mandatory-gender-quotas-work
-status-quota-cordelia-fine-4667

http://m.theatlantic.com/magazine/archive/2012/07/why-women-still-can-8217-t-have-it-all/9020/

http://www.ap2.se/Global/Kvinnoindex/NIS%20AP2%20
Fem%20Rep%20Index%20english.pdf

http://www.mckinsey.com/locations/swiss/news_publications
/pdf/Women_Matter_2012.pdf

http://www.catalyst.org/publication/527/commonwealth-bank-of-
australiaopening-the-door-for-gender-diversity

Low-carbon winners and losers

David Harris and Tony Campos — Mon, 30 Jul 2012 04:28:56 +0000

How high is your portfolio’s exposure to potential stranded carbon assets? According to Generation Asset Management, stranded assets are those with a value that would change dramatically, either positively or negatively, under certain scenarios such as a reasonable price on carbon or water. The soon-to-be-introduced Clean Energy Plan will put a price on carbon emissions for the world’s highest emitter per capita, but the impact on investors is not yet well understood. For Australian companies and their shareholders, it represents a new risk factor, and the way it is managed will increasingly influence economic winners and losers.

Extreme losses for shareholders as a result of such stranded assets appear unlikely, at least in the short and medium terms, but the new Australian legislation can be seen as the latest indication that the global economy has entered a sustained period of transition to a low-carbon model.

Many experts believe that such a transition requires internalising negative environmental externalities through appropriate pricing, which presents significant opportunities and material risks for investment portfolios.

The opportunities result from the potential in emerging economic sectors such as energy efficiency, water technologies, and renewable and alternative energy. The risks posed to portfolios of potentially dramatic asset re-pricing will command a historic shift in conceptual, strategic and tactical- investment decision-making.

A vanguard of institutional investors, including many Australian superannuation funds, is already working to exploit the opportunities and manage the risks posed by climate change.

Much of the activity can be characterised as opportunity seeking: for example, the creation of satellite portfolios designed to enhance exposure to environmental sectors in an effort to generate alpha. Although the poor performance of renewable-energy stocks tends to cloud perceptions, the opportunities in environmental markets beyond renewable, in areas such as energy efficiency, water technology, and waste and pollution control, are more apparent.

The FTSE Environmental Opportunities benchmarks highlight the outperformance for these sectors relative to global equity markets over the last five years. See Figure 1.

The impact of carbon pricing

An area of considerable concern that is less well understood is how to identify and integrate carbon risk factors into existing portfolios and strategies. The exposure of superannuation funds to Australian listed companies can take many forms, such as through passive (index-tracking) portfolios.

What will the impact on the value of these portfolios of a price on carbon emissions be? The picture is not entirely clear – even ignoring the ongoing debate about the future of the carbon-price legislation under a different government, the lack of sufficient investment-grade data published by companies presents a challenge to those looking to factor carbon risk into investment analysis.

What is mostly clear is that in the immediate term, the impact on company valuations and portfolio performance will not be significant. However, the impact in the medium term is likely to be more meaningful as the price of emissions rises and, in the long term, there is potential for dramatic re-pricing of assets.

On a global scale, what would happen if the world’s governments decided to forcefully enact policies meant to cap the rise in global temperature at 2° Celsius? That would require strict limits on the burning of fossil fuels, in other words a “global carbon budget” linked to the projected rise in temperature.

According to analysis by Carbon Tracker, a system that calculates carbon dioxide uptake and release at the Earth’s surface over time, the burning of only about 20 per cent of all known fossil-fuel reserves by listed companies in the next 40 years would fill such a carbon budget, leaving 80 per cent of the reserves unexploited. The impact on the valuations of the companies whose reserves would go untapped would create a carbon- asset bubble, the results of which would dwarf subprime. And this scenario only includes listed-company reserves, which actually represent a smaller proportion of known global reserves compared to those of state-owned firms.

The track record of the negotiations on the UN Framework Convention on Climate Change suggests that such a policy scenario is practically unimaginable. However, the lack of global political consensus actually makes the risks even harder for businesses and investors to manage because it increases the likelihood of sudden policy shifts and patchwork approaches. But just thinking through the potential implications of serious attempts to limit carbon emissions should underline to asset owners the size of the potential risks they face.

Lower emissions, higher profits

The question of what to do about these issues is addressed by a growing set of analytical techniques and investment tools designed to support the integration of carbon risks. In particular there is a shifting awareness that so-called carbon footprinting – looking at historic emissions data as a measure of carbon efficiency – is a blunt method of risk analysis. Forward-looking analysis is required in order to measure risk exposure in carbon regulated markets.

Looking at the impact of the incoming Australian regulations on utilities illustrates this point. The carbon intensity of power generation will affect the ability of utilities to pass on the full costs of paying for emissions to consumers. The less efficient, highly intensive emitters will see their profit margins shrink. According to information from ENDS Carbon, a provider of carbon-performance benchmarking, the emissions-intensity inflection point for Australian utilities is currently estimated at 0.86 t CO2/ MWh. For companies that are more efficient than this, the new carbon costs will be outweighed by higher energy prices. For the less efficient, increased customer payments will not compensate for costly carbon-emission charges.

In this scenario, from 2012 to 2022 the average cost of carbon for a largely coal-fired utility, such as International Power, will represent a much higher proportion of projected profits than for companies such as Infigen and Origin, which have generation portfolios that utilise various renewable and alternative energy sources.

As carbon-risk analysis becomes more sophisticated, so too are the tools that allow investors to incorporate these factors. A new generation of carbon-risk-adjusted indexes allow investors to increase exposure to companies that best manage carbon risk and reduce exposure to those that manage it poorly, while retaining similar performance and risk/return characteristics of the conventional benchmark. The performance and volatility of the FTSE CDP Carbon Strategy Australia 200 Index compared to the FTSE ASFA Australia 200 index demonstrates the affect of this approach (see Figure 2).

In fact, the performance is so close as to be virtually undistinguishable. This underlines the fact that, at least initially, the carbon-risk adjustments in carbon strategy indexes will not be significant enough to drive significantly different performance. However, as the carbon price begins to increase, and as companies improve disclosure of key carbon-related metrics to meet new regulatory requirements, it can be expected that the “carbon-tilts” in the index will become more defined and lead to a greater divergence in performance from the standard benchmark.

The precise impact on investors of a price on carbon in Australia will only emerge over time. However, increasingly sophisticated methods of carbon risk analysis and the incorporation of these methods into investment tools such as indexes will support the capital mobilisation that is needed to achieve an efficient low-carbon economic system.