Linda Duessel: Hello and welcome again to the Hear and Now Podcast. I'm Linda Duessel, Senior Equity Strategist at Federated Hermes and today I'm joined by Dr. Michael Viehs, head of ESG Integration. Hi Michael. So Michael, just to start out, can you explain to us how does Federated Hermes think about ESG Integration and what makes our approach unique?
Michael Viehs: Thank you, Linda, for having me. I think the first point that I would like to stress is that we always speak about ESG and engagement integration and there are already points to the key differentiators that we have at Federated Hermes, namely the EOS team at Federated Hermes, which is a dedicated engagement team which engages with invested companies on material ESG considerations that actually influence company's business performance, but also their long term resilience.
Michael: At the end of the day, what we think ESG and engagement integration leads to are better investment decisions for portfolio managers. So we believe that ESG information from third party sources such as Sustainalytics, MSEI, Trucost, you name them, together with the engagement information gathered by the stewardship team, helps our fund managers to make better long term investment decisions. We give them additional information pieces to evaluate companies and to also grasp basically the long term value creation that companies can deliver when they are more sustainable and have better ESG practices in place. But overall, I would say the engagement, the stewardship dimension is really key and that's a key differentiator for Hermes Federated Hermes.
Linda: Yes! Well you did bring up engagement. Can you flush that out a little bit more? What role does engagement play?
Michael: Yes. So engagement is really having a dialogue with invested companies about material ESG factors, about material environmental, social and governance factors that affect the long term business success of these invested companies.
Michael: You can think about ESG integration also a risk mitigation or risk management strategy, especially for the fixed income investors because when we speak with companies on a senior executive and board level, we always try to address those topics which impose a certain risk for companies that can be, for example, companies in the oil and gas sector, which might be exposed to certain climate change regulations that are upcoming, especially in Europe. It can have to do with companies which have maybe a less superior governance structures. Where, for example, minority shareholder rights are not respected well enough. And these are certain risks that actually can translate into material financial effects for both fixed income investors, but also for shareholders of course, but also for liquidity investors and also municipality investors, for example.
Michael: So this is really the key of the engagement that we try to bring about positive change for investors, but also for other stakeholder groups. So we believe when we engage with companies on ESG considerations, we make companies more sustainable, more successful over the longer run. They deliver an investor return. But on top of that, we also believe that we can generate an additional return, for example, for the society and the environment by making companies we invest in more sustainable.
Linda: So are only shareholders able to engage with companies?
Michael: So what's important, actually, and that's a very good question that we engage on companies. We engage with the corporate entity. We do not necessarily engage with the securities on the security level. We really speak with the company itself. With the CEO, for example, with the chair of the board of a particular company.
Michael: And that's actually then pointing towards the fact that not only shareholders can engage with companies, engagement stewardship is also relevant for fixed income investors, for bondholders, but also for private market investors such as real estate investors and direct lending investors. But most importantly for us, I think also for liquidity investors in the money market space because at the end of the day, if a company is hit by an ESG scandal for example, or a certain ESG effect that drives down, for example, the credit rating of a particular company, this at the end of the day is not only also a risk for shareholders, but also for money market investors who have exposure to these short term debt instruments. So at the end of the day, effects on a corporate level can actually have trickle down effects for other securities other than stocks basically.
Linda: So Michael, can you describe for us some of the key topics Federated Hermes engages on?
Michael: So you have to imagine we are engaging with companies on all material, environmental, social and governance factors and also strategy questions. So we do not see ESG space as a separate kind of topic. We see it holistically. ESG always in the context of a company's business strategy, a company's business model, and that makes us more credible than, for example, others in the space who are engaging with companies.
Michael: We do not engage with a particular company on the entire ESG universe because that's too broad. We always try to really engage with companies on only the most material ESG consideration, that is those topics that are mainly affecting a company's riskiness, but also affecting a company's long term business success. So it's really identifying what are the most relevant ESG topics for a sector and what are the most material ones for a particular company?
Michael: Let me give you an example. So for the fossil fuels companies that we are engaging with, climate change, the environmental dimension are really important ESG consideration. Whereas for example, for a financial services company, we are more likely to engage on corporate governance, board effectiveness, corporate culture issues because these are the more prevalent and also more financially relevant ESG considerations.
Michael: So, and I spoke already about a few examples we have. If I go a little bit more into the detail on the governance side of things, we have board effectiveness. So we speak really with companies about are the right people sitting on the board? Do we have enough market expertise on the board? Do we have, for example also relevant skillsets on the board which help actually advising and also guiding a certain company?
Michael: We are also engaging on executive compensation issues. Is the executive compensation structure in a large public listed company really incentivizing long term value creation, which at the end of the day benefits all investors? Or do we actually have to engage with the company on improving remuneration structures? On the social side of things, we have for example, topics such as human capital management, human rights practices, making sure that companies, especially with long supply chains, have proper supply chain standards, human rights practices in place. And finally on the environmental side of things, especially in Europe, we engage a lot on climate change considerations. So how resilient companies are with respect to climate change.
Michael: But we also talk with companies about water usage, for example, pollution and waste management. So this is kind of some examples of topics that we are engaging on. But as I said before, we are not engaging on the entire universe with every company. We really try to identify and focus on the most financially relevant topics in that regard.
Linda: Yeah, it sounds like a really some great in depth research that you do. And gosh, who does the ESG research within the investment teams?
Michael: So in our international division in London, we have the following setup. So the engagement team really is there to do the ESG research for their underlying engagements. When they want to speak to a chair or to a CEO, they do the fundamental bottom up ESG research in order to be able to engage with the company. On the investment side, we have decided to have this really special feature that all of our portfolio managers and all of our financial analysts do their own ESG research. So we do not have, as for example, competitors might have a separate unit of just ESG analysts. We really embed it into the mainstream investment decision making process by having it embedded in the investment process.
Linda: Another feature of what makes you unique?
Michael: Yes, exactly. Yeah. This is, I believe I'm doing now ESG integration for more than two years and I think this is really one of the key unique features because for us it's key to integrate it into the mainstream investment process. And what can happen theoretically if you have a separate entity of just ESG analysts that they do their ESG research, but it's then not really embedded and not fit into the investment process itself. And we try to avoid that by having the analysts together with the portfolio managers and together with us in the responsibility office to really do their own fundamental bottom up ESG research, which is then also embedded in the investment decision making process.
Linda: Okay. Great. Well, you mentioned materiality earlier and can you just delve into that a little bit more as to how important materiality is in the ESG and engagement integration?
Michael: Yes. I think it's really in what we have seen over the past few years. It's really key to really focus your efforts when you research a company on what are the key value drivers from a mainstream fundamental research point of view, but also from an ESG perspective. And I believe a lot of fund managers for a long time at Federated Hermes have already looked at, for example, corporate governance features of a company because every fund manager should take a look at who is running the company that I would like to invest in, who is sitting on the board. So these considerations are really important for a long time.
Michael: And subsequently we added, also of course, the social and environmental dimension. And with the help for example, of certain initiatives such as the Sustainability Accounting Standards Board (SASB), we actually help and guide our analysts and portfolio managers to focus their efforts on only those topics that they also deemed to be relevant for a company. So this actually makes the entire ESG and engagement integration process a little bit more streamlined and helps them focusing on the only those topics that matter for them from either a risk mitigation point of view or from opportunities point of view when you're talking about equity investors.
Linda: Thank you very much, Michael. And thank you to our listeners. We look forward to you joining us again on the Federated Hermes Hear and Now Podcast.
Disclosure: The views are as of February 5th, 2020 and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector. There is no guarantee that considering ESG risks will be a successful investment approach. Hermes Investment Management 20-30028 (2/20).