Aoifinn Devitt: Welcome to the Federated Hear and Now Podcast, where we discuss the key issues, challenges and trends shaping the investment landscape.
Aoifinn Devitt: I'm Aoifinn Devitt, head of Investment Ireland, at Hermes Fund Management Ireland Limited, a Federated company. I'm joined by Hamish Galpin, and Mitch Reznick, members of our investment team.
Aoifinn Devitt: This podcast is about U.N. sustainable development goals or SDGs, and how we may weave them into investing.
Aoifinn Devitt: First, let's talk a little bit about terminology. Environmental, social, and governance investing represents an evolution from investing according to socially responsible investment or SRI guidelines.
Aoifinn Devitt: Currently, 22.9 trillion is invested in ESG strategies globally, and growth is robust, at approximately a trillion dollars per year expected to flow into sub-strategies, according to the World Economic Forum. As more and more investors seek to incorporate ESG considerations into their investment processes, SDGs have proven to be useful signposts along the way. As signposts, they enable investors to measure more specific ESG outcomes.
Aoifinn Devitt: What exactly are the SDGs? The SDGs are a collection of a 17 global goals put forward by the United Nations, and approved by 193 countries in September, 2015. They are a universal set of goals, targets, and indicators for global development.
Aoifinn Devitt: They're also known as global goals. As such, they are designed to address the global challenges we face, and they've been called a blueprint for changing the world. How? By ending global poverty, safeguarding the planet, and aiming for prosperity for all, all by 2030.
Aoifinn Devitt: What exactly do these goals entail? There are 17 goals, all designed to be interconnected and to leave no one behind. Within those goals, there are 169 targets, and 230 indicators. As such, these goals aim high and wide, and can seem to be all encompassing and even overwhelming. They include goals such as, number one, no poverty. Number two, zero hunger. Down to number four, quality education. Number nine, industry innovation and infrastructure. Number 10, reduced inequalities. Thirteen, climate action. Fifteen, life and land. Seventeen, partnership for those goals. The question might be, how do we translate these goals into action? Particularly in an investment context.
Aoifinn Devitt: Let me give you an example. All of the goals here are laudable objectives, but some speak to us perhaps more than others, almost in a visceral way. For example, Goal 14 is a protection of life below water, or more expansively conserve and sustainably use the ocean seas and marine resources for sustainable development. I have always been a huge water sports fan. As a child, I spent hours on end swimming and jumping through waves in the frigid Irish Sea. Now, I live by the sea in Dublin. Every visit to the beach, I now spend my time picking up plastic from the beach, and when I'm with my children, we even turn this into a game.
Aoifinn Devitt: Research by Hermes has found that 8 million tons of plastic end up in the oceans every year. According to some estimates, there will be more plastic in the ocean by weight than fish, by 2050. More plastic than fish. And by 2050, an estimated 99% of sea birds will have ingested plastic.
Aoifinn Devitt: Plastic causes $8 billion in damage to marine ecosystems each year, and plastic pollution costs the lives of 100,000 marine mammals per year. It is a veritable plastic tsunami.
Aoifinn Devitt: How can we address this with companies? The problem of plastic waste on our beaches and in our oceans. We can engage with them, to try to get them to tackle a packaging waste. Did you know for example, that the bottle cap is among the five most found littered item on beaches.
Aoifinn Devitt: And how can engagement help? It can encourage resource efficiency and circularity at multiple points along the value chain. It can encourage companies to tackle the issue of packaging waste, make appropriate investments in research and development and product development, and this can then help us address other goals. As we mentioned, the beauty of these STGs is that they are designed to be interconnected.
Aoifinn Devitt: Another goal could be goal 12, which is responsible consumption and production. Tackling packaged waste goes beyond alleviating marine pollution. There are 600 billion plastic cups distributed worldwide every year. In the UK, only one in four of these cups are recycled.
Aoifinn Devitt: Let's move on now to speak with the two practitioners here, who have given a lot of thought as to how to align investment processes with the SDGs. Mitch, thank you for being here with us.
Mitch Reznick: Of course. Thanks. Thanks for having me.
Aoifinn Devitt: Can you tell me a little bit about yourself, and how you came to be involved in SDGs, and thinking about how we can weave them into the investment process?
Mitch Reznick: Sure. It's principally, there are multiple reasons. I think some of them you've touched upon, which is that more and more people are feeling the effects of climate change and societal degradation on a personal basis. As a result of that, this isn't just, these aren't just headlines or articles in National Geographic. This is real stuff. Investors are looking for ways to attach their money to societal outcomes that benefit the environment, sustainable outcomes in their investments.
Mitch Reznick: In terms of the SDGs themselves, what I like about them is that they provide in an elegant way, an elegant framework to reference all of these concerns and issues that you've talked about. It's a way to create norms around all these concepts of lingua franca, if you will, so that there's a simple way to talk about these with companies and investors and.
Mitch Reznick: Finally, as per guidance from the U.N., The amount of financing and capital that's required to solve these problems is so profound, that public capital or multilateral, institutional capital, say from the World Bank or the IMF, etcetera, is not sufficient. That to solve these problems, we need to partner with private capital. And that includes equity and debt investors. If you wrap up all three of those, and you combine that with the fact that we can do this while also creating attractive investment products, then it seems like a natural thing to fold the SDGs as a thematic into investment products.
Aoifinn Devitt: And why do you think they are emerging as a theme? Is this coming from investor demand? Do you think it is an area that can no longer be ignored as an in the area of investment?
Mitch Reznick: Well, I think the urgency with which, in particular, we need to resolve the issues with the climate change is acute, and many can see that. As a result of that, yes, we're getting a lot of reversing query, which is to say, investment requests from outside investors, and how our investments are seeking to contribute to the resolution or the slowing down of these problems.
Aoifinn Devitt: Thanks. Hamish, can you tell us a little bit about yourself and your background, and how you came to think about investing with an SDG aligned way.
Hamish Galpin: Sure. Thank you. Hi.
Hamish Galpin: Well, I've been a bottom up stock picker for a good number of years at Hermes, and actually, the concept of using the SDGs is all a part of, it's all about longterm shareholder value creation for me. It's an extra angle from which to think about businesses. It makes a lot of sense right now because from my experience, the sustainability is something that has gone from being something that companies ought to consider to something that they really need to consider. It's really a boardroom issue nowadays. Too many companies its dealt with in the legal department, and it's really something that has been elevated to board level because they're getting a lot of pressure from shareholders about their, what they're doing about environment and sustainability. They've got to track the next generation of employees into the business, and these graduates or younger people who just care far more about the environment and social matters than the current generation, plus those running these businesses.
Hamish Galpin: Also there's a lot more pressure on companies these days to ensure their, the adequacy of their supply chain and really to, for them to think about reputational risk and their social license to operate. The sustainable development goals are just a mechanism by which to engage with companies on these matters.
Aoifinn Devitt: Engagement is key to have an equity strategy that is SDG aligned. What exactly does that engagement look like? What are you engaging with companies on with respect to SDGs? Maybe we can think of a concrete example of what an SDG that, in particular, you have thought about in your engagement with the company.
Hamish Galpin: Well, actually, the great thing about the SDGs is that they're so broad in scope. Every company has employees. Every company uses energy in one form or another. Every company has supply chain to some extent, some deeper than others. Really there is any number of things with which we can engage companies on. What we're doing is taking some of the existing, the names that we know well, and working out which ones have the greatest impact potential, shall we say, and will engage with companies on those issues.
Hamish Galpin: We have a written act written to all of our companies on SDG eight, which is a decent employment initiative for instance. The reason I like that particular SDG is the fact that it reaches out to a lot of different aspects of the SDGs, not just the decent employment one, but it fits in with a gender equality as well, because clearly that pay gap is a, between men and female employees with the same jobs has come up as an issue on a number of different industries. We can think about quality of education as well. Bringing on people from a disadvantaged backgrounds into the labor force, giving them training. Clearly, a sort of good employment leads back into health and wellbeing as well, and then to introduction of inequalities and improving a lower paid outcomes through minimum wages, etcetera. We actually have a very broad scope of things with which we engage companies on.
Aoifinn Devitt: I think this is one of the beauties of this, is that one, engagement can actually touch so many different of those goals. It really is that they are fully, they are interconnected, which allows us to hit a number of objectives at once.
Aoifinn Devitt: Mitch, on the the credit side, how can a credit strategy be aligned with SDGs?
Mitch Reznick: Well, everything that Hamish has just mentioned is as important to credit investors as equity investors. Effectively, what Hamish is talking about, what we're talking about here in general, is capital structure agnostic.
Mitch Reznick: All these items that we're discussing here and that Hamish just mentioned, specifically, are self-reinforcing for the financial strength of the company itself, and that benefits both shareholders and creditors. We are not talking about issues that in some way or another may show some favorability toward one share class or one stake holder versus another. These issues are reflect, if a company is addressing these issues, they are thinking about the longterm sustainability of the company itself, as well as the sustainability of the environment and the society that is around them. Over time, if there is significant degradation, can have an impact on the company's ability itself to generate cash flows. Cash flows are, of course, how we value credit and how we value equity.
Aoifinn Devitt: Just getting back to one of the challenges maybe of having an SDG aligned approach. Is that sometimes the case, Hamish, that there's a very tenuous link between any engagement you might do in any so-called positive impact later down the line? Is it easy to always draw a connection?
Hamish Galpin: Well it's a (clears throat), it was a point I was going to make as Mitch was talking there that it's really, to my mind to finish off where we're talking about just a second ago. It's not so much about the different points in the capital structure. It's more about tuck and more about terms.
Hamish Galpin: Actually, to be able to achieve engagement with companies, you have to have a longer term investment horizon. It's only through that, I can think of some companies that have done nothing on sustainability, for instance. It takes, it's going to take several years for us to agree, a sustainability program and for a company to execute it.
Hamish Galpin: If you take some of the U.S. companies that have done nothing on sustainability, if they have to have a certain amount of CapEx up front to improve on their emissions or something like that, then that's going to take a while to plan and execute.
Hamish Galpin: It's going to take a while for us to actually see some outcomes from that. But actually, some of these initiatives really are worth waiting for because if we can, for instance, reduce pay gaps in the nursing sector, for instance, or improve the missions that companies put out. Actually, these are very significant outcomes, and we will be able to actually get tangible data from companies, to actually demonstrate an outcome.
Hamish Galpin: The point is we will get there, but it's going to take some time. That's why the term structure is very important because it's a, you have to be a longterm investor, and actually, from, that suits me as a long term shareholder in the business. And equally from the Bond's perspective, even if you even have relatively shorter term debt, each time a company comes back to the market, it's a chance to put pressure on that company to improve its SDG credentials.
Mitch Reznick: That's right, Hamish. And to your point exactly, which is that even if it's short term debt, companies are needing to refinance their capital structure frequently, which is effectively, an annual IPO, which is a point of contact and another link to the equity approach, which is through engagement, which is positive dialogue to encourage companies to affect change. That is a critical part of this, is having that dialogue with the company, a longterm dialogue. In many cases, companies are very new to these concepts and these ideas, and need to be brought along and educated, and see that, in fact, there is both a groundswell from investors, but also encouragement from regulatory bodies and through stewardship codes for companies to move in this direction. And again, that brings you back to the SDGs, which form a great frame of reference to have these discussions, and to report on progress.
Hamish Galpin: Actually the greater, one of the great opportunities for us is that, actually from my experience of talking to companies about this, a lot of very good things are already going on, on the ground. It's not exactly as if environmental concerns just popped up when the SDGs came along. Actually, companies have been working for years towards reducing emissions or improving yields and their factories, that sort of thing.
Hamish Galpin: The issue is that it hasn't really been, all this information, hasn't really been coordinated essentially through sustainability functions, shall we say, within a business. A lot of good stuff is going on in the ground, but it just hasn't been brought together, essentially, or even managed in a strategic manner. Actually, a lot of companies are now missing out on the opportunity for a better reputation within the industry, because they can really self promote more, than what they're doing. This is what Mitch was saying about education, and sort of through better disclosure. Then really they can, there's a very simple shareholder value creation opportunity just through better disclosure, and that ultimately leads to better ratings of companies.
Aoifinn Devitt: Do you think it's fair to say that, really, investors have no choice between being involved in this, what is really essentially a four way process of cooperation through communication between the companies, investors, governments and NGOs? There is a cost, obviously a huge cost with this. Some of this ambitious reach of the SDGs estimated has 7 trillion a year. How will we get there with that investor involvement?
Hamish Galpin: Well, it depends on whether you think of yourself as an owner of the business or a shareholder of a financial instrument related to the success of a business. People who are short term as will not really care about it, frankly. But they'll probably have capital taken off them in the course of time because, as you say, everybody's having to contribute towards this. Companies are having to do it. A company or companies want to do it, even. Actually, the providers of capital B at a pension funds or retail investors, or you and I do want to invest our money responsibly. On that, we'll channel capital towards people that think in that direction, and companies that think in that direction. That's very much, as some people like to say, "As a train that's left the station and isn't stopping".
Mitch Reznick: Right. The one amendment I would make to that comment is that it's not just about shareholders, it's about stakeholder. Being from, coming from the fixed income or credit perspective, whilst not owners, longterm financial stakeholder, and the path of this, the securities will track the trajectory of the path of the company as well. It's all very important to creditors as well.
Aoifinn Devitt: Just in terms of this longterm time horizon, is there a point at which they, Mitch, when it comes to engaging with companies, one can run out of patience, one can call time if the engagement has been taking place for a long amount of time and changes are simply not occurring?
Mitch Reznick: Right. Yes. We are, this is the critical point of engagement. It is to assess the earnestness with which a company seeks to create change. It is a test of credibility. But, it's also true that sometimes matters, for various reasons, are out of hands of management, where financial profile degradates. There's degradation of financial profile for some reason that is whether it's exogenous, or poor management from other areas as well, and that becomes a factor, because some of this does require longterm thinking and longterm investment. There are points in, when you can say, "Well, this doesn't look like it's happening anymore". We hope to discover that over a longterm relationship with the company, and we certainly don't expect significant progress or meaningful progress over a short period of time within, say months. These are evolutions that can take place over many months and years, and can be confirmed by measurement and discussion with the company. But if a company is on the right track, you have absolutely every reason to back that company, assuming that, from an investment point of view, makes sense.
Hamish Galpin: There is an aspect about walking the walk, and talking the talk to this. A lot of times you'll sit in front of company management teams and say, "Yes, yes, yes, we'll do something about this, or we recognize that's something important we have to do". But actually, it's like walking through treacle.
Hamish Galpin: We have had the impression, with a number of companies, that it's going to take a very long time. From that perspective, it's quite possible that we'll have to sell that sort of company, if we're just not making progress.
Hamish Galpin: Interestingly, if you think about it, Japan is an interesting example of this. Where you have companies that are, when you read the annual reports, the whole social ethos of a business is very important. Actually, the SDGs have been broadly talked about in Japan. Actually that's all very much, that's over well in Gurty. They talk about it, but actually, how many hard objectives are there to actually achieve goals that are not so strong in that? That's really our role, is to bring hard targets and timeframes, and a clear number of objectives.
Hamish Galpin: Now, actually, from from our perspective, we want to do things that make sense for the business, as well as have a social outcome. We're not going to pursue objectives that aren't really that particular material to the company or shows it's not going to have a big impact. We want to make, we want to agree objection with companies that make sense. The business, which means they're more likely to engage with us in and enact them, but actually, generate a social return as well. That's really the clear, the clearest objective of this engagement strategy.
Aoifinn Devitt: That seems like a very laser focused on efficient of engagement strategy. I suppose, that was one of the challenges that you engage, and you don't get the results.
Aoifinn Devitt: Another key challenge of this area might be for you, engage. You may get results, the company may be creating an impact, but it may ultimately not be financially successful. What do you do then? There is a perception, perhaps, that investors would have to sacrifice financial return, in order to generate a social return. What's your perspective on that?
Hamish Galpin: Well, there's two things. First, from the investment perspective. An investment is what is not working out from a financial perspective. Then this is an equity fund or an equity strategy and it will have to get sold. If it's not, if it's perhaps down to short term issues, then we might reduce the size of the holdings, but still maintain a holding and maintain engagement program. But at any one point in time, we're assessing the investment thesis and the engagement thesis, and have to adjust holdings accordingly.
Hamish Galpin: On the broader question of sacrificing investment returns to get social returns. My experience so far is that we, actually, we're actually getting better investment information from our engagement activities because we're getting a broader view on the business. I've got an extra sort of metrics from which to assess the business from an investment perspective as well. Talking about this over the long term sustainability of the business model from an economic perspective, and was seeing more people within the business. Actually, I think we're getting greater color on a business, and therefore, I think we have the opportunity to actually to outperform or to better than regular investment strategies even with an SDG perspective.
Mitch Reznick: That's right. I mean, that is the positive externality of engagement, this collateral benefit that you have from having discussions with companies. And there's a positive feedback loop. They ask questions from us, where we have area of expertise and can provide that to them, and demonstrates in earnestness that are referred to before. From a credit point of view, very similar to Hamish, these types of products are investment products. We've got colinear objectives of delivering a specific set of returns, depending on the product, but also an objective to deliver returns to society. Both need to be met at a simple level, at a specific level. But these are non-binary. It's not either completely delivering or not delivering from from a credit risk point of view or from an SDG point of view. You assess and you have scores, and you manage positions and holdings based on those assessments and scores.
Hamish Galpin: There is a material difference in my mind between ESG investing, SDG investing. ESG investing, for me, historically, has been about risk mitigation. We'll deal with a couple of companies and portfolios where they have ESG issues of one for another. It might be governance of a chief executive and chairman separation, that sort of thing. Or might be from, they have overly high emissions compared with other companies within their industry.
Hamish Galpin: There are particular spot ESG issues to deal with, and that's very much come from a risk mitigation perspective. We're operating on a number of holdings in the portfolio at any one time. From an SDG perspective, and this is what really, sort of, made it come alive for me. When I sort of first started looking at the concept of running this sort of strategy was that, I looked at all the SDGs and I realized that, actually, these are the sorts of things that I'm asking companies about already. Because I'm concerned about that staff turnover, I'm concerned about yields in factories and that sort of thing. Actually those are all parts of my assessment as to how well a business is run. Actually, how are they going to perform in the long runs? Or, actually ,the SDGs made me realize that there are... It's all about longterm shareholder value creation and there's a return aspect to it, as well as a risk aspect. So ESG analysis really focuses on risks, whereas SDG is about risk and return, and improving the overall risk return characteristics of a stock.
Mitch Reznick: I would, I would agree. I think, from my perspective, we do need to delineate ESG integration from those types of products that have a more, have an SDG theme along them. For me, very similar, ESG integration is a part of the mainstream investment process, so it's already going to be a part of what we're doing. In that capacity, we are focused on assessing and pricing the probability, the timing, and the materiality of these ESG factors, in so far as they affect a company's financial profile. Here, there is perhaps, within the SDGs, a less lower focus on governance itself, and more of a focus on what we would say would be the environmental and social aspects of E S and G. But, the engagement process and what we're trying... What we would be trying to achieve here is to see, for companies to affect positive change in society and in the environment, which we believe over time will be self-reinforcing financial strength of that company, and therefore, everyone is better off. We want these companies to create additional benefits to society and the environment.
Aoifinn Devitt: Thank you, Mitch.
Aoifinn Devitt: Hamish, has been a pleasure speaking with you.
Aoifinn Devitt: Until next time. I'm Aoifinn Devitt, head of Investment Ireland at Hermes. Thank you for listening to the Federated Hear and Now Podcast.
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