Leon Kahmi, Hermes Investment Management
“ESG research providers gather the data of around 30-40 issues and weight them in a subjective way,” London-based Kamhi told FSA.
“However, a more effective way to bring out meaningful results is focusing on two-to-three very significant issues that may impact the company materially.”
His team starts with in-house ESG scoring as a preliminary step. They then assess where the company is and where it aims to be in terms of ESG goals. Companies have to show the potential to bring improvements and generate a future financial return on that basis.
“We are not saying that all of the investments we make today carry the best ESG characteristics. We also do not exclude companies with the worst [ESG ratings]. Instead, we are searching for companies that are open to engagement for at least two years so that we can see changes happening and see if they are effective.”
(Hermes CEO gave a broad overview of the firm’s ESG approach in a previous interview with FSA).
Beyond scoring
To identify the companies with continuous improvements, the willingness to disclose information is one of the determining factors.
“Disclosure is not prevalent in the Asian corporate culture in general. Most of the time, they prefer doing it first before telling everybody about the underlying plans,” said Christine Chow, director at Hermes equity ownership services (EOS).
Christine Chow, Hermes EOS
Chow and her team, who have been approaching companies in the region to discuss improving ESG practices, give suggestions to companies in order to widen their disclosure range, such as revealing targets on carbon emissions and pollution reduction.
She noted that there are limitations on a pure quantitative processes when engaging with companies. “For instance, having a detailed labour policy does not necessarily mean that workers are treated properly or working under a safe environment. It is necessary to investigate on our own with regular visits to the company manufacturing plants and do our own analysis into the issues.”
It is also important to understand if the employees are able to form a union and if the union can initiate constructive conversation with the employer, she said.
Also beyond quant analysis, her team ask companies about third-party assurance or certification on specific issues such as data privacy protection. Chow said it could help the firm’s investment team get a better understanding of the company’s intention to improve. For instance, user data privacy protection can be one of the issues that fund managers assess for investments in the information technology and internet sector.
Developed market ESG
Companies in emerging markets are usually considered to be vulnerable to corporate governance malpractice, bribery and corruption. But Kamhi said certain sectors in the developed markets face similar problems.
“The banking industry is probably the sector that has had the most issues in terms of social and governance issues in developed markets,” he said. “Some US and European banks have had a number of conduct issues, for example the foreign exchange scandal and [Libor] interbank lending rates manipulation case in recent years. There is also an issue [re: Wells Fargo] over sales incentives to retail customers and in whose interests transactions are executed.”
Another issue about the banking industry is the breadth of their business activities.
“We look into whether a bank is involved in an area that is making a good return for shareholders as well as their employees. The broader issue is about how a bank’s activities support growth in the real economy rather than simply transactions in the economy.”
