Hermes finds ESG prospects among small- and mid-caps

Asset Class in Focus

There are opportunities for collaboration with smaller firms to meet their sustainable development goals (SDGs) while also enhancing investment returns, according to Hermes small- and mid-cap head Hamish Galpin.

The Hermes SDG Engagement Equity Fund, which Galpin manages, aims to generate strong investment returns while also “creating positive impacts on society through engagements focussed on the United Nations (UN) sustainable development goals (SDGs),” according to its fact sheet.

But, although the fund is guided (and restricted) by the SDGs, its primary objective is to produce financial returns.

First and foremost we manage a conventional fund,” Galpin told FSA in an interview.

“The intention is to earn superior financial returns for our investors, and we believe that buying the stocks of companies that are at an early stage of implementing SDG practices within their own operations and in their relationships across their value chains can best achieve this objective.”

The UN set out 17 SDGs in 2015 which were subsequently adopted by 193 governments. They contain a further 169 targets and 230 indicators that aspire to end global poverty, safeguard the planet and achieve gender equality –  among other objectives by 2030. The UN estimates that $5-7trn will need to be invested annually to attain these goals.

“We are not activist shareholders; instead we can offer ‘additionality’ to companies, for instance, advising them on how they might tap local suppliers to replace global firms, or by introducing them to a non-governmental organisation that could help them recycle waste or convert to new energy sources,” said Galpin.

“It’s not necessary to have a large stake in the company to make a difference. Many small firms, in particular, are under pressure to make changes in their business practices, and they are often receptive to collaboration,” he added.

The $232m fund holds around 70 small- and mid-cap stocks, chosen from 300 covered by 1o in-house analysts. They range from Cooper Companies, a US supplier of contact lenses, contraceptives and other medical goods – that faced legal action a few years ago – to Glanbia, Ireland’s biggest dairy processor with whom Galpin has been discussing ways of improving the ingredients of some of its products.

The fund has posted a 2.63% return since launch in late December 2017: a modest performance, perhaps, but a positive return despite the plunge in global stock prices in 2018, and in excess of both its benchmark MSCI AC World SMID Cap index (-2.24%) and its international equity small/mid cap category average (-3.73%).

It is authorised for sale to investors in Singapore, but not in Hong Kong.

Stock selection accounts for 80% of performance attribution, according to Galpin. However, it is not yet possible to disaggregate the direct impact of the the SDG emphasis.

There is no deliberate sector or country bias, but there is an industrial sector skew to the portfolio because it contains many of the small- and mid-sized companies that need to adjust their practices; and most holdings are companies based in North America and Europe.

“We have been pleasantly surprised about the willingness of our Asian holdings to engage in constructive dialogue,” said Galpin.

He highlighted Techtronic, a Hong Kong-listed power tools company that “has recognised the need for increased levels of due diligence through its supply chain, especially its suppliers of cobalt used in lithium-ion battery manufacturing”.

On the other hand, Galpin has “had his fingers burnt” in the past through post-IPO exposure to some Asian companies, whose lack of transparency about their cost ratios severely dampened returns on equity.

“We don’t need to be in Asia [or Latin America] to get diversification. Although we do not allocate by country [or sector], many of the best investment opportunities are with companies based in developed economies but which operate in emerging markets,” he said.


Hermes SDG Engagement Equity Fund vs MSCI AC World SMID Cap index and international small/mid cap equity sector average

Source: FE Analytics. Cumulative performance in US since launch on 29 Dec 2017. Fund authorised for sale to Singapore retail investors but not to Hong Kong retail investors.

 

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