360 degrees #7 - October 2020 -
We can’t build tomorrow’s world without you
SRI can finance your future and that of generations to come
SUMMARY OF CONTENTS
Taking action today to improve the world of tomorrow
The Covid-19 epidemic has plunged the global economy into an unprecedented crisis, disrupting our day-to-day lives and undermining many of the things we took for granted. We ought to take this opportunity to think more generally about the world we want to leave our children and grandchildren, a decidedly more virtuous and sustainable one. Of the many challenges we face, global warming requires us to take action now to transform our economic growth model and strive for a decarbonised economy so as to comply with the commitments set out in the 2015 Paris Agreement. The race against time has begun, and we investors are in a position to take action.
Sustainable investment is a concept with real substance that the OFI Group has applied for close to 25 years now. We select our investments with the aim of supporting and promoting companies that produce goods and services of benefit to the general community. These include a large number of European companies offering solutions for a successful energy transition and thus helping to build tomorrow’s ‘positive’ economy.
We each have a role to play if this transformation is to succeed. As asset managers, we take our role very much to heart in funding this vital transition alongside institutional and retail investors. We are also convinced that a company that incorporates sustainable development issues into its strategy creates opportunities, reduces risk and thereby helps to improve performance in the long run. OFI AM’s view is that being a responsible investor means adopting a comprehensive and integrated approach that is applicable to all investment strategies and involves active engagement with companies, encouraging them to change their practices in everyone’s best interests. The range of products and services we offer investors enables them to take concrete action through the investments they make and help build the world of tomorrow, whether through our theme-based, best-in-class or impact investing strategies.
The Group is fully committed to this approach. In recognition of this, OFI AM has just been awarded the highest rating (A+) from the PRI (Principles for Responsible Investment) for the fourth year running; the PRI is an initiative launched by investors in partnership with the UN, and OFI AM has been a signatory since 2008. This recognition is testament to OFI AM’s high standards when it comes to incorporating sustainable development issues and thus offering adequate SRI products and services that can build on our collective response to the challenges we face. We are empowering you to take action now to finance our future and that of generations to come.
SOME THOUGHTS ABOUT THIS DEEP AND UNPRECEDENTED CRISIS
JEAN-MARIE MERCADAL | Deputy Chief Executive Officer, Chief Investment Officer - OFI AM
The crisis triggered by the coronavirus pandemic has been a violent one from a human, economic, financial and especially psychological perspective. It has revealed various flaws in the way we organize our societies at a time when questions were already being asked about the sustainability of our growth models: about globalisation (even capitalism?), excessive consumption, the way we squander resources...
Socially Responsible Investment is key to everyone’s best interests.
In some respects, this dreadful coronavirus crisis has a positive side to it as health considerations have taken precedence over economic ones. The crisis may ultimately speed up this transformation, including the drive to tackle global warming. It should be possible to replicate the efforts made to protect public health in order to tackle the climate emergency, and companies will come under pressure to do their bit.
The notion of corporate social responsibility has indeed been brought under the spotlight recently. The public health crisis clearly raises questions about how capital is allocated between shareholders and other stakeholders (employees, suppliers, etc.), and this is going to become an increasingly important investment criterion.
The social and solidarity economy will develop into a major investment theme. Criteria such as the geographical location of subcontractors (from a security and carbon footprint perspective) will also be watched increasingly closely. We may see investment flows being diverted away from those companies that have been least responsible in fulfilling their social and societal (fiscal) responsibilities. In short, investors will be drawn to the very investment themes that SRI embraces. The next step is to select investments wisely, and it is essential here to achieve the best origination.
The ‘reshoring’ era?
Reshoring had already become a topic of discussion because of the need to reduce carbon emissions and the ‘trade war’ that had erupted between China and the USA. The current crisis has shown that a country may put its supply security at risk if it depends too heavily on other countries, while excessive outsourcing may diminish its know-how and erode its social fabric. Companies are now probably going to adopt strategies to reshore and shorten their production chains; however, they will no doubt be held back by higher costs (e.g. labour costs) in Western countries and will also need to train the local workforce in order to build up the skills they need. This process may concern only a few strategic sectors, or it might speed up the development of robotics. So companies specialising in automated production processes and robotics manufacturers may benefit.
The reshoring theme is likely to concern drug manufacturing in particular, for health security reasons. The distribution sector, too, will look for shorter circuits, which may also change the way in which the logistics industry operates. The process could also concern the tourism industry, with potentially adverse effects on airlines and cruiselines. Foreign tourist flows (particularly of Chinese tourists) may diminish, which could penalise countries like France. Conversely, China’s domestic tourism industry and infrastructure (currently almost nonexistent) will explode!
Technology will structure our ‘online’ lives
This became clear during the lockdown. We can no longer live without technology and we will become ever more dependent on it as time goes by; just look at the share prices of the big tech companies and of smaller companies operating in the teleconferencing sector. Economic agents across the board can be expected to develop their range of online services. This will probably draw even more investment into the industry: developers, grid infrastructure, telecoms, 5G, etc.
Remote working has proved effective and useful and has also had a positive ecological impact thanks to less commuting. Organisational structures will be thoroughly overhauled, and new concepts for office real estate may have to be thought up. Online shopping has found new consumers and will continue to grow rapidly. This will raise questions about the logistics chain, in particular the ‘last mile’ (drones, smart electric vehicles, etc.).
Online healthcare has broken through into the public domain: it is now being applied on a large scale and has proved effective. This is a real innovation and carries a great deal of potential. We will see a surge in online consultation and digital medicine software, for instance with artificial intelligence modules. Such software will be linked up directly to pharmaceutical drug distribution centres through automated order systems. There are various listed companies operating in this field, primarily in the USA. Some of these stocks already have market capitalisations in excess of $10bn and have performed very well on the stockmarket this year. The telemedicine industry has grown by an annual average of 25% since 2015 and the pace could pick up further; its total revenues currently amount to around $2.6bn, a figure that is expected to jump to $30bn in the coming years.
The scope and need for investment will be huge. Investments will, of course, be private; but this crisis has shown that well-organised, pro-active and forwardplanning public authorities can be effective too, if not always visionary.
State intervention is back… along with debt
The concepts of economic liberalism and globalisation had become popular and widespread over the past 30 years, but this ideology appears to have reached its breaking point during the crisis. Mentalities will now change more rapidly as people regain faith in the idea of public service in its broadest sense. Governments should, however, refrain from going too far as history has shown that excessive state control and nationalisation have their limits. Instead, their role will be to rethink a number of key issues, which will widen their public deficits even further. So joint publicprivate investment will be needed. This will revive the concepts of government planning and strategic management, impacting on a number of areas (beyond the government’s usual remit). Private funding will thus have to be found for healthcare infrastructure; food security and therefore the agricultural sector; national logistics systems, especially in the field of telecom grids (high speed networks, national coverage), etc. In addition, it was striking to see how rapidly governments intervened during the crisis, with the support of their central banks, so much so that populations will probably become very demanding with respect to wages.
Naturally, this will lead to questions about public debt and what it really means. The Western world, and Europe in particular, seems to be undergoing a form of Japanification, with massive public debt and most of it being held domestically by the central bank and savers. In such cases, the country can choose either to not repay the debt and instead renew it to infinity, or to increase tax contributions. Which no longer really makes sense. We are thus moving ever closer to the notion of ‘universal income’. Moreover, the combination of debt and cash injections raises questions about a currency’s intrinsic value, since each additional unit of debt creates less and less growth. This could be good news for real assets and gold and generate fresh impetus in favour of cryptocurrencies.
We are aware that it is tricky to carry out such an analysis during a period of such intense emotion. Major crises create shortsightedness, and any problems at the time tend to be overestimated.
Nonetheless, the topics we are addressing here seem legitimate and enduring, and they support the choices we have made in recent years in the area of Socially Responsible Investment. The world must learn its lessons from this crisis.
HOW DOES SRI EMPOWER US TO TAKE ACTION?
ERIC VAN LA BECK | Head of SRI Department - OFI AM
Socially Responsible Investment (SRI) offers investors a variety of approaches enabling them to activate levers of influence vis-à-vis companies and governments so that they factor in Environmental, Social and Governance (ESG) criteria more effectively.
These different approaches are most usually combined depending on the SRI strategy’s underlying purpose.
THE SELECTION APPROACH
This consists in selecting companies with the best ratings within their category according to a given set of criteria. For example, this can mean identifying companies with the best ratings within a given sector according to Environmental, Social and Governance criteria: this is referred to as ‘best-in-class’ selection. It is also worth mentioning the concept of ‘best-in-universe’ selection, which refers not to a sector but to a universe; or ‘best effort’ selection, which focuses on measuring the efforts made by a company to improve its ESG practices. Companies with the lowest ratings will, of course, be excluded from the investment universe.
THE ENGAGEMENT APPROACH
This consists in engaging in dialogue with the company with a view to raising its awareness of ESG issues and helping it improve its ESG practices. This approach involves the asset manager exercising its voting rights in General Meetings of Shareholders so that companies adopt more ESG-friendly resolutions. This approach may be taken based on an individual and/or collective initiative. If the company does not improve its behaviour within a given timeframe, it may be excluded from the investment universe altogether.
THE EXCLUSION APPROACH
This consists in excluding companies involved in controversial activities (tobacco, alcohol, arms, etc.). Besides omitting entire sectors, it is also possible to exclude companies that do not observe international standards or conventions (e.g. on child labour).
THE IMPACT APPROACH
This consists in selecting companies that stand out for their intention to generate a (measurable) positive impact on the environment and/or society through their business practices (e.g. employing young people, promoting gender parity, integrating people from disadvantaged backgrounds) and activities (e.g. renewable energy suppliers, waste treatment companies, pharmaceutical drug manufacturers).
These approaches are not mutually exclusive and are often combined when building ‘responsible investment’ portfolios.
It is possible, within a same fund, to exclude controversial companies, adopt a best-in-class approach to selection and also exercise one’s voting rights in General Meetings of Shareholders, while seeking to measure the impact of a company’s actions/strategy on the environment and on society.
A LOOK AT LABELS
In Europe, labels awarded by independent agencies or by entities reporting directly to government authorities help to standardise the range of SRI products available on the market and reassure investors.
The SRI Label not only requires transparency and high standards of quality when applying SRI; funds must also demonstrate the tangible impact their SRI policy has on the environment or on society, for example.
The Finansol Label recognizes solidarity-based savings products that are used to fund activities of social and/or environmental benefit, such as access to jobs and housing, or support for organic farming or green energy.
The Luxflag Label requires eligible funds to apply an ESG filter to 100% of their invested portfolios.
14 OFI AM funds
carry the SRI Label
3 OFI AM funds
carry the Finansol label
1 OFI AM fund
carries the Luxflag label
AN AMBITIOUS AND PRAGMATIC APPROACH TO WITHDRAWING FROM FOSSIL FUELS
ALAIN PITOUS | Director for Responsible Finance - OFI AM
Thermal coal and unconventional oil and gas mining remains the world’s biggest source of greenhouse gas (GHG) emissions. OFI AM has therefore set itself a clear and binding timetable to gradually exclude these fossil fuels from its investments over the course of the coming decades.
The Paris Agreement signed in December 2015 set a clear target commensurate with the challenge of global warming that faces humanity: to limit the rise in temperatures to less than 2°C by 2100, with 2050 being the first milestone when the aim is to achieve GHG neutrality, i.e. zero net emissions.
This deadline may seem far off, but the measures that need to be taken are urgent and we all need to step up to protect our planet’s future and that of humankind. But how can we stand by this commitment without the risk of triggering a major economic meltdown? The stakes are high and there is one key measure that needs to be taken as of now, i.e. we must gradually reduce the emissions generated from the mining of fossil fuels (beginning with thermal coal, and unconventional oil and gas).
Some 40% of the world’s electricity is produced from thermal coal, which is the main source of greenhouse gases and accounts for 45% of the world’s CO2 emissions! Investing in a company involved in thermal coal incurs many risks; environmental risks, of course, but also financial risks owing to the risk of asset impairment over the years ahead. We can say the same of companies operating in the unconventional oil and gas industry.
This is why OFI AM has made an explicit commitment to exclude thermal coal (i.e. companies involved in mining coal and/or producing electricity from coal) from its investments by 2030, and also to gradually withdraw from unconventional oil and gas activities with the ultimate goal of zero investments in the oil industry by 2050.
This dual target means that we must start applying a policy targeting investments in the energy sector in particular as of now.
By adopting this investment policy, OFI AM is also anticipating risks and protecting its clients from possible asset impairments that could arise at some stage in the future, depending on the different potential scenarios.
Such assets will be excluded from our portfolios gradually but as rapidly as possible. Bear in mind that it is difficult to envisage withdrawing from fossil fuels too quickly without running the risk of destabilising our economies, which are still heavily dependent on such resources. So ours is an ambitious but also a pragmatic approach. Innovation is a continuous process, so we can imagine that new technologies in the coming decades will speed up the transition towards renewable energies without triggering a major shock to the economy. The timetable we have set can therefore be adjusted if circumstances allow.
THE IMPORTANCE OF ACCURATE MEASUREMENT IN IDENTIFYING IMPACT COMPANIES
BÉRYL BOUVIER DI NOTA | European Equities Deputy Director and Impact Strategies Fund Manager - OFI AM
In order to identify ‘impact’ companies, it is necessary not only to examine financial criteria and systematically factor in Environmental, Social and Governance (ESG) criteria, but also to establish suitable impact measurement indicators and analyse each company’s intentionality/mission as well as the strategy they adopt for this purpose.
Impact must be measurable using specific and suitable indicators
Investing in companies that have a positive impact on the environment and on society is central to our approach. But this ‘positive impact’ needs to be measurable using a methodology that is suitable and meticulous. We all know that investing in companies that perform well on the financial front means selecting stocks with solid growth and earnings prospects, attractive financial ratios, manageable debt levels, etc.
But how does one measure a company’s non-financial performance? The difficulty lies in the fact that the sought-after impact may differ from one company or sector to another. In the case of an environmental services company, for instance, it may involve measuring the volume of waste treated, for another it might be the amount of drinking water produced, for another it may be the health benefits shown by clients who consume its products…
The PACTE law now encourages French companies to adopt a ‘mission statement’
This impact must therefore be measurable using specific indicators adapted to each company’s line of business.
OFI AM has thus established its own list of impact measurement indicators for European stocks, based on four benchmarks:
- 17 Sustainable Development Goals (SDG) defined by the UN.
By transposing these SDGs to the scale of each individual company, we can determine whether or not it contributes to various universal sustainable development goals.
- IRIS (Impact Reporting and Investment Standards) established by the Global Impact Investing Network (GIIN).
559 qualitative and quantitative metrics covering about ten different sectors.
- WDI (Work Disclosure Initiative).
139 questions to determine how companies manage the employees working in their direct operations but also those working in their supply chains.
- GRI (Global Reporting Initiative).
79 performance indicators to measure economic, environmental and social impacts.
A fund manager examining impact investing criteria will look beyond ESG (Environmental, Social and Governance) issues, which are now relatively well standardised.
To assess the impact of best ESG practices, they may for example measure the company’s carbon emissions and its CO2 reduction targets, or the effort it has made to train its staff members, or the share of independent members on its Board of Directors... These are the types of indicators we will try to evaluate.
Besides measuring indicators that are relevant to the company in question (depending on its sector and line of business), we also need to analyse its commitment and ambition to generate a positive impact and make sure that they are not merely ‘for show’. France’s PACTE (Action Plan for Business Growth and Transformation Act) now encourages French companies to define a ‘mission statement’. The most enthusiastic among them may even adopt the new legal status of ‘mission-driven company’.
We fully support this approach and have accordingly established a full analytical framework to assess how genuine a company’s intentionality is and whether it is actually reflected on the ground. There is nothing more detrimental than for a company to have an official ‘mission statement’ but without any evidence of it in its organization or strategic choices.
Our analytical framework, which we have named ‘Mission For’, is built on three pillars:
- Pillar 1: a formally defined intention/ mission, making it possible to distinguish those companies with official mission statements and to assess the mission’s relevance and legal remit.
- Pillar 2: the extent to which the company’s intention/mission is incorporated into its strategy, to verify whether the company has established targets, timetables and metrics to measure progress made towards these targets.
- Pillar 3: the extent to which the company’s intention/mission is incorporated into its governance structure, to examine whether the company’s decision-making bodies are well-suited to promoting and executing the mission.
Focus on ‘positive impact’ companies
Once this analytical process is complete, and a rating has been assigned to each company, ‘Mission For’ is then able to divide companies into four intentionality categories: ‘high’, ‘advanced’, ‘moderate’ and ‘inadequate’.
While giving preference to ‘positive impact’ companies, we think it makes sense to invest not only in companies with satisfactory ESG ratings but also those of benefit to society, i.e. providers of goods and services that are able to contribute positively and adhere to the Sustainable Development Goals (SDG) established by the UN in 2015.
Such companies are favourably positioned - geared towards a positive, more inclusive and more sustainable economy - and they have every chance of meeting the expectations of today’s engaged investors.
DANONE*: A ‘HIGH INTENTION’ COMPANY
Let us take the example of Danone, which stands out in the ‘high intention’ category of our ‘Mission For’ analytical framework.
The food company, led by Emmanuel Faber, has defined its mission as “bringing health through food to as many people as possible”. Besides officially declaring its intention, Danone also strives to continually improve the nutritional properties of its products and systematically seeks to promote healthier alternatives.
In addition, it places the emphasis on labour relations within its organisation and governance (the ‘S’ and ‘G’ of ESG). Examples of Danone’s commitment include the participative approach it has adopted to governance, enabling employees to share their points of view on the group’s roadmap; and its decision to make the variable compensation of its CEO and top 1,500 managers dependent on social and environmental targets.
NON-FINANCIAL ANALYSIS HELPS TO IMPROVE FINANCIAL PERFORMANCE
FRÉDÉRIC DATY | Head of Research and Financial Engineering - OFI AM
The link between stock performance and the incorporation of non-financial ESG criteria into stock analysis and stock picking has been a topic of debate ever since the concept of Socially Responsible Investment (SRI) first appeared. The generally accepted goal of SRI funds in the early days was to avoid destroying value relative to a more conventional approach to asset management.
The underlying idea behind OFI AM’s approach to ‘responsible finance’ is that companies incorporating sustainable development issues into their strategies deliver stronger growth over time and are more profitable and more resilient during periods of crisis. OFI firmly believes these factors will feed into share prices in the medium/long term.
OFI AM has developed a proprietary ESG analysis methodology that divides stocks into five different categories: Leader, Committed, Followers, Unclear and Under Surveillance. We used our considerable experience to conduct a study on the universe of eurozone equities examining more than 10 years of performance data for these five different groups.
We drew the following conclusions:
- 1 - OFI AM’s non-financial analysis methodology leads to significant outperformance in the long term.
The yield spread between the most and least responsible companies has steadily widened over the past twelve years. The ‘ESG premium’ during this period worked out at 96%, i.e. an annual average of 5.4% (vs. +36.7% for the market index, i.e. an annual average of 2.4%). The gap widened at a noticeably faster pace during the Covid-19 crisis. Our analysis indicates that this premium would have generated a yield of 12.55% in the first half of 2020. The investment strategy’s value creation relies on selecting companies with the best ESG practices but also excluding companies with the worst ESG practices.
- 2 - OFI AM’s non-financial analysis methodology leads to regular outperformance decorrelated from market trends.
During the period under review, and on a 12-month trailing basis, the ‘ESG premium’ materialised during both bullish and bearish market phases. The periods during which the ‘ESG premium’ was negative were very short-lived and only very minor.
- 3 - OFI AM’s non-financial analysis methodology is a source of valueadded.
When we compare the ‘ESG premium’ with other traditional equity style factors, we note that the rates of correlation observed (on average ranging from -0.40 to +0.40) and their wide dispersion point to no particular link between ESG and any one or more specific factors. The traditional equity style factors used were Value, Quality, Momentum, Market Capitalisation, Dividend and Volatility. For the purpose of our study, they were built using OFI AM’s proprietary approach. The outperformance achieved through non-financial analysis is therefore not linked to a structural style bias but corresponds to additional valueadded.
The results obtained from OFI AM’s stock analysis and rating methodology show that the model is a useful one and that performance improves when companies with the best OFI AM ratings are selected.
Cumulative performances of the most and least responsible companies over the past 12 years
The ESG ratings analysed are based on OFI AM’s rating methodology applied to the eurozone stock universe. The universe was split into quintiles based on the ESG quality of the stocks analysed, according to a ‘best-inclass’ approach, so that all sectors are represented in each quintile. Stocks in our portfolios and in the index are weighted by market capitalisation. ‘Leaders’ are companies with the best ESG quality scores, while companies ‘Under Watch’ are those with the lowest ESG scores.
BECOME AGENTS OF CHANGE WITH THE ‘ACT4’ RANGE
ERIC TURJEMAN | Head of Equity and Convertible Bonds - OFI AM
BÉRYL BOUVIER DI NOTA | European Equities Deputy Director and Impact Strategies Fund Manager - OFI AM
OFI AM will take action on your behalf with its ‘Act4’ (Act for) range dedicated to impact investing strategies. Through the strategies adopted and investments made, the aim is to deliver both a positive and measurable impact on the environment and/or society AND financial performance.
The best-in class approach to Socially Responsible Investment is now well-known among investors, whereas they are less familiar with the ‘impact investing’ approach.
While the best-in-class approach aims to support the most virtuous companies within each sector, the impact investing approach focuses more on companies whose positive impact on the environment and society can be measured.
The aim is not only to support companies that offer concrete and measurable solutions for a better world by analysing the whole impact chain (from the goods and services these companies provide to the tangible results they achieve through their activities and even, if possible, the long-term impacts on their stakeholders); it is also to generate performance by taking up positions on companies with bright growth prospects.
OFI AM has established its own list of impact measurement indicators for European equities along with an analytical framework enabling it to assess the suitability of a company’s mission/intention. We have named our framework ‘MissionFor’.
The OFI Fund - RS Act4 Positive Economy fund*, meanwhile, applies a mixed strategy by factoring in both the environmental impact and social impact generated by companies in the portfolio. The aim here is to address four distinct challenges: the energy transition, the protection of natural resources, health and social inclusion. Each portfolio company must generate at least 20% of its revenue from activities directly related to these fundamentally important issues.
The investment universe is made up exclusively of European companies.
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