Sustainable, Responsible &/or ESG Policy:
Our process is fundamentally one of positive screening; however, we think it desirable to make explicit where will not invest in companies in certain sectors or activities that have failed this approach. In particular, the portfolios avoid investment in any company that is or is likely to be exposed to:
- Human rights abuses
- Tobacco and armaments manufacture
- Products which involve experiments on animals, except for those conducted for the benefit of human or animal health.
- The generation of nuclear power.
We also avoid companies that generate over 10% of their turnover from any one or a combination of the following five categories:
- Animal fur products
- Pornography
- Irresponsible gambling
- Irresponsible drinking
- Worker exploitation or exploitative consumer practices.
Fossil Fuels
As sustainable investors, we are committed to using capital to support the transition to a more sustainable society by investing in those companies making:
- Products and services which help address major environmental and social challenges, including climate change
- Industry leading efforts to mitigate their environmental impact
We also avoid companies in sectors with extremely high environmental impacts unless there are strong mitigating factors.
In this context, and dividing ‘fossil fuels’ into extraction, power generation and services, our policy is:
- Extraction – we will not invest in oil and gas or coal mining companies due their high environmental impact and contribution to climate change
- Power generation – where we see companies with material exposure to renewable energy and a demonstrable commitment to evolve away from gas and coal, we will consider investing
- Services – for those companies providing services to extractive industries that make them safer and materially improve their environmental impact, we will consider investing
Sustainable, Responsible &/or ESG Process:
The integration of sustainability factors into investment decisions requires significant expertise and resource. We believe it is also best done internally as this allows the best decisions and greatest flexibility. We supplement our internal expertise with a high quality External Advisory Committee, which provides independent challenge and insight and ensures we implement our principles in a dynamic and fast changing world.
It is a process that is inherently flexible across both equities and fixed income, capable of meeting client needs on both a segregated and a pooled basis. The process has a clear identity, both in the way it selects holdings and in the way it builds portfolios.
Measure/Identify
Equity
It is important we focus our time on those areas most likely to yield strong investment ideas. We use our own knowledge and extensive experience of sustainable risks and opportunities: these allow us to identify companies with socially and environmentally useful products and services.
We supplement this with MSCI, to assist in identifying companies with good ESG standards, and CSFB Holt (a research tool of Credit Suisse First Boston, a broker/research provider), to identify companies with inherent value creation and strong competitive advantages.
Fixed Income
Initial sector research is undertaken by the credit analysts, who work closely with the Sustainable team in order to identify socially positive industries and sectors. A number of bespoke and external systems are used to identify the sustainable issues that could plausibly affect our outlook on a sector or help distinguish securities with lower risk. We use external data from MSCI and Bloomberg as appropriate to supplement our research effort and enable the teams to focus their primary analysis and financial modelling on lower profile corporate bonds which we consider to be less extensively researched by the wider market.
Avoidance Criteria and Do No Significant Harm
The Sustainable Team Investment Process is fundamentally based on positive screening; looking for companies providing a net benefit for society through their products and services (the “what”) and/or demonstrating leading sustainable practices in the way they operate (the “how”).
The team has also developed avoidance criteria (negative screening) to ensure the investments are compatible with the Sustainable objective of the portfolios and meet the Do No Significant Harm principle.
As such, the Sustainable Investment Team will not invest in any company that is or is likely to breach the UN Global Compact 10 Principles1 or any company that fails or is likely to fail to satisfactorily mitigate its negative environmental or social impact (e.g. fossil fuel extraction).
Specifically, for companies operating in the fossil fuel and mining industries, the team is committed to support the transition to a more sustainable society and has divided ‘fossil fuels’ into extraction, power generation and services and has the following policy for companies involved in:
- Extraction – not to invest in oil and gas or coal mining companies due to their high environmental impact and contribution to climate change
- Power generation – are deemed investable if companies have material exposure to renewable energy and a demonstrable commitment to evolve away from gas and coal
- Services – are deemed investable if those companies providing services to extractive industries make them safer and materially improve their environmental impact.
In addition, the sustainable investment team avoids investments in companies involved or likely to be involved in
- Armament manufacturing
- Tobacco production
- Nuclear Power Generation
- Animal testing for anything other than human or animal health purposes
- Pornography
- Sale of animal fur products
- Irresponsible gambling
- Irresponsible drinking
Bespoke Analysis
After we have mapped out the universe, for each investment that is considered, we undertake a thorough analysis, independent of third-party systems, to assess the suitability of a potential investment from both a financial and sustainability standpoint.
The sustainability analysis is common to both equity and fixed income investments while the financial analysis is tailored to each asset class.
Within our investment decision-making process, financial and sustainability analysis have equal weight although we always start by considering whether a potential investment is sustainable or not.
We believe our process which combines qualitative and quantitative analysis is repeatable and auditable and demonstrates the interaction of financial and sustainable considerations in our investment decision-making.
Sustainability-specific analysis
The sustainable research framework is based on a holistic approach of a company’s sustainability focusing on its products and services as well as its operations. After the analysis we then complete a scorecard giving us aggregate Sustainable score of 50 made of products and services (out of 25) and operations (out of 25) as shown below.
- Products and services – we look at the products and services of the entity and its role in supporting the transition to a more sustainable society. We include a detailed assessment of the industry’s impact, company specific impact as well as detailed checks against all our avoidance criteria and controversies.
- Operations – we analyse the way a company manages its operations and the environmental and social issues it faces (scored out of 25) as well as its corporate governance. The analysis includes
- Corporate Governance: board composition, remuneration, audit and accounting practices
- SASB Materiality: assess company’s practices against the most relevant environmental, social and governance issues
- Climate: carbon footprint & intensity, energy management policies
In addition, the analysis identifies company specific engagement points which feeds our engagement agenda.
Equity-specific analysis
Our analysis of equity investments is based on the goal of paying a fair price for long-term structurally value creating businesses. Similar to the sustainability analysis our framework is divided into two parts; Value Creation and Valuation.
- Value Creation – we apply clear principles about the type of companies we wish to invest in from a financial perspective. Our fundamental principle is that the companies we invest in will be able to create shareholders’ value over the long-term by combining returns above cost of capital and structural growth. The primary way we judge this is through an assessment of a company’s competitive advantage, industry’s attractiveness, management strategy, capital allocation and risks (scored out of 25)
- Valuation – we use discounted cashflow and multiples-based valuation methods to judge the growth and returns implied by the current share price, enabling us to understand market expectations and if we are paying a fair/attractive price for an investment. We also assess the resiliency and adaptability of the business and use valuation to assess the risk of permanent capital loss. (scored out of 25)
The scoring process gives us an aggregate financial score (out of 50) which when combined with the Sustainability analysis give us a full picture of the attractiveness of an investment.
Fixed Income-specific analysis
In broad terms, our credit research framework centres on an identification of the opening lender position (e.g. key financial ratios) at the point we purchase a bond and a forward assessment of potential balance sheet volatility and fluidity of that lending position. Our focus on the sustainability of the opening lender position reflects two specific bond characteristics.
- Risk and return are asymmetric: bonds have capped upside (they do not participate in the profit growth of a company) but full exposure to capital loss.
- Future deterioration, whether through increased leverage or increased subordination, is very difficult to price.
These characteristics support our view that understanding the covenant, structure and security of a bond and focusing on more fundamental corporate characteristics makes it easier for us to evaluate potential outcomes and therefore to determine an appropriate valuation level.
Our approach to security selection combines three distinct stages:
Stage 1 involves an assessment of our opening lender position. This includes current leverage, adjusted for RLAM’s view of the true ‘economic’ liability position (‘off balance sheet’ items such as pension and lease liabilities and other contingent liabilities), balance sheet liquidity and our perception of a company’s control over cashflows. In addition, our analysts focus on the actual borrowing entity with a consideration of seniority and structural subordination (how close we are to the assets and cashflow generation of our borrowers).
Stage 2 is a consideration of the potential fundamental volatility of this historic snapshot; key elements include capital intensity (short and long term), operational gearing, pricing power and volume variability. Furthermore, we will evaluate management incentives to ascertain board motivation and the extent to which a company’s strategy may diverge from the interests of creditors. At this stage, our analysts, whether the inputs have been derived internally (in the case of private companies, small/mid-caps and Special Purpose Vehicles) or captured from external sources, should have a clear understanding of a company’s fundamental balance sheet volatility.
Stage 3 is an assessment of true credit enhancements (e.g. covenants, structure and security). These factors can provide the greatest certainty that our initial lending position will be maintained and not compromised through additional leverage or subordination. In our opinion, this step is the most crucial. Not only are these features, where present, the most permanent and protective of possible credit characteristics but their objectivity allows for extremely high conviction evaluation. Probably most compelling is that, because these enhancements are not reflected within ratings, benchmark position or bond liquidity, they are often overlooked and undervalued by the market. In addition, as these features tend to remain constant over the life of the bond, unlike Stage 2, which requires much greater ongoing maintenance, we believe that this stage is the single most efficient use of our credit research resource.
Only once all three stages have been assessed can the team make a fully informed decision as to whether a credit spread is providing sufficient compensation for overall credit risk, encapsulating both probability of default and severity. Indeed, if we can increase conviction that the opening lender position will be maintained then this supports our ability to more accurately price the specific credit risk each bond exhibits.
As a manager of fixed income Sustainable funds, RLAM believes that ESG issues are vital in all credit research. As such, we combine rigorous financial analysis with assessments of how ESG factors could influence the risk profile of the issuers. We have to judge whether the overall risk profile, based on financial and ESG factors, is appropriately reflected in the valuation of a bond.
We combine this analysis with a number of other features, in particular, a bias towards secured debt or bonds with strong covenant protections and an emphasis on portfolio diversification. Overall, our approach allows us, as active managers, to take advantage of credit market inefficiencies arising from over reliance on credit ratings and benchmark composition.
The Sustainable funds which contain fixed income give preference to issuers where the provision of debt financing will support the move toward a more sustainable society. Like with equities, this can be through supporting entities with socially and environmentally useful products and services, or those with strong ESG management. To this end we include four themes which we believe benefit society:
- Community: covering education, health and social care.
- Housing: with a focus on social and affordable housing.
- Utilities & Environment.
- Infrastructure.
These themes focus on those areas where we believe there is a clear benefit to society and also a clear long term investment case. This means that we will look for opportunities in a wide range of areas e.g. social & affordable housing, hospitals, transport, roads, schools & universities, water infrastructure, electricity distribution and telecommunication. We will aim to have at least half of the Fund’s bond holdings in securities linked to one of these themes, subject to sufficient portfolio diversification being achieved.
Our work is then considered by our Advisory Committee which provides independent challenge and insight and ensures we always implement our principles.
External oversight – RLAM External Advisory Committee
RLAM benefits from an independent External Advisory Committee which independently oversees the investment universe for RLAM’s range of sustainable funds. This committee is multi-disciplinary, consisting of academics and industry experts, and meets at least three times a year. The committee receives reports on sectors and companies and advises on the approval and exclusion of companies as well as topical issues relevant to the sustainable investment universe. The committee is responsible for ensuring that the criteria and spirit of our sustainable philosophy are observed. It is, however, an advisory body and so stock selection and portfolio decisions are not subject to approval or sign-off. Biographies of the Committee were included earlier in this document.
Resources, Affiliations & Corporate Strategies
RLAM has an in-house team consisting of 11 Responsible Investment (RI) professionals that are a dedicated resource for implementing our stewardship and responsible investment activity by directly supporting front office teams to integrate material ESG research into investment processes.
The RI team is led by Head of Responsible Investment who reports to the Chief Investment Officer (CIO) and is a member of the Front Office leadership team. RLAM’s Investment Committee however has ultimate responsibility for setting RLAM’s risk appetite and reviewing our strategic risks. Our Chief Investment Officer is a regulated Senior Management Function (SMF) and is the Executive team member that is accountable for setting the investment strategy, and overseeing our Responsible Investment function, including our approach to stewardship and climate investment risk. The CIO, with support from the investment teams, updates the Investment Committee and monitors responsible investment in line with RLAM’s risk tolerance threshold. The CIO is also responsible for ensuring responsible investment, stewardship and climate change risk management is embedded across RLAM’s investment strategies. The CIO is a member of RLAM’s Executive Committee and chairs the Investment Committee.
UN PRI
RLAM has been a signatory to the United Nations Principles for Responsible Investment (UN PRI) since 2008.
As a result of our membership status, we commit to submitting and publishing our annual assessment response to demonstrate adherence to the principles. Our summary scorecard as at 2020 has been provided below. These scores are a testament to our continued efforts to become leading in responsible investment. We are engaging with the PRI to understand the current changes to its methodology and how we might need to adapt our practices to capture the required information according to these changes going forwards.
- Strategy & Governance - A+
- Listed Equity – Incorporation - A+
- Listed Equity - Active Ownership - A
- Fixed Income – SSA - A
- Fixed Income - Corporate Financial - A
- Fixed Income - Corporate Non-Financial - A+
- Fixed Income – Securitised – A
Stewardship Code
For a long time, we have been a tier one signatory of the 2016 UK Stewardship Code. That is why we wanted to be early adopters of the 2020 UK Stewardship Code, following its release in October 2019. After implementing the new reporting standards set by the FRC in our 2020 Stewardship report, a year earlier than required, we received highly positive feedback from the FRC and were featured as examples of best practice throughout the FRC’s Review of Early Reporting. We were recently recognised as official signatories to the Financial Reporting Council’s UK Stewardship Code 2020. This follows the submission of our Stewardship and Responsible investment 2021 report (covering our stewardship and responsible activities in 2020) earlier this year.
RLAM is also member of:
- Investment Association – Member of the IA Responsible Investment and Sustainability committee as well as the Climate Change and Stewardship working groups.
- UK Sustainable Investment and Finance Association (UKSIF), since 2016
- Climate Action 100+ – Co-leading engagement and dialogue with Glencore on climate risk. Member since 2019
- 30% Club Investor Group – We participate in regular investor meetings to discuss board and executive diversity and participate in collaborative engagement. Member since 2016
- Institutional Investor Group on Climate Change (IIGCC) – RLAM leads the sector-focused work on Utilities. We are also members of the Resolution and Paris Aligned Portfolios Advisory Groups. Member since 2019
- Workforce Disclosure Initiative (ShareAction) – We co-signed on the Workforce Disclosure Initiative, convened by ShareAction. Member since 2018
- Just transition – Joined in November 2020 and supported the launch of the Financing the Just Transition Alliance.
- Global Real Estate Sustainability Benchmark (GRESB) – We are a member of GRESB and our property team regularly engages with them on ESG performance in our property portfolio. We have been members since 2013.
- CFRF (FCA and PRA Climate Financial Risk Forum) – Disclosure working group member. Member since 2020
- TCFD – As part of our commitment with TCFD, which we formally became a signatory of in 2020, we are incorporating scenario analysis, for physical and transition risk into our analysis. We have several metrics and tools at our disposal to help us evaluate security and fund-level exposure to climate risks which we can use in quarterly ESG reviews, in-depth security analysis, or company engagement
RLAM signed the “Net Zero Asset Management initiative” in March 2021. This follows the Royal London Group commitment to the net zero investment framework earlier in the year. The Net Zero Asset Managers initiative launched in December 2020 and aims to galvanise the asset management industry to commit to a goal of net zero emissions.
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