For professional clients only, not suitable for retail investors.
Sustainability Sustainable investing at RLAM  |  November 2020
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SUSTAINABILITY  November 2020
George Crowdy Sustainable Fund Manager
November 2020 SUSTAINABILITY
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Welcome There has been a huge increase in the media coverage of sustainable and ESG investing over the past year, and a lot of new acronyms being thrown around that can make it all quite confusing. We think it would be helpful to take a step back and explain what sustainable investing means to us. For us, sustainable investing is about investing in companies that have a net benefit to society and the environment, either due to the products and services they sell or in the way they manage the environmental, social and governance (ESG) issues they face. We do this for two key reasons. First, we think that by allocating your capital in this way we can help support positive environmental and social change. Secondly, we also think it makes great investment sense. A key part of what we think differentiates us and our process is that we give an equal weighting to both sustainable and financial characteristics in deciding where to invest as we think they are equally important drivers of future investment returns. On the sustainable side, we are looking for evidence of strong corporate governance, environmental and social standards, in addition to assessing the net benefit to society from a company’s products and services. On the financial side, we assess a company’s future growth prospects, competitive advantage,
return on invested capital (a measure of how good management is at creating value for investors) and the management team’s ability to make good decisions on behalf of shareholders. We also focus on valuation and want to pay a fair price for what we own.
cultures and how companies treat their employees and the communities in which they operate. Those companies managed for all stakeholders including the environment, society, employees, communities and shareholders will, we think, continue to be duly rewarded.
It is increasingly clear to us that strong sustainable credentials are often a good leading indicator of future financial performance with respect to growth and profitability. In many ways, sustainable analysis is just financial analysis in disguise and something the vast majority of investors continue to overlook. To us it makes sense that companies supporting a cleaner, healthier, safer and more inclusive society should be more attractive places to invest.
We believe that the Covid-19 crisis has accelerated many key sustainable trends, including the need for more resilient healthcare systems and a more connected digital economy, and our funds are well positioned to continue to benefit from future growth in these areas. We are encouraged how investors are increasingly coming round to our long-held view that investing through a sustainable lens actually adds to investment performance and that sustainable funds are finally being chosen as core investment solutions. We expect this trend to continue.
Our philosophy of investing in companies that provide solutions (and avoiding those that create problems) has really been put to the test as the world has been hit by the Covid-19 pandemic. Our approach has steered us away from parts of the market that are most impacted by the pandemic, such as energy and travelrelated companies, and towards areas such as innovative healthcare and the technology solutions that have kept economies functioning as people have moved to working from home. While many of the business we invest in have actually seen higher growth as a result of the pandemic and will arguably come out stronger, the crisis has given us a fascinating insight into company
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For us, sustainable investing is about investing in companies that have a net benefit to society and the environment.
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SUSTAINABILITY November 2020
Interview with Carlota Garcia-Manas Senior Responsible Investment Analyst
Q What is your role? A I lead the engagement function at
RLAM. I develop our engagement strategy, set up our various engagement programmes and monitor their delivery, and continuously evaluate new initiatives. I also direct our collaborative engagements and conduct advocacy activities.
Q What is engagement? A Engagement is the purposeful
dialogue between investors and
companies. We engage with companies to collect information to support better investment decisions. Also, we engage to achieve change within companies, to contribute to improving their performance by raising standards and outcomes.
Q A
What do you enjoy most about your role?
I particularly enjoy using techniques I have learnt through my career in various fields in corporate engagement. For example, customer relationship management (CRM) systems for business development are very useful for engagement prioritisation, setting milestones and activity monitoring. I am also fascinated by corporate governance and leadership, and I enjoy applying some of the negotiation and influencing techniques learnt academically in my conversation with corporate leaders.
Q Have you evidence of
engagement supporting better outcomes for investors?
A There is empirical academic
evidence that ESG engagements can create value for investors, either by generating positive returns or by significantly reducing a firm’s downside risk. Responsible investors have been thought of as the ‘canary in the coal mine’ in that they uncover emerging material issues that make ESG engagement important. For instance, in August 2020 we had a successful case of engagement during a Covid-19-induced virtual AGM. SSE, a utility company that we hold in the sustainable funds, agreed to adopt a strategy that incorporates social considerations and ‘Just Transition’ into their decarbonisation plans, prompted by our engagement
efforts. A pioneering move to link social considerations with climate ones, which we expect will support the company’s licence to operate and reputation, and consequently its long-term resilience.
Q How do you decide to engage with a company?
A We have planned RLAM priority
thematic engagements, engagements from emerging ad hoc risks and invitations to collaborate with other investors on their engagement priorities. We focus on engaging in areas where we think we may make a difference. We have a ‘funnel’ through which we pass engagement opportunities, asking ourselves: 1 Do we have a significant holding? 2 Is there is a significant reputational risk? 3 Does it fit our priorities/themes? 4 Is there a potential material impact?
At the fund level, we will discuss our suggested engagement priorities with the fund managers and agree a plan of action where the link between ESG themes and their financial materiality is further refined.
Q What are key areas of
engagement at RLAM and in the sustainable funds?
A RLAM has six 2019-2021
engagement themes: climate risk; social and financial inclusion; the circular economy; innovation, technology and society; corporate governance; and diversity.
The sustainable funds are one of the most interesting fund ranges to analyse from an engagement point of view. One would expect there would be nothing to engage on!
November 2020 SUSTAINABILITY
However, despite conducting a strict screening and evaluation of ‘net benefit’ to include companies in our funds, we do not believe that the companies that we hold are perfect. The emergent nature of ESG issues and their sometimes underrated risk capacity makes them perfect to refine the sustainable profile of the holdings in these funds. Our current engagement activity for our sustainable funds seeks to improve the companies’ gender and ethnic diversity policies, understand and reduce cybersecurity risk, and increase uptake of Net Zero (greenhouse gas emissions) commitments and climate action for the technology sector.
Q What do you do when engagement doesn’t work?
A As long-term investors, when we
engage with companies, we aim to build a relationship. This will lead to a meaningful dialogue that can better support our investment case. On occasion, we will constructively propose that the company change its
behaviour in areas that we consider could materially impact its business. We can use different escalation techniques to make our voice heard when engagement does not deliver the outcome that we were seeking. These include collaborating with other investors, using proxy voting or filing a shareholder resolution. Ultimately, if we consider the risk is too high and not being addressed by the company’s management, we would consider an exit strategy.
Q When do you decide to partner
with other investors to engage?
A We are part of alliances of investors
collectively seeking to improve specific issues by engaging with companies, such as Climate Action 100+ or the 30% Club. We find these collaborations particularly effective in cases where the size of the holding is important (e.g. when companies have engagement policies that restrict their dialogue to majority shareholders only) and when the engagement would benefit from local presence (e.g. when we
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engage with companies outside our jurisdiction and partner with a local investor). We also find collaborative engagement through trade associations useful to engage with policymakers in relevant areas.
Q How can clients find out more about RLAM’s engagement activity?
A We share quarterly reporting of our engagement activities and thematic progress reports with clients. We also publish our stewardship report annually and publish some of our success stories of engagement on our blog and social media. In today’s more virtual world, we are using webinars to provide updates which also give clients a chance to ask us the questions that matter to them.
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SUSTAINABILITY November 2020
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We believe that fixed income markets offer a rich seam of opportunity for investors looking for socially-positive investments.
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November 2020 SUSTAINABILITY
Sustainable fixed income With greater market focus on sustainable investing in equities, some investors can overlook the opportunities that fixed income markets present. Within our fixed income range, we can access critical areas of investment hidden to equity investors, better identify risks and broaden our engagement, ultimately helping to deliver better outcomes for clients.
Access to out-of-reach sectors By investing through debt, we can gain access to socially-critical areas of the market that are largely inaccessible to listed equity investors. In practice, this means that a significant part of our sustainable fixed income portfolios are inclined towards social and affordable housing, hospitals, less carbon-intensive transport, schools and universities, water infrastructure, electricity distribution and ‘not-for profit’ community-minded financial institutions. By investing in these areas, we can support sociallybeneficial organisations, and with less market attention on midcap/non-equity listed companies, we can target superior risk-adjusted returns for our clients. Focusing on these areas dovetails with our equity funds, preventing a duplication of risk-taking across both asset classes.
Engagement as a lender Some investors also assume that engagement is best left to equity markets, with bondholders merely a passenger
on a company’s journey. At RLAM, we believe that targeted engagement by bondholders is not just possible, but beneficial to all stakeholders. While our points of influence are more limited in relation to large global companies, our focus on secured debt and more highlycovenanted issues gives us greater access to the ‘decision makers’ and, consequently, allows us to have greater impact both in relation to bond structures and ESG considerations.
Rich seam of opportunity We believe that fixed income markets offer a rich seam of opportunity for investors looking for socially-positive investments, without compromising returns. The RL Sustainable Managed Income Trust offers clients a clear investment process, which incorporates a consideration of whether the companies we choose to invest in provide a net benefit to society from an ESG perspective, while still targeting attractive returns based on our clear orientation towards bottom-up stock selection. Our approach to screening for positive choices is bespoke and differentiated – relying on an experienced multi-disciplinary team of individuals working collaboratively. Sustainable Managed Income allows investors to harness our unique credit philosophy of portfolio diversification, bias towards secured bonds and active portfolio construction with a rigorous emphasis on sustainability.
Shalin Shah Senior Fund Manager
Examples Thames Tideway Tunnel: this bond is funding a project constructing a 15-mile super sewer underneath the River Thames, which once complete will prevent millions of tons of raw sewage from spilling into the river. In addition to the fantastic environmental benefits, the bond benefits from a strong security and covenant package, as well as excellent visibility on cashflows through a supportive regulatory framework. Greater Gabbard OFTO: this bond is backed by an offshore transmission operator, connecting the Greater Gabbard wind farm near Suffolk to the National Grid. The connection adds enough green energy to power 530,000 homes. The revenues servicing our bonds are very stable and are not based on the output of the windfarm. Furthermore, we have security over the business and covenants to protect our lending position.
Fund positives Access to experienced multidisciplinary team Harness unique credit philosophy and rich heritage in sustainable investing Access to critical sectors that remain largely inaccessible to equity investors Positive investment choices without compromising return
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SUSTAINABILITY  November 2020
Our current equity themes Themes can and do change overtime. We think it important to have the flexibility to evolve as society evolves, ensuring that at all times we are investing in the most relevant themes and those most likely to deliver strong investment returns. Our current themes are as follows: Industry 4.0 Steam was industry 1.0, electricity 2.0, and the computer 3.0. Industry 4.0 is about data and using it to bring together the physical and digital worlds to enhance the efficiency of a range of existing industries. This theme has been accelerated by the recent Covid-19 crisis. Agriculture and naturalness Demands on food production will continue to grow as demand for protein is linked to rising wealth, particularly in developing countries. The current
system, based on the use of chemicals to enhance production, needs to be changed for smarter, more natural methods of food production. Artificial intelligence and cloud computing The exponential growth of data and computing power is allowing data to be used to make better decisions in areas such as healthcare diagnosis and energy usage. Electric/autonomous vehicles Transport remains one of the major sources of pollution through the use of the combustion engines. Cars are also the source of many deaths and injuries. Electric and autonomous vehicles offer the opportunity to move transport into a cleaner, safer future. Next generation medicine The current healthcare system is based on diagnosis methods and drug treatments that are slow and often
ineffective. The ability to extract more accurate and timely health information from our bodies, and the ability to obtain our individual genetic profile, offers the opportunity to significantly enhance the standard of healthcare. Social infrastructure Areas such as water and electricity still require significant investment in the future to connect developing countries to these basic utilities and also improve the way they are delivered in developed countries. Other areas such as social housing are also relevant to this theme. Energy transition The way we have extracted energy from the sun recently is through fossil fuels. Renewable energy, such as solar and wind, offers the opportunity to extract energy directly from the sun in a cleaner, more sustainable manner.
November 2020 SUSTAINABILITY
Covid-19
How investors can support society at a time of a pandemic The current coronavirus pandemic is perhaps the greatest challenge the world has faced since the Second World War. Not since then have we faced a consistent threat to our health and wellbeing that has impaired our ability to go about everyday life. As investors who want to support the transition to a cleaner, healthier and safer society, we think many of the companies we own can help us to come out of this extremely challenging time. Here are some examples: Philips Philips is a health technology company focused on improving people’s health across the continuum from healthy living and prevention to diagnosis, treatment and home care. The company offers products and services in diagnostic imaging, image-guided therapy, patient monitoring and health informatics, as well as in consumer health and home care. Philips is a critical provider of intensive care monitoring equipment as well as a manufacturer of ventilators, which have been at the front line of Covid-19 treatment.
AstraZeneca AstraZeneca (AZ) is a world-leading pharmaceutical company with a particular strength in new and innovative cancer treatments. These are improving patient outcomes in areas such as lung and breast cancer. AZ is also playing a leading role in the development of a vaccine for Covid-19, working in collaboration with Oxford University. This vaccine is now in late-stage trials, which if successful could mean it is available to the general population in the first half of 2021. AZ has committed to selling this vaccine at cost, thereby making no profit on it.
Microsoft Microsoft sits at the heart of the digital world, offering both cloud computing services that allow businesses to operate remotely and collaboration tools such as Teams. If Covid-19 had happened 20 years ago, the social and economic cost would have been much higher as remote working would not have been possible on the scale it is today. Certain types of technology have become essential infrastructure and allowed individuals to communicate and work digitally in ways Covid-19 has not allowed physically.
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SUSTAINABILITY November 2020
Engagement Engagement with companies on ESG issues forms a core part of our stewardship responsibilities. It is an activity that all of our clients have come to expect from us as a long-term asset manager Here are two examples of the work we have been doing: High-pressure laminate cladding and fire risk management engagement During the first quarter of 2020, we received responses to letters sent at the end of 2019 to 19 property companies in which we are shareholders and bondholders. Our belief was that these companies were exposed to risks associated with the high-pressure laminate (HPL) cladding common with high rise properties. HPL cladding is distinctly different from the aluminium composite material (ACM) linked to the catastrophic Grenfell Tower fire that occurred in London in 2017. HPL was signalled for the first time in November 2019 as a contributing factor to the fire at The Cube student accommodation in Bolton, which was the event that initiated our engagement. We reviewed each of the 16 responses we received. Thirteen of these companies confirmed that they did not have material exposure to HPL cladding or were in the process of conducting remedial work. The other three respondents were conducting surveys. We observed varying levels of thoroughness among the responses received, which informed a second phase of engagement beginning May 2020. We aim to ensure that appropriate fire safety standards are in place as this is indicative
of the risk posed to sustainable cashflows of our credit holdings. We are therefore following up with companies that haven’t responded regarding their exposure to HPL cladding. We are also requesting details on the companies’ disclosure of their fire safety policy, the scope and breadth of their risk management strategy, and whether they produce a remediation or reparation policy and external audits on their fire safety risk management. To date, we have received 10 responses. We will continue to assess companies on this risk as we evaluate its materiality to future capital allocations.
‘Just Transition’ to low carbon energy engagement with utilities Our continued engagement around underlying systemic risks, in areas where we think we are more impactful at bringing about sustainable change, allows us to identify and monitor sector trends. Following structural changes in the energy utility sector, for example, we refreshed our analysis of its climate risk and ratcheted up our requests to companies. We initiated engagement with the UK’s ‘big six’ utilities in 2018, partnering with the Friends Provident Foundation. We focused on the ‘three Ds’ of risks to the sector: decarbonisation, decentralisation and democratisation. Our engagement aids our evaluation of companies’
preparedness for the energy transition, which in turn will inform our capital allocation decisions. Since our initial dialogue, several companies have shifted their business models and there has been a notable focus on decarbonisation from the sector with the UK and Europe committing to Net Zero by 2050. Furthermore, we identified the social justice concerns of workers and customers in particular as an area of material impact. The second phase of our engagement started this quarter, with a number of follow-up meetings set to take place. We are scrutinising companies’ assumptions and the alignment of their business models, infrastructure and investment pipeline to the principles of Net Zero. We are proposing a ‘Just Transition’ strategy to be embedded into their decarbonisation plans. Just Transition highlights the socio-economic impact of the low-carbon energy transition on workers, communities, and consumers. We are also building our understanding of barriers to scale innovation to achieve decentralisation and community-ownership business models. This is particularly relevant to the contributions to network flexibility, to the ‘prosumer’ (provider-consumer) and demand-side-response models, and to storage solutions that experts consider enablers of the energy transition. Finally, we are querying companies’ strategies to assess if these are influencing public policy and consumer behavioural change through marketing activities.
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Our fund range
We also offer a bespoke segregated service for institutional clients. We can tailor asset allocation to equities and/or fixed income, UK or global benchmarks, and embed sustainability criteria to your exact requirements.
Fixed income World IA Mixed Investment 40-85% Shares Sector
Potential return
Our funds are designed to work both as single funds and as a suite. We range from 100% fixed income to 100% equity, with three mixed asset funds grading upwards in between. The aim is to ensure that whatever the risk profile, income or capital requirements there will be a fund to match your requirements, all under the same RLAM sustainable investment process.
UK equities Overseas equities
Managed Growth IA Mixed Investment 0%-35% Shares Sector
Equities
Leaders IA UK All Companies Sector
Global IA Global Sector
Diversified IA Mixed 20%-60% Shares Sector
Managed Income IA Sterling Corporate Bond Sector
Fixed income
Potential risk
Equity
Sector rankings
1 year
3 years
5 years
Fund size
Sustainable Managed Income Sterling Corporate Bond
41/98
25/94
34/84
£180.7m
Sustainable Managed Growth Mixed Investment 0-35% Shares
1/55
1/53
1/43
£703.0m
Sustainable Diversified Mixed Investment 20-65% Shares
3/168
1/148
1/134
£1.9bn
Sustainable World Mixed Investment 40-85% Shares
2/174
1/152
1/127
£1.8bn
Sustainable Leaders UK All Companies
23/246
3/238
5/223
£2.2bn
Sustainable Equity Global
–
–
–
£77.7m
For illustrative purposes – reflects approximate percentage asset allocation, weightings may vary. Past performance is not a reliable indicator of future results. The value of investments and the income from them is not guaranteed and may go down as well as up and investors may not get back the amount originally invested. Source: RLAM and FE as at 30 September 2020. Percentile rankings are for main units only, for the appropriate sector. All Fund Performance shown is based on the C Acc share class, which is the clean share launched post RDR except for Sustainable Diversified Trust which is C Inc share class.
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Further information Webinars and videos Stewardship and responsible investment report Sustainable fund pages
Contact us For more information about our range of products and services, please contact us. Royal London Asset Management 55 Gracechurch Street London EC3V 0RL 020 7506 6500 institutional@rlam.co.uk bdsupport@rlam.co.uk www.rlam.co.uk
For professional clients only. Past performance is not a reliable indicator of future results. The value of investments and the income from them is not guaranteed and may go down as well as up and investors may not get back the amount originally invested. The views expressed are the author’s own and do not constitute investment advice. For more information on the fund or the risks of investing, please refer to the fund factsheet, Prospectus or Key Investor Information Document (KIID), available via the relevant Fund Information page on www.rlam.co.uk All information is correct at 30 September 2020 unless otherwise stated. Issued November 2020 by Royal London Asset Management Limited, Firm Reference Number: 141665, registered in England and Wales number 2244297; Royal London Unit Trust Managers Limited, Firm Registration Number: 144037, registered in England and Wales number 2372439; RLUM Limited, Firm Registration Number: 144032, registered in England and Wales number 2369965. All of these companies are authorised and regulated by the Financial Conduct Authority. Royal London Asset Management Bond Funds Plc, an umbrella company with segregated liability between sub-funds, authorised and regulated by the Central Bank of Ireland, registered in Ireland number 364259. Registered office: 70 Sir John Rogerson’s Quay, Dublin 2, Ireland. All of these companies are subsidiaries of The Royal London Mutual Insurance Society Limited, registered in England and Wales number 99064. Registered Office: 55 Gracechurch Street, London EC3V 0RL. The Royal London Mutual Insurance Society Limited is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. The Royal London Mutual Insurance Society Limited is on the Financial Services Register, registration number 117672. Registered in England and Wales number 99064. Telephone calls may be recorded. For more information please see our Privacy Notice at www.rlam.co.uk Ref: N RLAM PD 0019
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