What does sustainable investing mean to you and how does it manifest itself in this strategy?
In simple terms, sustainable investing is the consideration of social and environmental factors alongside financial return, such that the companies we invest in are in some small way contributing to a better future – from the products they produce, or the services they provide, or the way they manage their business. These considerations are important in our investment decisions, affecting ultimately the risk profile or the growth potential of an investment.
ESG has faced criticism from some in the fund buying community. What would you say to this cohort?
Some of the criticism aimed towards ESG from certain members of the fund buying community is fair. ESG is a broad term, and there are different interpretations and different priorities depending on an individual’s viewpoint. At times, it’s been too simplistic – with companies, activities, or industries being feted as unequivocally good and others as unequivocally bad. In our view, the reality is always more nuanced and at Federated Hermes we have always been honest and transparent with our clients. I see that improving across the industry.
I believe the other reason for pushback has been performance. On average, ESG driven funds have struggled, especially over the past two years, as interest rates move higher. So, I think the onus is on portfolio managers to demonstrate that their approach can deliver alpha outside of a zero-interest rate backdrop – something which we believe we can deliver.
At times, ESG has been too simplistic - with companies, activities, or industries being feted as unequivocally good and others as unequivocally bad.
There has been a high degree of correlation and holdings commonality among sustainable strategies. Why is this and how do you solve this problem?
We do see some pockets of the market that look over owned in sustainable strategies. One factor historically driving that has been a prominent role of ESG ratings, driving investors towards developed market growth stocks, and the other is the climate focus of many funds, leading to a relatively narrow group of clean energy stocks.
For each of these problems, there is an easy solution. For instance, we don’t rely on those third party ESG ratings. Instead, we do our own analysis, supported by engagement to better understand the profile and the culture of a business. That can lead to a broader array of stocks – in emerging as well as developed markets – and away from that narrow growth focus. Secondly, our objective isn’t just climate oriented, with nearly 50% of the strategy weighted to social themes. That brings with it greater style and sector diversification and, we believe, better value.
The strategy was launched in 2021. Can you talk about the design and why you felt it offered investors something different?
We launched the strategy in 2021 with three key building blocks in place. Firstly, a decade-long expertise in ESG integration. Secondly, our best-in-class engagement capability in the form of EOS, our dedicated stewardship arm and, thirdly, a leading impact equity franchise experienced in impact identification and quantification. Each of these pillars help to drive a differentiated perspective on the investment opportunity.
So, from growth stocks in impact investing, to quality names in ESG leaders, and through to value in the improvers that we identify supported by engagement, we’re not constrained to a narrow group of well held or expensive stocks. Instead, we own plenty of less obvious more attractively valued companies, alongside that core of blue-chip high-quality businesses.
Many sustainable investment strategies have struggled over the past two years in an environment of inflation and rising rates. How has the Sustainable Global Equity Strategy fared during this time?
Our message to see clients at launch was a simple one. Given our approach, we expected the strategy to deliver more resilient through-the-cycle returns. Little did we know at the time that 2022 would prove to be the litmus test of that, as inflation and interest rates both moved dramatically higher. We are pleased with how performance held up. There was some drawdown in early 2022, but less than most periods and over the calendar year, we were within a fraction of the index. For some ESG funds, 2023 has also been challenging, albeit for different reasons. Again, our portfolio has performed well – comfortably ahead of the index year-to-date, and ahead since inception.
We are very encouraged by the numbers in this first two and a half years. We ultimately believe our approach gives us the tools to navigate this new market backdrop irrespective of the macro environment that prevails.