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Explained: our focus on Sustainable Wealth Creation
Sustainability
We aim to change investment for better, forever, for all
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Explained: our focus on Sustainable Wealth Creation
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1. What is the fund and why launch it now?
The corporate sector is at a tipping point. Globally, governments have come to recognise that without mobilising corporate investment and innovation, a shared sustainable future cannot be achieved. Encroaching regulation, the crises triggered by Covid 19, and the increasingly visible impact of climate change on our everyday lives are changing the paradigm for growth in the corporate sector. This profound shift in global economic focus represents a multi-decade opportunity.
The Federated Hermes Sustainable Global Equity (SGE) fund seeks to invest in those companies that we believe will contribute most to this transition. Alongside financial outperformance, the fund targets key environmental outcomes with a lower carbon, waste and water footprint relative to the benchmark.
The fund was launched as part of Federated Hermes’ product line reclassification and expansion which provides clarity to investors aligned with EU regulation. The EU’s Sustainable Finance Disclosure Regulation, the first part of which went live in March 2021, aims to address the lack of consistency in sustainable investing.
We believe this will help clients as the clear positioning of the fund helps investors to identify it as a sustainable offering – something that is becoming increasingly important considering the recent proliferation of ESG-related products in the market.
2. What makes the fund stand out?
SGE is a high-conviction strategy that invests in companies helping to create a more sustainable future. It is the culmination of what we do best at Federated Hermes, a business with nearly 40 years’ experience of responsible investing. As a concentrated, high-active share fund that follows a ‘best ideas’ strategy, SGE benefits from three key sources of alpha: sustainable leaders, impactful companies and future leaders.
We only invest in companies that make a difference. This is reflected in the strategy holdings, which are all aligned with, and facilitating progress on, one or several of the UN’s Sustainable Development Goals (SDGs). To make these links, we leverage the combined resources of more than 50 people within Federated Hermes, all of whom are experts in their field and skilled at identifying truly sustainable investment opportunities that are consistent with the UN’s framework.
Investment philosophy
3. Who manages the fund?
SGE draws on the very best equity investment expertise at Federated Hermes. Martin Todd is the lead portfolio manager and brings to the fund his experience managing a sustainable focused European equity strategy for the last five years.
Martin also co-manages the Impact Opportunities strategy.
Ingrid Kukuljan and Henry Biddle are co-portfolio manager and deputy portfolio manager respectively. Ingrid is Head of impact and sustainability at Federated Hermes and has over 22 years of experience in financial services. Henry, meanwhile, has experience running Federated Hermes’ US SMID Cap strategy so has a background in searching for companies underneath Wall Street’s radar.
We are also fortunate in being able to draw from the best ideas of a large analyst pool. The 40 stocks in the portfolio have 14 different covering analysts.
Henry Biddle, CFA, ACA
Portfolio Manager, US SMID, Federated Hermes Limited
Martin Todd, CFA
Portfolio Manager, Sustainable Global Equity, Impact Opportunities, Federated Hermes Limited
Ingrid Kukuljan
Head of Impact & Sustainable Investing
4. How do you define a sustainable company?
Our belief in what constitutes a sustainable company starts with understanding that companies contribute to sustainability in different ways. And some of these ways go far beyond just ESG.
As investors, we look at sustainability from three perspectives:
Essentially, sustainable investments should be companies with a business model built for the long term, a positive or improving ESG profile, and whose activities have an overall positive impact through what they sell.
That tends to mean businesses with a clear purpose, who have invested to enable greater control over their own destiny, together with a sharp focus on innovation and future growth.
We may target companies who are leaders in ESG by virtue of the way they operate, while we also look at companies that are making an impact through their products.
Finally, and most crucially, we target companies that may not be seen as sustainability leaders today, but the rate of change and/or their direction of travel leads us to believe the company has the potential to be a leader in the future.
All three of these types of companies can be very attractive long-term investments and our process is designed to uncover and capture these opportunities at attractive valuations.
How do we gauge sustainability?
5. What change can investors drive in public markets?
Over the past decade, impact investing (investments made with the intention to generate positive, measurable social and environmental impact alongside a financial return) has gone from being largely the preserve of philanthropy and private markets to becoming a credible public market strategy.
SGE helps drive impact through a robust and repeatable process that focuses investment on themes linked to the UN SDGs, considers the impact of companies and their products, and leverages EOS (which has US$1.7 trillion in assets under advice as of 30 June 20201) to give us greater influence to affect positive change.
In the wake of the Covid-19 pandemic, the estimated funding gap for achieving the
SDGs has soared to US$84-101tn.1 Governments can help direct investment though stimulus, policy and regulation, but they can’t tackle the problem alone.
The private sector is required to drive the innovation and adaptation required. With the market capitalisation of global public equity markets approximately US$117tn2, the sheer volume of capital provides the potential for transformational impact. It is therefore essential that public-market capital is directed towards solving the structural, underserved needs of society.
Public equity sustainable funds channel capital towards companies that are having a positive impact on people and the planet, helping to reduce their cost of capital. For investors, they provide the opportunity to invest in impactful companies that are driving the sustainable transition in a liquid, scalable and accessible way.
In addition, investors can also use their position as shareholders to help drive change over the long-term. Through active long-term engagement, we discuss with businesses how they can drive positive impact in wider society. Then, through our public advocacy work we push for greater awareness among policy makers, more ambitious targets and ultimately push for higher standards across sustainable finance.
6. How do you incorporate thematic investing into the strategy?
We generate ideas through our thematic framework, which identifies megatrends aligned with the delivery of the UN SDGs. We have identified the most investable and impactful themes across the SDG spectrum and divided them into four key categories.
Within each category, we have focused on the most crucial and urgent issues that are likely to impact the largest number of people globally. The themes are social inclusion, health & wellbeing, environmental preservation and finally efficient production & resource usage.
Figure 5: Sub-themes within the four SDG-aligned themes
To illustrate how this works in action, let’s take an environmental and social example:
‘Environmental’ example: Sika
Green construction
Sika is a speciality chemicals manufacturer focused on providing sustainable solutions for the construction industry. The sector accounts for 37% of all energy-related greenhouse gas emissions3, through materials innovation. Sika is reducing the industry’s environmental impact.
Source: Company reports March 2021 and Federated Hermes research. The above information does not constitute a solicitation or offer to any person to buy or sell any related securities or financial instruments.
‘Social’ example: Bank Rakyat
Driving financial inclusion
Bank Rakyat is a leading Indonesian bank which is driving financial inclusion through its uniquely positioned business and clear digital strategy. Through its microfinance franchise it is providing access for the first time to millions of individuals and small businesses.
Source: Company reports and Federated Hermes research. The above information does not constitute a solicitation or offer to any person to buy or sell any related securities or financial instruments.
7. How big is your investable universe & how do you filter for ideas?
Our benchmark is the MSCI ACWI Index, which represents a full opportunity set of large and mid-cap stocks across 23 developed and 27 emerging markets4.
There are four broad stages to our investment process that help identify the most exciting companies:
This approach combines one exclusionary and three inclusionary steps, which ensures that we have a variety of different ways of finding the most exciting sustainable companies.
The exclusionary step reduces the investment universe to approximately 2,500 stocks. From there, the thematic analysis, positive screens and sharing of ideas help us to create a broad watchlist of 100-150 companies. We target 30-40 of those companies more closely and we typically own between 35-45 stocks in the portfolio.
8. What role does engagement play within the strategy?
Direct engagement with the companies we invest in is vital to achieving long-term impact and a key differentiator of this fund.
We work in collaboration with our world-leading stewardship business, EOS, where we are supported by 38 engagement professionals with dedicated engagers per theme within the fund.
Dedicated engagement specialists
Environmental preservation: Sonya Likhtman
Health and wellbeing: Amy Wilson
Efficient production and resource usage: Lisa Lange
Social inclusion: Roland Bosch
As well as working closely with our EOS stewardship team, we benefit from ESG analysis and engagement from Will Pomroy, Head of Impact Engagement – Equities, who acts as lead engager sitting within the investment teams.
By engaging with companies on specific, relevant objectives aligned with UN SDGs, we gain valuable insights into investment risks and longer-term opportunities that the company is exposed to. Such insights cannot be uncovered through ratings; they include how a firm manages scarce resources, how it invests in its people, and how it supports equitable economic growth.
Engaging as a constructive partner is necessary to establish management buy-in, while true impact needs investor intentionality and additionality. This involves sharing insights and contacts in a purposeful manner. Furthermore, change does not happen overnight, so engagement requires patience and perseverance.
We use our proprietary milestone system, developed by EOS and shown below, to track our progress towards each engagement objective.
Figure 7: Our engagement framework
Source: Federated Hermes, as at 30 June 2021.
9. What are the style biases within the fund?
In terms of overall style, the fund is reasonably balanced, but with a bias towards quality. While we are also slightly overweight growth and underweight value, we are fully conscious of the factor exposures of the fund and believe our process leads to differentiated companies with relatively balanced risk factors. This is because the fund is constructed around three alpha drivers – ESG leaders, impactful companies and future leaders – which gives us access to a wider range of opportunities and provides a degree of diversification.
Figure 8: Sustainable Global Equity Style Analysis
Style Skyline source: Style Analytics as at 30 June 2021.
10. Is there a ‘green’ bubble?
The marked increase of inflows into ESG-related investments in recent years has prompted this question among some market participants.
Typically, when there is discussion of a bubble forming, there are certain key indicators which become evident. Investors start to talk only of what can go right rather than what can go wrong. Valuations start to be ignored, with high level narratives taking precedence over financial metrics. As we look at our universe of stocks today, we aren’t seeing irrational exuberance.
On the whole, valuations are being scrutinised. Company conference calls are littered with questions around supply-chain bottlenecks and cost inflation, or the challenges in new technologies, materials and solutions. Moreover, the very fact that we are frequently asked this question provides some comfort that we are some distance away from a bubble forming.
We view the shift towards sustainable investment as a structural trend. This shift is being driven by a range of factors, such as the clear direction of future policy and regulation and the growing importance of environmental and social issues for consumers.
Our focus on sustainability does not take anything away from the price we are willing to pay. Every stock we own must be attractive from a valuation perspective. We consider valuation over the long term – five years – consistent with our investment time horizon. We therefore put far greater emphasis on discounted cash flow models and sum-of-the-parts metrics instead of focusing on one or two-year forward multiples.
Moreover, sustainable investing is still at a nascent stage, incorporating a number of different approaches and processes. If anything, we see a broadening of the investable universe given the growing awareness of corporates to their broader societal impact.
Source: Clark, G.L., Feiner, A., & Viehs, M. (2015) “From the stockholder to the stakeholder: How sustainability can drive financial outperformance”
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This document does not constitute a solicitation or offer to any person to buy or sell any related securities or financial instruments. The value of investments and income from them may go down as well as up, and you may not get back the original amount invested. Past performance is not a reliable indicator of future results and targets are not guaranteed.
3 2021 Global Status Report for Buildings and Construction, published by the UN Global Alliance for Buildings and Construction as at 19 October 2021. 2021 Global Status Report for Buildings and Construction | Globalabc
4 MSCI, 2021
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