We are members of, among other initiatives, the Transition Pathway Initiative, Portfolio Decarbonisation Coalition, the Montreal Pledge, and Climate Action 100+. We have also committed to support the TCFD, as documented in our white paper, ‘The low carbon opportunity – and the risks of missing out’. We believe the TCFD could be a game changer, enabling all investors to make more informed decisions that take into account climate risks and opportunities. The adoption of the TCFD’s recommendations is essential to advance the quality of mainstream financial disclosures related to climate change risks in companies and portfolios.
At Hermes, climate change is – and continues to be – a critical element of our broader strategy to integrate ESG factors into all of our Global Equities strategies. We have stepped up our data procurement in this area, liaised with climate change experts, and hosted a number of internal sessions discussing the risks and opportunities of climate-risk-related issues.
Stewardship is also a core element of our investment approach, and we actively advocate for change at particular companies as well as at a broader market level in an effort to ensure robust corporate governance structures and principles are implemented and applied. Moreover, our responsibilities and investment philosophy are underpinned by a number of key guiding documents, namely ‘Hermes Responsible Ownership Principles’, ‘ESG matters’, and ‘Delivering holistic returns’.
Coming clean on carbon: Our investment approach
It is possible to assess climate change-related risks through the use of our proprietary tool, the ESG Portfolio Monitor, which Hermes has used to measure portfolio-level carbon footprint since 2013. It is now part of our portfolio monitoring process.
Meanwhile, the ESG Dashboard, another proprietary tool, helps us assess the environmental-risk exposures at the company level over time (see Figure 3). It is available across our entire investable universe of companies – approximately 4,500 stocks – and it pits companies directly against the KPIs of the industries to which they are exposed. The Dashboard also presents any KPIs which could represent a weakness for the business, thereby alerting investors to any red flags or issues worthy of corporate engagement, such as climate change or carbon risks.
Figure 3: Carbon capture: the ESG Dashboard
Source: Hermes Investment Management as at March 2018
Managing and assessing climate- and carbon-related risks
We use the ESG Dashboard to conduct a qualitative assessment based on the following climate-related metrics:
- Environmental footprint: Environmental factors are used to identify companies that operate sustainably, with robust policies and procedures in place.
- Carbon exposure: The Dashboard’s environmental impact lenses show the percentage of a company’s assets at high, medium or low carbon risk based on its business and geographical grouping. Companies can often have similar GHG emissions but different risk exposures due to their geographical grouping.
- Controversial business: examples include companies operating in the Arctic, which have contributed to pollution in the region. It is important to gauge the action taken by companies to remedy any adverse impacts.
- Company positioning: This includes assessing company statements, membership of climate risk-related organisations, communication with shareholders, and stress-testing and scenario reporting.
- Alignment with the UN Sustainable Development Goals (SDGs): The Dashboard uses the SDGs as a framework to identify a company’s specific focus, highlighting its reliance on green revenue sources, such as renewable energy or transformative technologies. This helps us identify forward-thinking companies that are delivering positive environmental and social impacts.
- Company disclosures: Disclosures related to environmental targets and climate change are essential as they assess the ambition and mind set of companies. For investors, transparency is significant as it helps them understand how companies assess climate-related risks and opportunities.
These considerations are captured in an environmental score which identifies companies that are exposed to less environmental risk relative to industry peers. It also takes the company’s historical – and current – performance into consideration, favouring companies with an adequate level of disclosure about environmental risk, which is demonstrative of a proactive, risk-focused approach.
Across our suite of Global Equities Strategies, we assess companies based on relevant environmental metrics, ensuring robust management of climate-related risks. These risks are then analysed in the context of our long-term time horizon and incorporated into our valuation of companies. Our Low Carbon Strategy goes even further, as we avoid companies that have material exposure to fossil fuels and a high carbon intensity. Instead, we favour companies that support the transition to a low-carbon economy and focus on minimising further climate change (see Figure 4).
Figure 4: Our low-carbon investment strategy
Source: Hermes Investment Management as at March 2018
Searching for the next decade of winners
The transition to a low-carbon economy also presents investment opportunities. Today, we seek to identify companies which do the following:
- Align their revenues to green opportunities, by generating revenues from solar power, green financing or energy efficiency;
- Fulfil broad sustainable trends, such as pollution or waste reduction;
- Find solutions to adverse climate change-related impacts, through the creation of eco products or automation;
- Sign up to climate change-related initiatives, such as RE100 and We Mean Business;
- Make climate change-related commitments, such as using alternative fuels;
- Enter green indices, for example Green200; and
- Adopt the TCFD’s recommendations.
For successful companies, governance is key, as evidenced from our previous research paper, ESG investing: Does it just make you feel good, or is it actually good for your portfolio? We look for accountability at the board level to demonstrate best practise when assessing climate-related risks.
Some companies are already leading the way on mitigating climate change and carbon-related risk in their respective industries. For example, one of our current holdings, a European pulp and paper manufacturer, has set meaningful energy consumption targets and assessed its product footprint in detail, while an Australian miner, another holding, has completed a scenario analysis of its business. Additionally, at board level, some companies are encouraging their executives to tackle climate change faster by applying targets within remuneration schemes which have long-term payoffs.
Engaging on climate change risks
It is also important for companies to discuss and disclose their approach to climate change. As aforementioned, stewardship is a fundamental part of our investment approach. This is driven by Hermes EOS, which advises on proxy votes and engages company directors and executives about ESG and strategic risks that concern shareholders.
By engaging frequently with companies on climate change risks and environmental reporting, as well as wider issues around policy and sustainable business practices, the insights from Hermes EOS create a powerful force for positive change. Examples of constructive engagement include: encouraging the adoption of the TCFD recommendations for disclosing clear, comparable and consistent information about threats and opportunities related to climate risk, speaking with companies ahead of their AGMs to flag climate risk-related issues that could be remedied, acting as active owners on behalf of shareholders, tracking companies’ progress on climate change issues and sharing company best practice where possible. Moreover, our voting policies and membership of industry initiatives, as previously discussed, encourage companies to align their business models with the 2015 Paris Agreement.