Blending quantitative financial analysis with qualitative evaluation while incorporating sustainability factors is essential when assessing a security, according to Hamish Chamberlayne, head of global sustainable equities at Janus Henderson Investors. Such an approach is necessary to managing risk and identifying companies that have the foundations for continued success.
Among the quantitative data that Janus Henderson analyses are carbon footprint, employee growth, gender diversity as measured by the number of female executives, being global impact signatories and whether the company has had controversies. In-house research teams then use this data and customised research to compare sector peers on environmental, social and governance (ESG) factors.
However, data alone will not provide sufficient insights to assess the risks and growth potential of a company. The challenge is further compounded by a lack of uniformity in global quantitative ESG data. This absence of standardisation and transparency in ESG reporting and scoring has presented significant challenges for investors.
"It is important to recognise the importance of qualitative assessment. This is where we have a real edge. We believe that there is a huge amount of value to be offered from a more considered active investment approach, which includes company visits, speaking to staff and questioning management," Chamberlayne said. "We apply our investment research and the qualitative assessment to the quantitative data to validate and verify the company's potential.”.
Chamberlayne added that an active approach is critical because it is through engagement, in-depth analysis and thorough due diligence that managers can identify companies that are more likely to succeed over the long-term.
“When one allocates to passive, one directly abdicates the ability to make a conscious decision about how capital is being allocated.”
Strategy built on four pillars
While quantitative and qualitative analyses are necessary, a robust process to select the right companies are just as crucial. For Janus Henderson, the global sustainable equity team’s stock assessment process is based on four pillars.
Firstly, companies must fall under at least one of the team’s 10 sustainable development themes that encompass positive criteria. These themes are divided into two categories: environmental, including efficiency, water management and sustainable transport; and social, involving knowledge and technology, quality of life, health and safety.
"Our investment process starts with a consideration of what is the company's product used for. Then we look at how the company is being managed; how it is treating its employees; and what is its carbon footprint. It is an integrated process," explained Chamberlayne. "The 10 themes help us to generate alpha because we believe that companies with products or services associated with these themes are going to be more likely to have resilient and compounding growth characteristics."
"The assessment is quantitative and qualitative in nature and involves a rigorous look at the life cycle of the products or services," he added. A critical quantitative criterion is that 50% of the company's revenue must be associated with one of the 10 themes.
The second pillar is based on "do no harm" criteria, which means avoiding investing in companies that are engaged in activities that are harmful to society and the environment. Chamberlayne said this also makes good investment sense because there is greater long-term investment risk associated with companies that are contributing to environmental or societal harm.
The third pillar involves fundamental research based on the triple bottom line of planet, people and profit – which involves analysing the operational characteristics of a company and how it is managing relevant ESG risks. "We believe companies with sound governance practices and strong stakeholder relations that manage relevant environmental and social risks responsibly have a greater chance of creating sustainable value for shareholders," Chamberlayne said, adding his team would also look at the cash-flow growth potential of the company three to five years out.
The fourth pillar is active portfolio construction and risk management, which assesses valuation, portfolio fit and engagement. "Here, we aim to go beyond the data, as we put qualitative context to the data that companies report," said Chamberlayne.
For instance, it's challenging to assess culture with purely quantitative data. In this aspect, the Janus Henderson team conducts interviews with management. "We believe that well-managed companies with strong, vibrant, innovative cultures will be the ones that will create the most value over time," added Chamberlayne.
The Covid-19 crisis has proven that an innovative culture is essential for resilience. There is a "strong link between sustainable development, innovation and long-term compounding growth", said Chamberlayne. This is evidenced by the performance of the sustainability portfolio’s companies during the pandemic. Among these are companies in sectors such as telehealth, renewable energy and infrastructure that focus on communications and network.
"If a tech company promotes productivity with regards to the use of resources, that is a benefit towards a sustainable economy. It's all about finding these resilient compounding companies that are producing the goods and services needed for a sustainable future economy," said Chamberlayne. "We see great alignment between sustainability and generating strong investment performance. Sustainability and resilience are one and the same thing."
Succeeding with sustainability
While a robust selection and investment process is essential for achieving returns, another significant consideration is the alignment of financial goals as well as a clearly defined strategy implemented with discipline and consistency, said Chamberlayne.
In this regard, a key factor at the start is to ensure that financial goals, values and beliefs relating to the strategy are aligned. This can come in multiple ways, for instance, between an end investor's values and beliefs in relation to an investment strategy; between a client and a fund manager in terms of delivering on the mandate given and process outlined; and between the fund manager and the management teams of the investee companies.
Also important are integration and buy-in. The use of sustainability factors needs to be integral to day-to-day operations and investment decision making. This includes integrating ESG risk factors into the broader risk management framework via formal, quantifiable and realistic limits, Chamberlayne said. Investors need to subscribe to the concept of incorporating ESG factors into their investment approaches as a way to enhance their ability to generate more robust risk-adjusted returns for clients. Given that environmental and social factors will, by their nature, play out over several years or even decades, investors also need to have a sensible time horizon and even expectations.
Clarity is also crucial. The mission and goals of ESG need to be incorporated, articulated and documented in a clear philosophy and investment process. Transparency and reporting are essential considerations as well. One of the foundational aspects of sustainable investment is transparency, added Chamberlayne. Transparency in how you are incorporating ESG principles into your investment approach and then transparency on reporting those results.
Since the multiple definitions and approaches to investing sustainably can become confusing, evidence of the consistency between how they articulate their philosophy and how decisions impact investment outcomes will differentiate strategies.
The final factor is collaboration. The value of effective external partnerships is integral to delivering on the investment goals of the strategy. This means setting out a blueprint to ensure precise and effective coordination and communication with the fund manager, trustees and investment committee, and any other partners.
Combining art and science
Success in sustainable investing requires both a qualitative and quantitative approach that takes numerous factors into consideration.
Beyond data, the global sustainable equity team at Janus Henderson believes that more nuanced information resulting from direct, in-person company engagement offers many advantages. Combining this with a well-defined stock selection framework and an alignment of financial goals allows the team to better identify those companies that have a positive impact on the environment and society, while at the same time benefiting their clients.
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