Three managers presented their wares in a mock mandate pitch at the PRI in Person in Berlin that sought to identify how leading asset owners are assessing their managers’ investment practices and how they integrate ESG.
Jennifer Anderson, investment manager at the $13.5 billion TPT Retirement Solutions, formerly The Pensions Trust, played the role of the asset owner.
Before listening to the mock pitches, Anderson detailed the attributes of a successful manager and explained the criteria TPT uses in its evaluations.
She said all of TPT’s managers are rated on ESG criteria, including integration, stewardship, communication and transparency. TPT is committed to being a responsible investor, is a 2010 signatory to the Principles for Responsible Investment, and is working to embed the principles into its processes and practices across asset classes and managers.
TPT’s experience with investment managers is extensive. All its investments are outsourced, and it usually works with about 20 investment managers.
Anderson stated that a successful manager would be: 100 per cent staff owned or operating at arm’s length from significant long-term shareholders; a specialist in a single asset class; of modest size but with sufficient assets under management for critical mass; and willing to close to new business.
She explained that a manager’s people should be able to articulate clearly its investment process or philosophy. She added that they should not be afraid to show conviction or fear being viewed as contrarian or visionary; they should have a successful track record, a long-term mindset and the ability to separate trends from noise.
A successful manager’s process involves, Anderson said: a benchmark-agnostic, concentrated portfolio; long-term projections of key financial metrics; low portfolio turnover; a focus on the quality of management, cash flows and earnings; strong engagement with management; some different way of filtering the stock universe that provides a competitive edge; and a focus on responsible investment as part of the sustainability of future earnings and cash flows.
She explained that TPT’s evaluation process involves three stages. The first stage is creation of a long list, using Mercer’s manager database. The second stage is to reduce that to a short list, based on research on about 20 candidates and to do more in-depth research on that group. Stage three is to interview the shortlisted managers and agree on a preferred provider.
“Appointment of a new manager is where we get the greatest say,” Anderson says, “We assess many things. ESG is part of what we assess. Mercer awards each manager an ESG score. Where we engage is in the interviews.”
The manager interviews that Anderson conducts usually last about three hours, but in this session at PRI in Person, titled, ESG Integration: how to assess investment managers’ practices, the three managers were given 10 minutes each to make a mock pitch for a mandate.
The candidates make their pitches
Alex van der Velden, partner and chief investment officer of Ownership Capital, presented for a mandate on global equities; David Sheasby, head of stewardship and ESG at Martin Currie, presented for emerging markets; and John William Olsen, fund manager at M&G Investments, presented for European equities. Each gave their investment philosophy, potential edge and track records.
There were several relevant similarities among the managers. All three said ESG concerns were fully integrated into their investment process and addressed by portfolio managers; all three also had active shareholder engagement as part of their process and long-term horizons. They all had concentrated portfolios as well, with Ownership Capital holding only 20 stocks, Martin Currie about 40 and M&G beginning with a universe of 100. Finally, all three managers reported spending much time on company due diligence before deciding to invest.
Pitch 1: Alex van der Velden, Ownership Capital – global equities
Ownership Capital is a Dutch fund manager, started in 2008 at PGGM, focused on long-horizon investing with engaged ownership. The fund uses a unique 10-year financial model. Ownership has $2 billion in assets under management, serving only pension funds and endowments, which have long-term goals. The manager has returned 16.8 per cent since 2010, compared with the MSCI World Index return of 11.5 per cent (and Credit Suisse Hedge Fund Index of 8 per cent)
In making his pitch, van der Velden argued that traditional approaches to investment are no longer ideal and that engagement on ESG and ownership concerns is a better way of managing capital.
“The problem with traditional approaches [is that] a rapidly changing world is being met by business-as-usual methods like divestment, reactive engagement, focus on the best in class, and thematic strategies,” he explained. “They are all point solutions, not structurally better, so remain outside the mainstream of how most people invest…We think the solution is engaged ownership, where engagement is part and parcel of the investment process. It’s part of how you manage the portfolio for every company you own.”
He outlined three parameters for Ownership’s process.
“The first evaluation parameter is performance,” he said. “We believe ESG issues can affect the performance of investments. So then ESG integration must deliver better performance. The second evaluation parameter is ESG integration into investment analysis and decision-making processes.
“The third parameter is engagement outcomes; not only engaging when things go wrong but, as active owners, preventing companies from going off the rails in the first place. To achieve that you need a different process.”
Anderson questioned van der Velden based on these parameters. She noted that many global equities managers are saying ESG integration is an important part of their process and asked how Ownership Capital is different.
Van der Velden said assessing ESG integration, “should involve a meaningful differentiated selection process that evidentially enhances risk/return. We started by building 10-year financial models. Portfolio managers were asking themselves where this company would be in 10 years. [This gets them] thinking more about ESG because financial models can’t capture the long tail like ESG can. You need your own tools to analyse risk. There’s a lot of greenwashing going on out there.
“The carbon intensity reduction of our portfolio has been double the benchmark. We can persuade even large companies to consider sustainability.”
Anderson asked if the manager could evidence better risk-reward and better engagement outcomes.
“Engagement is so hard to measure,” van der Velden replied. “We often focus on the engagement activity rather than outcomes. Have them show you their models. [Perform] proactive engagement, before something goes wrong, and ask them how they are dealing with sustainability or succession planning.”
Pitch 2: David Sheasby, Martin Currie – emerging markets
Sheasby’s pitch stressed differentiators that hinged on ESG factors.
“The key distinguishing factor is how we embed ESG,” he said. “We believe ESG plays a core role in understanding businesses. Underlying our approach is that the market underestimates the ability of companies to generate long-term returns, and ESG is an important contributor to that. ESG is incorporated throughout the process, and [managers are] inherently risk aware.
“There are four key aspects of our process – idea generation, fundamental analysis, stock selection and portfolio construction. Each idea we come up with is pitched to the team, to leverage their experience and [facilitate collaboration]. Fundamental analysis is the core of what we do – understand the drivers of cash flows and capital allocation.”
Anderson asked what resources support that; for example, is there a separate team?
“We believe it has to be the portfolio managers themselves to make it fully integrated,” Sheasby answered. “We think it makes us better investors, gives a more holistic view of the company. We think governance is the most important criteria. If that’s done right, then the company has a better chance of generating long-term sustainable returns.”
Stock discussion, he explained, is subject to broader peer review from the whole investment team. Martin Currie is building a concentrated portfolio of 40-60 stocks.
Anderson then asked whether there are style biases in Martin Currie’s portfolios.
Sheasby responded: “We don’t start off with a view to have a style but, if anything, a slight bias towards quality.”
He described the firm’s engagement with Credit Corp, a leading financial services group in Peru. It is among the world’s most profitable financial groups, with a 20 per cent return on equity. An assessment identified some issues with disclosure and risk management, particularly on the environmental side, as mining sector investment is key in the country. Martin Currie staff spent some time with management, working with them on the risks and opportunities, addressing some of the issues, and introducing them to a bank in another country. Credit Corp adopted the Equator Principles and did a benchmarking exercise versus industry best practice.
Engagement and active ownership informs ongoing analysis, Sheasby said. In emerging markets, some companies are interested in speaking to engaged investors. They may be at a stage where they need help; for example, Credit Corp was interested in making the changes but didn’t know what to do.
Anderson asked how a long-term focus is reflected in portfolio turnover.
Sheasby said Martin Currie is running a concentrated portfolio so returns are driven by the high active share. Portfolio turnover is relatively low, 20 per cent to 40 per cent, he said.
Pitch 3: John William Olsen, M&G Investments – European equities
Olsen’s pitch emphasised the long term and taking everything into account.
“You need a holistic approach,” he said. “You can’t just latch onto the numbers, or the management team, or the strategy – it’s all important, you need to look at everything.
“For us, the starting point is to have a long-term investment edge, if you are long term, you have to [focus on things] short term investors don’t. You have to do your homework, buying into the culture and investment model. My holding period is about six years.
“[There is a] limited number of stocks we look at, in Europe a universe of about 100. We spend a lot of time analysing them before deciding to invest. Mostly we examine them, and then put them on the shelf, we don’t invest immediately. We do the work ourselves.”
Olsen noted that, in some cases, ESG can be a competitive advantage – it can be a tailwind or a headwind; for example, he noted that at Unilever, sustainability was being driven by the top.
He also mentioned the importance of connecting with management in assessing companies.
“You need to get under the skin of management teams to understand the culture – and make sure there’s not just greenwashing,” he said. “Try to meet as many levels of management as we can.
MSCI is the main source of ESG research but Olsen said M&G’s analysis adds to that.
“Standardising too much, making things too objective, you can lose out. We can add something on top of [for example] MSCI or Sustainalytics,” he asserted. “The average age of our companies in the portfolio is 100 years; they have a sustainable culture.”
Anderson asked the implications of being part of a larger investment house, and how much autonomy M&G has.
“We have a franchise [arrangement] where we can amend our own models,” Olsen said, adding that this provides M&G the strength of a large firm.