Trading insights: Incorporating sustainability into the investment process

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Andy Howard: If you look at the world's largest 100 asset owners globally, more than half of them have got some form of climate commitment for their sort of wider organization.

Eloise Goulder: Yeah.

Andy Howard: What I think that's shifting to now is how am I actually investing? How do I think about sustainability and how do I approach this as being a tailwind, and something that can help us deliver better performance rather than a constraint.

Eloise Goulder: Hi, I'm Eloise Goulder, head of the Data Assets & Alpha Group here at J.P. Morgan, and today I'm delighted to be joined by Andy Howard, who is head of Sustainable Investing at Schroders Asset Management to talk about incorporating sustainable investing principles into the investment thesis. So, Andy, thank you so much for joining us here today.

Andy Howard: Thanks, Eloise. It's great to be here.

Eloise Goulder: Andy, could you start by introducing yourself and your background?

Andy Howard: I'm the global head of Sustainable Investment at Schroders. I started off in finance several decades ago, back in the late 1990s as a steel analyst and moved from steel to mining over the following few years. And one of the things that struck me was that all the stuff we were learning at the time were how to analyze financial statements. How to analyze P&Ls, balance sheets, cash flow statements, turn them into DCFs and all of which is really valuable. But it wasn't an awful lot of focus on where are these numbers actually coming from. What does this company actually do? And it felt to me that there was this disconnect between the things that were important to the people running a business and the things that we were looking at as a set of financial analysts trying to analyze that business. So as a mining analyst, you spend a lot of time going to far-flung parts of the world, and you go and speak to mining companies and get the presentations from mine managers. And they spend 10-15 minutes at the beginning of every presentation talking about health and safety, what they were doing with local communities. As an analyst, I'm sitting there thinking, I don't know what to do with this. Does this go in my model? How do I incorporate this? Because it's clearly important but I don't know what to do with that information. We had a lot of focus on the outputs, how much money does a company make without that much visibility into the inputs of how is this company run and what makes companies healthy and successful. So to me, that was the beginning, of how do we bridge from the way that a company thinks about running its business day-to-day in terms of managing its employees, managing its relationships with local communities, its customers, its regulators, managing its environmental footprint. All of these are things that are important to businesses. And if we can get a better understanding of those issues, and we can use that information to build a better view of which companies have got a more durable, sustainable business model, that should help us make better investment decisions.

Eloise Goulder: Absolutely fascinating to hear that context and that route for you through single stock research, and specifically through steel and mining companies into the world of sustainable investing. And Andy, as your role today as head of Sustainable Investing at Schroders, what exactly is your mandate?

Andy Howard: Well, it certainly covers quite a few areas, and I'm going to lean helpfully on some eyes that our marketing team have developed. First of all, it's around insights. So how do we try to use our IP, our insights into industries, companies, economies, to get a better understanding of the social environmental forces. The issues that will be impactful to companies or to assets over the longer term. What we might call research, modelling, analysis that can help build better insights. Secondly is around influence. We are not passive observers in this journey. We spend a lot of time, thousands of hours every year, meeting management teams of companies around the world. We have a depth of knowledge of many of those companies and industries. And using that relationship to encourage change, where companies are grappling with questions around how do they transition, what will their business need to look like. And how do we support companies on the journey that they're on is an important part of the influence that we can bring. The third eye is around innovation. How do we develop different kinds of investment products? We are seeing many clients who are increasingly looking to have a positive impact with the investments that they're making. Then the fourth eye is inspire – is really around how we manage our own business. How are we thinking about our own business model and our own license to operate in a way that will make sure that Schroders over the long term is a healthy, successful, thriving business?

Eloise Goulder: Thank you for going through all of that. And I'm particularly interested in that second eye you mentioned, influence – because it suggests that your impact within sustainable investing is not just in investing in the better companies, the right companies, the companies that tick certain boxes. But it's also through having direct influence and impact on the very companies you operate with.

Andy Howard: Absolutely - as an active manager, we've spent a long time trying to build some sort of understanding of where the company strategy fits into the context of our view of the industry. Using that sort of perspective to talk to management teams, help understand what they're trying to achieve, form a view on what good looks like for that management team, and then to, somewhere between encourage and facilitate management teams to think about how do they build long-term healthy businesses? That's how we broadly think about influence.

Eloise Goulder: That's really helpful. Thank you, Andy. And you started at Schroders back in 2016, I'm intrigued as to how your role has changed over that period of time, and how the way you think about this across the organization as a whole has changed over that time?

Andy Howard: Well, for one thing, and this isn't unique to Schroders by any means, sustainability was a smaller part of the asset management industry, even nine years ago. Having said that, a lot of the things that we're looking at, are not totally dissimilar. Climate change, inequality, social tensions, nature loss are all issues, that were on the agenda in 2016, 10 years ago, 15, 20 years ago even, and are still on the agenda. What I would say has changed have been a fewfold. One, the intensity of those questions, or those challenges has only got tougher. So, if we think about something like climate change, back in 2016, countries that represented a few percent of the world's economy, had made commitments around becoming net zero, or around reducing their emissions. Today, countries that represent over 90% of the world's economy, have committed to becoming net zero.

Eloise Goulder: Mm.

Andy Howard: Back then, you had a handful of companies that had committed to becoming net zero. Today, it's almost half the value of the MSCI ACWI, or the global equity markets, have committed to decarbonization in line with the Paris Agreement goals. So, you've had this change in terms of sustainability, shifting from being a challenge which will emerge in the future, to a challenge which is already starting to play out in a lot of areas. I think the second thing that's changed has been our ability to analyze those things. If you think about sustainability reporting, something called the Global Reporting Initiative, the closest thing we have to an accounting standard for sustainability data, was launched in the late 1990s. In less than 25 years or so roughly, you've gone from a few companies providing some form of sustainability reports, to now four out of every five companies globally are providing sustainability reporting which is consistent with GRI standards. Over 95%, according to KPMG, of large global companies are reporting some form of ESG data. And you've got regulations coming in many parts of the world that's going to push that up even further. So, certainly, in particular in the EU where something called SFDR, Sustainable Finance Disclosure Regulation, you've got similar regulation coming in the UK, all of which is, basically, forcing more measurement, more objectivity, more transparency around what does this fund intended to achieve, and how do we measure whether it's doing the thing that it's supposed to be doing? That's also turned the exercise from being a-a storytelling one, to being a measurement one. It's become a-a much more mature industry in a relatively short space of time.

Eloise Goulder: I mean, so many of the changes you just described, sound like a very positive development, much more commitment from the countries, the economies, and the companies themselves. Much more disclosure of that, much more data available to collect, and a much greater desire and ask to be measuring what you're doing. I guess I'm waiting for a "but", or an "if". And I’d be re-miss if I didn’t mention the current political landscape! The political will and narrative seems to have changed a lot!! And many of the goals that we previously discussed within an ESG lens, have since changed. So what’s your take on all this, Andy?

Andy Howard: Well, there are certainly "buts", and there are other "buts" that I'll throw in as well. Around the topics that you're describing, whether it's around energy transition, or whether it's around defense. These things go through ups and downs. If I think about the transition, or climate change, last year was the first year that global temperatures, reached 1.5 degrees Celsius above pre-industrial levels.

Eloise Goulder: Mm.

Andy Howard: As a point of reference, that was the objective of the Paris Agreement, where global governments got together and committed to limiting long-run temperature rises to no more than 2 degrees, and to aim for 1.5 degrees. So, we've just hit 1.5 degrees.

Eloise Goulder: Yeah.

Andy Howard: And we've done it pretty quickly less than 10 years after the Paris Accord was signed. And so, the issues aren't going away. Yes, the headlines will go more positive, more negative, sentiment will swing, the valuations of companies will move around. That's likely to happen, but the long-term challenges are not getting any more straightforward. And certainly, how we try to look at this, is to try and take a long-term lens on where are we heading, and then to try and understand where's the market at a point in time, where sentiment at a point in time, and therefore, where do we want to be focusing in the short term, but also making sure that we're building the right understanding for the long term, in order that as sentiment moves, as headlines change, we're prepared for that.

Eloise Goulder: Yeah. And it's particularly interesting, because coming from our lens, as a data-driven team that spends much time with shorter-term investors, so much of what we do is looking at, let's say, social media data to have a prediction on stock prices in the next 5 or 10 days. But what you are discussing is a very different form of alpha, where you can cut through that noise, you can ignore that noise arguably, and really analyze what's gonna change over the longer term. How do you think about alpha and outperformance in your world, and what really is your target?

Andy Howard: Ultimately, that's the point of this exercise across the firm, is to try and build an understanding of things that we think will impact businesses in a way that can help us make better investment decisions. But I think it goes back to the timeframe question. So, the question, in terms of alpha, comes down to, where can we find things that we think will have an impact on the value of the business, the asset, the company that we're invested in? Where we have the ability to create some form of incremental information, some sort of insight that isn't well understood by the market, what's gonna make this company successful in the long term? Obviously, depends on the business, but it's probably gonna be something to do with its ability to attract great people into its organization that can continue innovating, and continue building great products. It's gonna be something to do with its ability to create a supply chain, and a value chain that continues to deliver high-quality products in a consistent, and sustainable way. It's probably gonna be something to do with its ability to navigate regulation. It'll probably be something to do with its ability to connect with customers in a way that persuades them to continue buying its products, and to continue placing a value on its brand. All of those things I've just described is sustainability. That's about a company's connection and management of its relationships with different stakeholders, social and environmental stakeholders. And they're almost certainly won't be the most important factors for what do this quarter's earnings look like, but they are the thing that will determine whether this as a company five, or a few years from now, is able to consistently generate a slightly better level of performance than a company that's struggling on all of those fronts.

Eloise Goulder: You are also highlighting lots of risks, and I'm wondering how you think about this from a returns versus risk perspective, because in many cases, aren't you looking for companies where you can really mitigate risks around the viability of a company in the longer term?

Andy Howard: Yes. So, I find it very tricky, to sort of disentangle the risk and the opportunity, because in many ways, companies succeed where they're able to navigate the risks that an industry faces more effectively than other peers around them.

Eloise Goulder: Mm.

Andy Howard: And are, therefore, able to eke out an advantage, and a increase market share, and an increased share of wallet by managing disruption more effectively than their peers. Another word for disruption being risk. So, I do think, ultimately, that is the objective. It's not straightforward. And the value of sustainability analysis and ESG analysis, I think goes far beyond that. So, it is partly about, the tail risks to the degree that we can, but it's also partly about, eking out a small advantage as a result of the way you are running your business, the sustainability of your business model, your license to operate, your ability to just carry on being a slightly superior business over time. And the compounding effect of that on, ultimately, the value of the business.

Eloise Goulder: And you mentioned data earlier as one of the many changes that there is so much more data available now with companies having much greater reporting, and disclosure type requirements. How does that affect the way that you do your job, and you look at these things?

Andy Howard: Mm-hmm. Well, if I go back 15 years or so in trying to do any kind of objective analytical sort of ESG analysis, you'd pretty much have to start from what data can I find? What information can I find? And how do I somehow turn that into a score? That equation has now turned on its head. Today, you start from the question, "What do I want to understand about this business?", start from the question, and then you turn to the data, and it means that, sometimes the information that companies are reporting, is not the information you're gonna necessarily going to want to use to answer that question. So, a good example here, is around human capital. Companies talk about human capital a lot. "People are our greatest asset," is a pretty widely used phrase. You look at what they're reporting, you can barely find salary data. You can find very little information about what they're actually doing to invest in building a strong, sustainable, productive, motivated, impactful, valuable workforce.

Eloise Goulder: Mm-hmm.

Andy Howard: And so you've got this disconnect oftentimes. In many cases, companies, people, their workforce, is a really important part of how those companies deliver value, ultimately, for their business, and for their shareholders. But it's hard to analyze from the outside. So, you say, "Well, it's important. What information can we find that helps us understand that? And if it's not coming from the companies, where can I find some information?" So, now, things like Glassdoor mean that, that equation isn't really any longer in company's hands, we will analyze the things that we want to analyze to the best of our ability, and use the information that we can find to help analyze those questions. Rather than relying on what is it that the company wants to tell us, and how do I use that to form an opinion?

Eloise Goulder: That makes so much sense. First of all, the fact that you have so much data available to you, you have to be really careful I guess to frame the question correctly, and just find the data that's most pertinent to your question. But, also, this idea that the company isn't the sole provider of that information. I mean, it's something we see more generally with this democratization of information available online. I referenced social media earlier, that's a great source of information for shorter-term investing as well. But again, not necessarily in the hands of the companies. And your mandate as head of sustainable investing, it's such a broad one. What are the main areas you really look into within that umbrella?

Andy Howard: Whether we talk about climate change, nature loss, economic growth, inequality within different countries, globalization, all of these are connected trends, and trying to disentangle one or two of them in isolation, becomes quite tricky. Having said that, we do tend to focus an industry on particular topics, and I think it's fair to say, climate change is an unavoidable part of the-the overall agenda - how do we think about managing climate risk, and managing climate exposure. And how do we do that in a way that ensures that we are capturing the value that we know can be unlocked as companies decarbonize, as companies transition? We've seen that companies that can do that effectively, have often delivered on average, better performance than those companies that haven't transitioned. I see no reason why that will change. But it's not a straightforward exercise. Nature loss is a second area that's getting more and more focus, is essentially a meta version of the same question. So, to the degree that climate change is a function of a wealthier, hungrier, larger global population, putting more pressure on the world's resources, the same challenges appear across the broader spectrum of nature. And we're starting to see more focus on that. It's a much more complex topic. It doesn't have quite the same volume of data, and it's not quite as easily analyzable, but certainly, that's an area where we think we can add a lot of value. So the-the World Economic Forum has said that about half the world's GDP is highly dependent on nature. The OECD has said about one and a half times the world's GDP comes from the value that nature provides. Nature, is the environment that we all live in and we all rely on. People may be familiar with something called the Global Footprint Network. How many worlds does it take to support today's population? Up until about the 1970s, we were consuming less as a world population than the world was able to provide. So we were operating in surplus, slightly. Since then we've been moving further and further into deficit. So that every year we are consuming more and more of the world's natural resources to support the world economy, and that deficit is getting bigger and bigger over time. And we're starting to see the cracks in that beginning to appear, whether that's around coral loss and deforestation. pollution, we're beginning to see the effects of that coming through. And we're beginning to see a reaction to that from policymakers and from consumers and from society as a whole. So we're starting to see things like regulation that now requires companies in many countries to be clear about where are they sourcing their forest and wood products from, and how are they being produced in different parts of the world? Growing focus in, biodiversity net gain, which is a principle of ensuring that when we develop things, we've got a commensurate or a offsetting benefit in terms of developing and supporting biodiversity conservation in different places. They're all sort of fairly small examples, and we are at the very beginning of a journey. Similarly, social change, Cambridge University ran a periodic survey where they look at the populations of democracies around the world. In the last one just over half the populations of the world's democracies on their surveys were dissatisfied with the political system that they were living in. This isn't a question about democracy, but it is a question about a level of social tension that I think is emerging in many parts of the world that's having an impact. So, understanding the implications of the reactions to social challenges and social tensions, and the concerns that that's creating, is similarly, a big part of what we're trying to disentangle. On the other hand, on the positive side, how do we harness and leverage, and help and support the fund managers and the analysts who are making investment decisions to make a slightly more informed investment decision, hopefully, then they might otherwise not being armed with that sort of framework, that sort of analysis. That's the intention, that's the objective. And let's not pretend we've nailed all of this. There's no textbook. There's loads of books to tell you how to do a DCF analysis or how to approach valuation, there's a reasonably well-worn path, how to do sustainability analysis, there is no textbook answer. We're all trying to find a better way of doing this. And I think the thing that encourages me the most is that I think we are asking the right questions and we're armed with the right tools. We're just trying to eek away an edge at trying to find slightly better answers to questions over time. And if we can keep on doing that, that should keep giving an advantage.

Eloise Goulder: And where you sit within the organization. That's an interesting one because I imagine that looking back five, 10, 15 years, it was very common for a sustainable investing ESG type team to be separate from the investing team. Would you argue that across the industry as a whole you are more integrated? And can you give me any tangible examples of how you are really working directly with the portfolio managers?

Andy Howard: Yeah, one of the things that we've really focused on over the last few years is what we'd call integration. Which basically means asking the question, what's the right approach for identifying the relevant ESG factors that are relevant to a particular investment team? How do we analyze those factors? How do we incorporate that analysis into the way we make investment decisions? If we can channel that knowledge into trying to build a slightly better understanding of things that perhaps we haven't historically looked at as an industry that should be valuable, harnessed in the right way. In some ways regulation has been inevitable-certainly, and it's been a powerful force across the sustainable investment field. One of the challenges with regulation and the sort of focus that it's created and put onto, how do we demonstrate that this fund is doing what it says it's doing has been a focus on, well, therefore, does this become about a series of rules? Does this become about-

Eloise Goulder: Mm.

Andy Howard: -if it's a sustain-sustainable fund, it's got this score, it's got this carbon exposure, it's got this set of rules-

Eloise Goulder: Yes.

Andy Howard: -and that's how we define sustainability. And it doesn't boil down to a set of rules. It boils down to informed decision making. And in many cases, a large degree of judgment around how do we form a view about what a particular trend or a particular issue might mean for a particular company and how that might impact the investment case. And so I think that we've tried very hard to mitigate or to avoid falling into the trap of is thinking about sustainability as a set of rules or a set of criteria or a set of hurdles that you need to get over.

Eloise Goulder: Absolutely. And these rules are essentially a set of binary decisions, aren't they? Whereas in reality, there's a continuous scale of how effective a company can be at managing its long-term risks. So we've covered so much. Before we go, can we talk about what's next? I mean, what are you working on right now, and what do you think will be the big changes in your space over the next say 12 to 24 months?

Andy Howard: Well, I think if I look back over the last couple of years, there were a lot of commitments made. There was a lot more focus placed on sustainability, and we've seen that become much more ubiquitous. For example, if you look at the world's largest 100 asset owners globally, more than half of them have got some form of climate commitment for their sort of wider organization.

Eloise Goulder: Yeah.

Andy Howard: What I think that's shifting to now is how am I actually investing? How am I deploying capital in a way that delivers those objectives and those goals that many organizations amongst our client base have set? How do I think about sustainability and how do I approach this as being a tailwind, and something that can help us deliver better performance rather than a constraint. How do I think about why are we looking at climate change in the first place? We're looking at this because the transition to a low carbon economy seems an inevitability at some point. That transition is gonna be really disruptive to pretty much every industry. That disruption will create risks and it'll create opportunities. And there'll be a-a huge amount of value that gets moved across markets from losers to winners. If we can figure out today who the winners are and who the losers are likely to be, even if we can't get it right, if we can get it reasonably right, then that should help us to deliver better performance. And so this isn't ultimately a question in how do I mathematically reduce the carbon emissions of portfolios? The question is, how do I build portfolios that will transition and adapt in a way that helps us to capture the opportunities that are created from that disruption and to avoid-- so as far as we can the risks that are created from that disruption. It's quite easy mathematically to reduce the carbon intensity of a portfolio, you just sell high carbon companies in steel, chemical, utility companies, and buy some low carbon companies in other sectors. Is that likely to be a persistent source of adding value seems unlikely to me. Having said that, if we can find the companies irrespective of whether they're high or low carbon in the first place, that are decarbonizing most quickly. Our experience has been that they can deliver and have historically delivered significant sustained out performance driven by superior earnings. And so if we can identify those companies, where the value is being created through the way that those companies are changing. If we can engage with those companies to support that change, that's a way in which we can unlock value for our clients through getting exposure to the companies where the transition is playing out and the value's being unlocked, and our clients are gonna benefit from that.

Eloise Goulder: So many of the ways you've described your role, Andy, strike me as being quite unique relative to at least my old understanding of sustainable investing in ESG. The breadth of the lens in which you look at sustainability, covering not just climate change but also nature loss and also societal change. And then this idea that you're using this as an opportunity to create value, it's not just a constraint. Yes, on the one hand, they might affect the risks associated with the company, but equally, they affect the revenue opportunity of the company. And finally, the way your work is so integrated at the very heart of the investment process I-I find that fascinating, too. So thank you so much, Andy. It's been a really insightful conversation.

Andy Howard: No, thank you so much, thank you.

Eloise Goulder: Thanks also to our listeners for tuning into this biweekly podcast series from our group. If you'd like to learn more about Andy's work and Schroders as a whole, then please do have a look at the links in the show notes. Otherwise, if you have feedback or if you'd like to get in touch with our team, then please do go to our website at jpmorgan.com/market-data-intelligence, where you can always reach out via the Contact Us form. And with that, we'll close. Thank you.

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