Quality Growth Boutique

ESG: Investment Principles and Policy

White Paper
Sustainable Investing

At a high level, for a company to sustain its growth and reach its long-term potential, we believe management needs to maintain a healthy balance between four core stakeholders: shareholders, employees, customers, and society. A company with a good long-term growth opportunity needs to be governed effectively in order to navigate the many challenges it will face over time. We view ESG as important and integral to a company’s long-term potential.

At Vontobel Quality Growth, we have consistently applied a long-term investment approach for more than twenty years. When investing for long holding periods, we have found it is essential to understand environmental, social, governance as well as other core areas of sustainability such as regulation. However, for context, management’s inclination to follow or disregard ESG best practices will not necessarily have an immediate impact on the company’s performance – but over a few years, the likelihood of an impact becomes much greater. We see ESG as an integrated part of a long-term investment process, much like safety is to driving. If you drive without using the mirrors, it does not mean you will get to the supermarket quicker or slower the first year, but with time the chances of a costly encounter rise.

Our philosophy around ESG stems from our beliefs that include:

  • Management decisions impact earnings sustainability and shareholder value.
  • Management decisions can lower or raise a company’s exposure to ESG.
  • We only invest when comfortable with ESG risk; our primary concern is downside risk.
  • Deep research and constant questioning is the most effective method to uncover and engage on ESG. We believe ESG scoring provides discipline, but can provide false security.
  • As asset managers, it is our fiduciary duty to provide sound stewardship over the funds entrusted to us. We execute on this responsibility through our deep research-based “Quality Growth at a Sensible Price” approach where returns are driven by underlying earnings growth.
  • Active engagement, as owners, with managements brings benefit to both parties.
  • Understanding and engagement on ESG issues can deliver value to investors over the long term.

We believe deep analytical work needs to be carried out on each individual company held or under consideration in order to understand the potential threats opposing the growth opportunity. The following guidelines are examples of some of the issues we focus on, bearing in mind that the intensity of ESG risks range broadly by geography, industry and individual company.

Governance

Management decisions are central to a company’s performance, as well as how it handles its ESG risks. The board sits at the head of the management pyramid. Its primary function is to bring a team of expert individuals together to make the best overall decisions for the current and future direction of the company.

Board of Directors

  • We support the separation of CEO and Chairman roles and oppose the unifying of the two positions under one person except under exceptional circumstances when a strong lead independent director is designated. A capable Chairman able to lead the directors and control the ambitions of a strong willed CEO if required.
  • Diversification and depth of industry experience on the board.
  • An effective board that, despite diversified backgrounds, can work as a team to maintain the company’s goals, values and ethics.
  • Board should set growth and risk goals and ensure the course is held.
  • Independent directors — suitable proportion of independent directors to reflect non-controlling shareholders. We support the free communication of independent directors with non-controlling shareholders.
  • Independent directors should have open access to management at all times.

Key Individuals

  • Controlling shareholders – we look for alignment of interests with controlling or influential shareholders or shareholder groups, as well as suitable regulatory protections for minority shareholders alongside proven enforcement capability.
  • Key-person risk can bring particularly sharp downside risk should a problem occur. We look for a sensible back-up plan for decision making and transition should a key person become unavailable.
  • Constitution – support the practice of one vote for one share. We do not support the use of anti-takeover mechanisms or shifting of legal jurisdiction for a similar purpose.

Management Approach

  • Remuneration policy – should be easy to understand how it ties to performance, contain both long and short-term goals, and be straightforward to measure. The policy should balance performance, value to shareholders, and company culture.
  • Remuneration – all equity grants should be made at or above market price at time of grant.
  • Financial reporting should be intelligible and without regular large ‘non-recurring’ items.
  • Communication with stakeholders should be clear and regular on items that matter to them.
  • Corrupt practices are not acceptable anywhere.

Social

Social focus reflects the company’s relationship with its human capital and the broad community touched by its presence. One of the substantial risks for consumer facing businesses in particular is its reputation - its ‘brand’.

  • Respect for employees. Employees are the thinking assets of the business and it is important that a company affords a safe working environment, training, prospects, pay and benefits that will fairly reward effort and incentivize.
  • Companies should commit to not violate local laws or norms.
  • Companies with employees managing sensitive operations, such as bank risk officers, should provide anonymous whistle blower channels to senior management and the board.
  • Effective management of the company’s brand. We look for management track record of protecting the company’s reputation.
  • Ethical product marketing – aggressive sales tactics are a red flag of potential weaknesses in a business model.
  • Product safety – companies need to take comprehensive responsibility for the safety of their products. Testing programs can deploy best practices and provide early warnings of production problems.
  • Community interaction - has the ability to bring non-governmental support to communities. Benefits to the company include lifting teamwork and interaction within a company, as well as positively reinforcing the reputation of the business within the communities where they operate.
  • Protect customer and employee personal data.

Environmental

Sustainable use of physical resources. We look for policies and practices that use scarce resources judiciously to avoid future shortages for the company or communities in which it operates. Resource management needs vary by industry and geography and include: water, energy from carbon fuels, and impact on biodiversity.

  • At a minimum, comply with all environmental regulations and aim for industry best practices.
  • Programs to train and support small agricultural businesses in the supply chain can support sustainability, improve yields and reduce water usage.
  • Companies able to develop substitutes for resource-heavy inputs may create an advantage of higher future production volumes and potentially lower input costs.
  • Processes to minimize pollution.
  • Climate change – analyze and understand the impact of the company’s operations and supply chain on the environment and risks it might bring to climate change. Look for processes and development goals to minimize greenhouse gas emissions.
  • Report regularly on programs and metrics associated with environmental and climate impact.

Regulation

We believe sustainability covers many areas not explicit in the ESG acronym - an important example is Regulation. Many powerful businesses with dominant market positions can face greater disruption risk, positive or negative, from regulation than from competitors. We see regulation as often resulting from an abuse of one of the stakeholder groups. Government and regulation can inflict damage to a company’s value. We believe it is important that management can steer a course that can minimize negative regulation impact.

  • Search for new laws and rules being introduced by a government as well as keeping a pulse on sensitive political issues that can spill into punitive government action.
  • Management should have the company operate in a way that is least unlikely to draw negative responses from stakeholders and regulatory risk.
  • Management should communicate with shareholders any perceived threat from new regulation.
  • Communicate plans of action to reduce the impact of new or likely legislation.

Engagement

We believe regular communication with our investment company managements is of great importance. Our investment process is not activist, and we do not seek to initiate an investment with a view to alter management’s approach in order to generate returns. However, when we become uncomfortable with ESG related issues, we look to engage directly with management for clarification and remedial actions if required. Also, ordinary shares carry the right to vote. As standard practice, we vote all proxies when possible and economically sensible.

Quality Growth Boutique
Turning Stones Blog
Emerging Markets

ESG: Can social and short-term investors co-exist?

Get Social, ‘S’ from ESG, wrong and a company stands to lose customers and employee loyalty, and damage value of the business. The priority of owners in how socially responsible investments are made, and the expected returns, are key. Liquid markets can deliver rapid change in ownership. Can the two coexist? Owners are as much part of the solution as part of the problem.

Read more