SLGI Asset Management Inc. incorporates environmental, social and governance factors (ESG) into our process for evaluating, selecting and monitoring sub-advisors. In this report, MFS Investment Management (one of our sub-advisors) provides an update on their ESG activities in the first quarter of 2021.
In January 2021, we joined the FAIRR Initiative (Farm Animal Investment Risk and Return). The FAIRR Initiative is a collaborative investor network that raises awareness of the ESG risks and opportunities brought about by intensive animal agriculture. We joined this initiative to improve our access to research and analysis on ESG risks and opportunities in protein supply chains as well as to enhance our engagement opportunities with relevant companies.
We also joined the Ceres Investor Network in March 2021. Ceres is a non-profit organization focused on transforming the economy to build a just and sustainable future for people and the planet. The Ceres Investor Network includes over 180 institutional investors that collectively manage more than US$30 trillion in assets. Ceres is a major sponsor of collaborative initiatives such as Climate Action 100+, The Investor Agenda and the Net Zero Asset Managers initiative. We are a long time member of the Carbon Disclosure Project (CDP), and we felt that Ceres could enhance our ability to engage on sustainability issues across the industry with companies, other asset managers, asset owners and policymakers.
Japanese corporate governance
During the quarter, our Japanese equity team refreshed and updated our Japan corporate governance scoring model. The team looked at portfolio holdings through this tool to find companies with material improvement or deterioration in key governance and capital allocation measures, including board independence, diversity, size, return on invested capital, cross shareholdings, etc. This exercise helped the team identify companies that required additional encouragement to improve their governance structure either through proxy or investment-led engagement.
A Japanese coatings and paints company was found to have made significant progress on governance improvement underpinning already strong fundamentals, which gave the covering analysts more conviction in the company’s ability to generate returns sustainably over the long term.
Plastic waste was an emerging theme for our team in 2020. Our ESG analysts developed a framework for assessing the environmental impacts of single-use plastic packaging and the implications for the entire plastics value chain. This framework initially focused on the chemicals, plastic packaging, consumer staples and waste management industries. It provided a basis for identifying the associated risks and opportunities, especially in regard to changing consumer preferences, regulation and costs associated with plastic packaging that may affect the competitive positioning and profitability of many companies over the long term. Our analysts’ evaluation included engagements with various companies and the development of data- sets to compare company progress to stated targets.
During the quarter, our consumer staples team built on the past thematic research on plastic packaging, analysing the earnings impact of the increased use of recycled feedstock and substrate substitution on brands with very high exposure to plastic packaging.
Their research involved meetings with company management, building their own internal dataset of corporate targets and commitments versus the progress that companies had made towards achieving those targets, and engaging with different non-profit research platforms, including the Ellen MacArthur foundation.
China’s net zero announcement
Together, our Singapore based ESG analyst, our Asia utilities analyst and our coal analyst sought to determine how Chinese utilities companies could adapt to China’s newly announced net zero targets.
Despite the lack of detailed milestones and targets set by the Chinese government on achieving net zero, our analysis indicated that China could use its vast network of state-owned enterprises (SOEs) to facilitate an energy transition through improved lending standards, setting coal power caps and directly subsidizing large SOE utility companies. Although China continues to ramp up its coal production, it has in the past shown a willingness to retire coal assets very early, with asset lives much shorter than those of developed market coal assets. This will decrease the stranded asset risks for corporates. The team agreed that some combination of renewables, nuclear and carbon removal would be needed for China to lower emissions, but that returns on invested capital for renewables were likely to decline in the near-to-medium term especially as subsidies are rolled off.
Our London based chemicals analyst continued his environmental analysis of industrial gases companies, especially their ability to be enablers of decarbonization for other industries and companies. His work on green and blue hydrogen indicated that there is likely to be higher growth in this area and the main economic obstacle to scale is cost. Higher carbon prices (over $50/ton), subsidies, technological advancements and customers switching to hydrogen despite the economics in order to meet their own sustainability targets could all result in green hydrogen scaling faster than over the 10 years that the industry expects.
Our analyst believes that as hydrogen adoption starts increasing, industrial gas companies’ existing infrastructure and technical expertise for producing, handling and transporting hydrogen will give them a clear advantage, from a risk/reward perspective, over new players trying to enter the “hydrogen economy.”
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