Why ESG matters to all fund managers

A fund manager’s job is simple, but not easy.

They take a universe of companies and filter them down to those which they think have the best potential. The exact methods they use differ from manager to manager, depending on their investment style and process. But in general, most fund managers try to invest in those they think offer the most attractive combination of risk and return potential.

To do this, the manager needs to understand the opportunities to grow revenue and profits for each company in the future. But also the risks that reduce the chances of that happening. By risks, we mean things like regulatory issues, pressure from competitors and changes in what people want. But in recent years, lots of fund managers have put more focus on environmental, social and governance (or ESG) risks, as well as the more traditional ones.

What is ESG, and why do fund managers care?

We think ESG analysis is an important part of a fund manager’s due diligence. It can unearth valuable insights and help improve investment decisions.

When it comes to ESG issues, fund managers consider a number of factors – things like, whether the company effectively manages its carbon emissions, whether it treats its customers, staff and suppliers fairly, and whether senior managers are incentivised appropriately.

Issues related to the way a company’s managed, and its effect on the environment and society can damage its reputation, impact profits and harm a company’s share price. This matters today more than ever. In a world dominated by social media, a company's misdeeds appear on the news feeds of millions in a matter of hours, potentially sparking outrage, backlash and boycott.

If a fund manager highlights serious ESG issues, they might choose to avoid the company and invest elsewhere. If the issues are less serious, and other investment considerations stack up, the manager might choose to invest. Some fund managers will then engage with the company and encourage them to address any outstanding issues.

ESG isn’t just about risk though. It can help highlight opportunities too. For example, a company could be making more progress when it comes to reducing carbon emissions than its competition. But if this isn’t being reflected in the share price, an opportunity could be on the cards, providing the rest of their analysis stacks up.

How does HL consider ESG in the Wealth Shortlist selection process?

There are a number of Responsible Investment funds on the Wealth Shortlist. But there are a range of other funds on the list that consider sustainability and ESG risks in various ways – we aim to find out what each manager’s approach is and whether it’s suitable for the fund’s longer-term objectives. It’s worth considering the aim and investment process of each fund to determine their approach to ESG.

Not every fund will actively seek to have a positive impact on the environment and society around them. Some funds invest in areas that others will avoid, like tobacco or gambling. Others might invest in companies typically viewed as unethical, but where they see room for improvement, they’ll engage to encourage the business to behave better. At a minimum, what we do expect is for Wealth Shortlist fund managers to consider ESG risks and opportunities when they invest.

We regularly meet and speak with a range of fund managers, and ESG has naturally become a bigger part of those conversations over the years. During these meetings, we discuss how ESG fits into the manager’s investment process and look at examples of times they’ve engaged with companies on ESG matters.

Following each fund manager meeting, we then assess how the manager incorporates ESG into their portfolio. We also look at whether the approach they discuss is clearly reflected in the way they invest, and if they’re supported to integrate ESG by the fund group they work for. Overall, we want to see proof the manager walks the walk, as well as talking the talk.

We communicate our views to investors through our fund updates.

Investing in funds isn't right for everyone. Investors should only invest if the fund's objectives are aligned with their own, and there's a specific need for the type of investment being made. Investors should understand the specific risks of a fund before they invest, and make sure any new investment forms part of a diversified portfolio.

This article isn’t personal advice. If you’re not sure if an investment is right for you, ask for financial advice. All investments and any income from them can fall as well as rise in value, so you could get back less than you invest.

Fund in focus #1: Aegon Ethical Equity 

Aegon pitches itself as a leader in responsible investment. Aegon fund managers see it as their responsibility to encourage companies to maximise investment returns through good governance and respect for the environment and society.

The Ethical Equity fund won’t invest in companies some might deem unethical – from tobacco and alcohol producers, to munitions manufacturers and companies that use animal testing.

The fund’s manager, Audrey Ryan, aims to identify and understand the key environmental, social and governance risks of each company, industry and sector she invests in. She believes companies that lead the way in governance and sustainability tend to outperform over the long run.

The fund recently invested in Volution Group. The investment’s a good example of how the manager considers ESG in her investment process. Volution Group is a leading supplier of ventilation products across the UK, Europe and Australasia. Sustainability is a key part of the company’s strategy. It’s set ambitious targets to increase the number of low carbon products sold, and the amount of recycled plastic it uses, by the end of 2025. 

Ryan believes the company’s progress on sustainability should help it navigate regulations on CO2 emissions, which are expected to tighten over the coming years. She also thinks the company’s attractively valued compared to other similar businesses across the globe, with plenty of future growth potential, although there are no guarantees.

Ryan and the wider Responsible Investment team at Aegon also take every opportunity to make their views heard. They vote at all shareholder meetings and engage with hundreds of companies every year on a range of issues including ESG disclosure standards, protecting biodiversity and executive remuneration.

Investors should note the fund currently holds shares in Hargreaves Lansdown plc. The fund’s investments in smaller companies add risk.

More information about Aegon Ethical Equity, including charges

Aegon Ethical Equity Key Investor Information

Fund in focus #2: TM CRUX European Special Situations 

We think it’s important that every fund manager considers the ESG risks and opportunities of companies they invest in. Even those that don’t place a specific focus on Responsible Investment.

The TM CRUX European Special Situations fund is managed by Richard Pease, a fund manager we’ve long held in high regard.

He invests in flexible, efficient and well-managed businesses, which means the fund generally tends to be less exposed to serious ESG risks. Nevertheless, the manager considers ESG risks as part of his investment process.

For example, from an environmental perspective, Pease believes newer, more efficient machinery is good for the planet, but should also result in less unexpected downtime and cost over-runs. While social factors, such as good workforce relations and diversity, lead to more productive employees. When it comes to governance, a fair employee pay policy should incentivise employees and avoid unnecessary risk taking.

CRUX’s approach is arguably not as comprehensive as some competitors, but the fund doesn’t claim to be a Responsible Investment fund like Aegon Ethical Equity. CRUX is also a relatively small business and lacks the high levels of resource enjoyed by some peers. We take these factors into account when considering the fund’s approach to ESG.

When it comes to engagement, Pease meets company managers on a regular basis, providing feedback on things like strategy, dividend policy, balance sheet management, executive pay and ESG factors. If he really disagrees with a company’s actions though, he’ll sell the investment.

Pease and his team also vote at all shareholder meetings. Although confidence in the management team is a pre-requisite for investing, so he rarely needs to vote against them.

The fund invests in companies of all size, including higher-risk smaller companies. Investing in a relatively small number of companies is also a higher-risk approach. 

More information about TM CRUX European Special Situations, including charges

TM CRUX European Special Situations Key Investor Information

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