Stewardship Enquiry

Questions are being asked regarding the role of corporations in society. Similarly, expectations regarding the role of shareholders are changing and proposed changes to the UK Stewardship Code reflect this.

The Code sets the framework for how fund managers should think about the companies they invest in and hold them to account. The first of its kind was established after the global financial crisis and has now been replicated in a number of other markets. The most recent iteration being the EU Shareholder Rights Directive.

In fact, on the face of it, the rest of the world has now caught up with the UK on stewardship. In response (and also in response to the critical Kingman review), the FRC has come out all-guns-blazing in an attempt to regain the UK’s mantle of being a stewardship ‘leader’. Proposed changes to the Code include: a broader rationale for engagement (other than short-term corporate governance), a wider range of asset classes, and better reporting of engagement outcomes. It also seeks to get other players in the investment value chain, not just the asset managers (e.g. the asset owners), to pay more attention to stewardship activity. The climate crisis is also specifically carved out as a stewardship issue.

Fine. Like many other sectors, the asset management industry needs to do more and explain the role that it plays in society. But ‘society’ and the readers of ‘engagement reports’ also need to recognise that as fund providers, our fiduciary (legal) responsibility remains to our clients. The mug on my desk says, ‘capitalists with a conscience’; there is a role for us to engage with companies on ESG when we believe our investors capital is at risk or where there are opportunities for investee companies to benefit from environmental/societal drivers. As we have previously said, ‘who cares wins’ , so we are more than willing to challenge companies and their executive management teams on a range of ESG issues, including on long-term strategic issues like climate. For instance, we were one of the few institutional investors to support the Follow This shareholder resolution at BP’s AGM; which sought the company to set emission intensity targets for the fuels that it sells. Finally, as active investors, if we need to, we have the ultimate sanction available to us, an ability to sell the shares of any company when we feel the ESG risks are too great.

Not shying away from voting against management:

Source: ShareAction. Proxy Voting Policy & Practice: Charity Asset Managers in Focus Investor Report December 2018

But we also need to be honest and pragmatic about what and how much we can achieve in our engagement efforts. The rationale for any stewardship activity must always be investment performance. Bear in mind that a lack of engagement reporting by a fund provider could mean they are (mostly) investing in the ‘right’ companies! Asset management has an important role to play in society, but it can’t fix all its ills or fill the void left where governments fail to prepare for the future.

About the author

Ryan Smith is Head of ESG Research. He joined Kames Capital in October 2000 as an SRI analyst and was appointed to his current position in September 2002. He has 18 years’ industry experience*. His role involves managing the team that conducts the ESG screening process for our Responsible Investing funds. Ryan’s team also provides corporate governance screening and research for all equity investments, and conducts research into environmental and social issues. Before joining us, he worked as an environmental chemist for Severn Trent Water. Ryan has an MSc in Environmental Chemistry from Nottingham Trent University and is a CFA charterholder.  *As at 30 April 2019.

Sign up to receive our fortnightly Soapbox email

Nothing new under the sun

Every single second, the sun furnishes the earth with more than six thousand times the energy produced by all our power plants, engines, factories, furnaces and fires combined!

And as far back as 2000 years ago, Chinese architects were aligning windows and doors with the southern sky to let sunlight flood into rooms during winter, heating cold interiors. The Greeks and Romans expounded similar architectural principles. Then coal came along and these design principles fell out of favour…unlucky for us.

But, there’s nothing new under the sun (as they say). Fast-forward to 2019, and take a look at the world. Homeowners in many markets are increasingly warming to the idea of solar panels on their roofs- particularly in California, Germany, and Australia.

  • In Australia more than one in five homes now use solar panels.
  • California was the first state in the US to require that from 2020, every new home is built with a solar system (and California builds about 100,000 housing units each year).

Plus, a recent survey* by CITE research suggests that, regardless of politics, built-in rooftop solar in every new home is an idea that appeals to 70% of Americans.

Solaredge Technologies Inc. has been a beneficiary of this demand. By making each solar panel ‘intelligent’, the company’s technology optimises the power generation of a rooftop solar system. In the residential space, Solaredge provides an array of features: its own smart inverters, cloud-based monitoring systems, solar-based water heating and third-party battery storage systems.



Source: Solaredge

And as the economics of batteries fall and the proportion of electricity generated by renewables rises, home energy storage technologies (solar + battery) become increasingly compelling/necessary. Wall mounted batteries are already relatively low cost ($2500-$10,000), often with short pay-back periods in certain markets and if you’re in California, one can imagine why it might be attractive to have backup power in the event of a brownout or blackout, (the frequency of which are expected to increase as utility PG&E implements cautionary measures to reduce the risks of wildfires).

In Germany, one out of every two orders for rooftop solar is already sold with a battery storage system.



Source: Bank of America Merrill Lynch

4 reasons why energy storage will win

We have previously written about the disruption of the traditional centralised power generation model of utilities. But it’s not just technology disruptors like Solaredge** that are interested in this new market. Ikea have offered solar + storage products (which one assumes doesn’t come flat-packed) and Shell*** recently purchased Sonnen, Germany’s leading maker of home batteries. The future is 4D , Decarbonised, Decentralised, Digitised and Democratised. It’s not yet clear who will provide it, but it probably won’t be long until having rooftop solar, a battery and an EV car will be a genuine reality for many.


*CITE Research (www.citeresearch.com), on behalf of Vivint Solar, conducted a nationally representative online survey of 2000 US adults age 25+ from June 13-16 2019.
**Solaredge is held in the Kames Global Sustainable Equity Fund, as well as other Fund portfolios.
***Royal Dutch Shell is held by sever Kames portfolios, but is not held in our Sustainable or Ethical funds.

About the author

Ryan Smith is Head of ESG Research. He joined Kames Capital in October 2000 as an SRI analyst and was appointed to his current position in September 2002. He has 18 years’ industry experience*. His role involves managing the team that conducts the ESG screening process for our Responsible Investing funds. Ryan’s team also provides corporate governance screening and research for all equity investments, and conducts research into environmental and social issues. Before joining us, he worked as an environmental chemist for Severn Trent Water. Ryan has an MSc in Environmental Chemistry from Nottingham Trent University and is a CFA charterholder.  *As at 30 April 2019.

Sign up to receive our fortnightly Soapbox email

Tipping points

As we mentioned in last week’s Soapbox, the direction of travel of greenhouse gas emissions is far from good – even BP agree! Which means that the longer governments delay, the more forceful and urgent the policy response needs to be.

In her last hurrah as PM, Theresa May’s committed the UK to a zero carbon target by 2050. The cost? Huge, obviously! Our energy infrastructure is vast and complex and has take more than 150 years to build. But the cost of doing nothing is even greater and the longer we do nothing the more expensive it gets! And anyway, as the advisory group on the costs and benefits of net zero sets out in its report, it’s pretty much pointless trying to estimate what the cost might be; economists struggle to estimate GDP more than a year or two out.

However, all is not lost. What we do know is the remarkable speed with which renewable energy costs have fallen, rendering those earlier forecasts of the costs of decarbonisation extremely pessimistic. How quickly? Since 2010, solar PV prices have fallen 83%, wind turbines 25%. LED lighting has gone from 5% of the global lighting market to 40% in six years and renewable investment now outpaces fossil fuels. In the UK,

It’s the first time since the Industrial Revolution that more electricity has been produced from zero and low-carbon sources rather than fossil fuels. It’s tremendously exciting because it’s such a tipping point.”  John Pettigrew, CEO of National Grid, recently.

It’s not unreasonable to expect similar cost reductions in other key technologies, such as batteries, fuel cells and electric vehicles:

“Once a technology becomes sufficiently competitive, it starts to change the entire environment in which it operates and interacts. New supply lines are formed, behaviours change, and new business lobbies push for more supportive policies. New institutions are created, and old ones repurposed. As costs fall and expectations of market size increase, additional investment is induced and the political and commercial barriers to a transition begin to drop away. A tipping point is eventually reached where incumbent technologies, products and networks become redundant.”    -Source – Report to the Committee on Climate Change of the Advisory Group on Costs and Benefits of Net Zero

The economics of clean energy are increasingly compelling and the scales are tipping in its favour as the diagram from Carbon Tracker shows below.

And once the economic tipping point is reached, the opportunity for politicians to act is enhanced. The energy incumbents’ ability to obfuscate and lobby is increasingly overwhelmed by financial reality. A political tipping point becomes a possibility. In enacting more sustainable energy policies, politicians are, after all, simply aligning themselves and policy with the economics of a rapidly changing energy landscape.

We would therefore argue that it feels like we are at, or are approaching multiple tipping points. New energy technologies are cheaper than fossil fuels for electricity and will soon be cheaper for transport. For the reasons set out above, anchoring views around concrete climate change policy commitments is not appropriate as the process of decarbonisation will not be linear. Companies that sell unsustainable products will face strategic dilemmas. But the biggest problem we face also creates enormous investment opportunities… and those companies providing solutions that address climate change should benefit from secular tailwinds.

About the author

Ryan Smith is Head of ESG Research. He joined Kames Capital in October 2000 as an SRI analyst and was appointed to his current position in September 2002. He has 18 years’ industry experience*. His role involves managing the team that conducts the ESG screening process for our Responsible Investing funds. Ryan’s team also provides corporate governance screening and research for all equity investments, and conducts research into environmental and social issues. Before joining us, he worked as an environmental chemist for Severn Trent Water. Ryan has an MSc in Environmental Chemistry from Nottingham Trent University and is a CFA charterholder.  *As at 30 April 2019.

Sign up to receive our fortnightly Soapbox email

We beg to differ

The Kames Global Sustainable Equity Fund was set up to be deliberately different from other sustainable strategies already in the marketplace.  Three years in, despite all the interest in ESG, new fund launches and rebranding of existing stuff, it still feels like that’s the case. Why?

Difference 1 – Disruptive growth
Take an existing investment approach, overlay with an off-the-shelf ESG rating product and yee-haw, get on board the ESG bandwagon. But as we’ve outlined before, these approaches tend to result in vanilla funds with similar investment outcomes – a tilt towards low volatility and quality and away from momentum. Fine. Let the me-toos keep investing in all the same best-in-class stuff and we’ll focus on those parts of the market where considering sustainably has been proven to add the most value, but requires more intelligent thinking.

Active Factor: ESG vs. Benchmark (Feb. 2019)

Active factor exposures: Difference in exposure between the index and its benchmark. Eg: MSCI World ESG Leaders vs MSCI World for the year ending Feb 2019
* While Momentum for 1 year ending Feb 2019 is high, historically its low
Source: Bloomberg Intelligence

 

Difference 2 – Highly active
44% of US domiciled funds are passively managed today. Passive share has more than doubled since 2009. Vanguard, one of the biggest passive asset managers, now owns more than 5% of almost all S&P 500 stocks. Passive ESG is the latest thing and maybe passives can be effective stewards of the economy. Or maybe not. Regardless, perhaps we should view it as an opportunity. Much like vanilla active ESG, as passive ESG grows, perhaps so will the need for complementary concentrated highly active alternatives (99.5% active share and actively engaged) like ours.

Difference 3 – Honesty
We have always been candid with ethical fund clients about the portfolio impact of the client-led exclusions that we apply. We need to be similarly honest about ‘impact’. Despite what companies might tell us about themselves, everything is not awesome or aligned with the UN Sustainable Development Goals (SDGs). We are happy to tell you the fund’s carbon footprint (it’s great btw), but we would rather spend time explaining our philosophy and chewing over the nuances of how we think about sustainability.

To end, I know we have talked about Everbridge before, but if we must put a number to ‘impact’, how about the following, taken from the company’s recent earnings call…powerful stuff

Just this past Friday, a major cyclone landed on India shores, directly impacting our recently won customer, the state of Odisha.

To highlight the relevancy and value of our solutions, let me read from a recent New York Times’ article entitled: How do you save a million people from a cyclone? Ask a poor Indian state. Appearing in the Times on May 3, 2019, and I quote “Flights are canceled.  Train service was out, one of the largest biggest storms in years was bearing down on Odisha, one of India’s poorest states, where millions of people live cheek to jowl in low-lying coastal areas in mud and stick shacks.  The government authorities in Odisha, along with India’s – along India’s eastern flank hardly stood still.  To warn people of what was coming, they deployed everything they had: 2.6 million text messages in local languages and very clear terms, a cyclone is coming, get to shelters.”

 The article goes on to detail, all of these efforts and ends with the following. And I quote, “Seems to have largely worked, Cyclone Fani slammed into Odisha on Friday morning with the force of the major hurricane, packing 120-mile-per hour winds, trees ripped from the ground and many coastal shacks smashed. It could have been a catastrophe.  But as of early Saturday, mass casualty seems to have been averted. While the full extent of the destruction remains unclear, only a few deaths have been reported in what appears to be at early warning success story*.

*Everbridge’s 2019 Q1 Earnings Conference Call transcript

Disclaimer – At the time of writing, we held a position in Everbridge.

About the author

Ryan Smith is Head of ESG Research. He joined Kames Capital in October 2000 as an SRI analyst and was appointed to his current position in September 2002. He has 18 years’ industry experience*. His role involves managing the team that conducts the ESG screening process for our Responsible Investing funds. Ryan’s team also provides corporate governance screening and research for all equity investments, and conducts research into environmental and social issues. Before joining us, he worked as an environmental chemist for Severn Trent Water. Ryan has an MSc in Environmental Chemistry from Nottingham Trent University and is a CFA charterholder.

*As at 30 April 2019.

Sign up to receive our fortnightly Soapbox email

Saintly Central Bankers

The legal mandates of central banks (CB) typically include responsibility for price stability, financial stability and the safety and soundness of financial institutions (e.g. our banks and insurers). So they’re effectively tasked with scanning the horizon to identify and understand those structural issues that could impact our financial systems …. and the economy. Importantly, they are also generally autonomous from our political systems.

Climate change is a market failure; carbon isn’t assigned its necessary economic cost.  Which means CB’s, led by the Bank of England Governor Mark Carney, are increasingly discussing the financial stability implications of climate change and the required appropriate response. Many are concerned that without further mitigation, cumulative emissions pose significant risk of economic disruption.  CB’s views on what constitutes an appropriate time horizon for considering risks seem to be changing.

For instance, historically, weather related ‘shocks’ to the financial system have been short-term, the impact on output or inflation has been temporary and policy-makers have been able to ‘look through’ them. However, some are now beginning to think that the increased frequency and amplitude of adverse weather shocks can no-longer be ignored if we are to avoid more extreme outcomes, the financial impacts of which would be difficult for central banks to manage. Separately, the impact of climate related employment shifts on wage inflation or energy price shocks as we shift to renewable energy are other considerations which could make CB inflation targeting more difficult in the future.

In their regulatory role, CB’s perspectives are also changing. Insurers have long been on the front line of dealing with the weather related impacts of climate change. They have adapted their modelling and pricing accordingly. This is less the case for banks. Late last year, the ECB indicated to the Euro-zone banks it regulates, that it had identified climate-related risks as being among the key risk drivers affecting the euro banking system. Similar messaging has come out of the Bank of England.

What are these risks? Both the banks and their regulator are still exploring this. But basically they are either physical risks e.g. mortgages of homes at risk of flooding or consumer loans on diesels cars etc., or transition risks i.e. those relating to the shift to a low-carbon economy. Responses to a Bank of England survey last year suggested that relatively few of the UK banks are managing these risks in a strategic fashion, principally because their business planning horizon only stretches to a few years out.


Examples of climate-related financial risks to bank assets
Source:Transition in thinking: The impact of climate change on the UK banking sector, sept 2018.

Time horizon is the common link between a lot of these considerations for CB’s and the financial institutions they regulate. Think short-term and there is little incentive to address climate change. Do too little, too late and you might not be able to manage the impact. But do anything too radical in the short-term and you risk materially damaging your business or the systems financial stability. This is the balance that our national and central banks must find. However, they are now undoubtedly giving more consideration to using the tools they have to address climate change.

 

About the author

Ryan Smith is Head of ESG Research. He joined Kames Capital in October 2000 as an SRI analyst and was appointed to his current position in September 2002. He has 18 years’ industry experience*. His role involves managing the team that conducts the ESG screening process for our Responsible Investing funds. Ryan’s team also provides corporate governance screening and research for all equity investments, and conducts research into environmental and social issues. Before joining us, he worked as an environmental chemist for Severn Trent Water. Ryan has an MSc in Environmental Chemistry from Nottingham Trent University and is a CFA charterholder. *As at 30 November 2018.

Sign up to receive our fortnightly Soapbox email