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Podcasts from abrdn Investment Trusts: invest in good company.

Host: Hello, and welcome to the latest in the abrdn Investment Trusts podcast series. With me today is David Smith, Head of ESG in Asia. We'll be talking about the ESG process at abrdn. David, I wonder if we could start with a big picture view of ESG. What is it? Why is it important?

David: Hi, well, thanks for having me. ESG refers to the analysis of environmental and social and governance factors. And really, that's an understanding of the way the company is managed. So that's the governance part. And also the impact that the company is having on the environment and on society at large. As long term investors, we think that understanding these factors help us make a better judgement around the quality of the company. So rather than looking at a narrow information set, just the financial numbers and how much money we think the company is going to make next year, for example, looking at a broader spectrum of information around these E and S and G factors, helps us fully understand the way the company is positioned for long term sustainable growth.

Host: Okay, and then there are different interpretations of ESG. And it can sometimes end up being a bit of an alphabet soup, you know, SRI and ESG and these kind of things. How do people's views tend to differ? And what's the ASI philosophy on this?

David: Absolutely, you’re right. And it can be, can be a bit of an alphabet soup, as you say. There's a there's a variety or spectrum of views as to approaching this, this issue. And we've seen some people have looked at screening and removing certain sectors, which is an approach that might see someone exclude a certain company or a certain country, right up to the other end of the spectrum, which is around the integration of these factors in the investment process and the way you look at companies to better understand the company. And for us, as we look to manage our portfolios, we've looked to integrate ESG as part of that investment process. So our philosophy sees us do a lot of research before we buy companies, look to understand the way they interact with their supply chain, the way they impact the environment, how much are they polluting the sea or the earth or the air? How are they working with employees, for example, and how are senior management incentivized, and how are the board of directors put together. The other difference in approach is that we've seen one approach have a large group of ESG analysts in a HQ of a fund manager, for example, that work loosely with fund managers and contribute indirectly to the investment process. We've chosen an alternate approach whereby we have ESG analysts such as myself, integrated within the investment team within the region that we're looking at, to allow us to be closer to companies, closer to markets, closer to the countries and closer to the issues that we're looking at, and to be able to work more closely with fund managers, as we meet and understand the companies that we’re looking to invest in.

Host: Okay. And then, I mean, certain areas, such as strong governance have presumably always been part of the investment process, and the way that people select companies. But how is the ESG process kind of involved in recent years in terms of both the areas that you look at and also the kind of disclosure you're getting from companies?

David: Yeah, that's a great question. So ESG has always been part of our due diligence process when we're looking at companies. But I think it's fair to say that we have iterated and strengthened the process on ESG over the last, let's say, three, five years or potentially longer. And that's not really been around a change in the process. It's just been a strengthening of the way that we've looked at it. It's been a deeper integration of these factors as part of our process. It's been around putting additional resources within regions within different fund management teams across abrdn. We now have dedicated ESG analysts in every region for equities for abrdn. I think the information we're getting from corporates is also evolving. So within Asia if you were to go back, well, I've been with the firm for almost a decade now. If you go back over that period of time, at the beginning we saw reasonable disclosure in some of the developed Asian markets. But really, the E and S component of ESG was somewhat nascent in terms of the disclosures and reporting that companies were making. And we've seen the strong focus on ESG reporting from corporates around this region, driven by strong interest from fund managers such as ourselves, and also from broader societal interest really pushed that reporting forward. Now, there's still a big spectrum of quality of reporting. And the challenge in Asia is that it is a market that is characterised by high levels of information asymmetry across the region as to ESG quality. So to an extent, to put it simply, it's very difficult to know how good companies are in terms of ESG by reading the annual report. There are some companies that do really, really well at managing their environmental impact and have really, really good supply chain management, for example. But they’re simply not reporting well on that - they're not telling their story good enough. And I suppose the bigger risk is the companies that report this really, really well and have really nice, glossy annual reports, but are perhaps not managing those risks or minimising their impact as much as we would like them too. So one part of our work as owners of companies and being situated in this region, is to work with the companies that we own in our various portfolios constructively, to encourage them to disclose more, but also to work with them to look at comparable companies across the region from their sector and say well, look, this is an example of the kind of disclosures you could be making. This is the kind of reporting you could be looking to. And also, here's the benefit of making those disclosures and improving your reporting quality, because we think that investors around the world are increasingly looking at ESG factors. And so by having better disclosure, and more fulsome reporting, we think those companies would be more visible to global investors looking at this region. So you see reporting improved, it's still a broad spectrum, but we're spending a lot of time working with companies to help them better tell their story.

Host: And obviously, there's a lot going on internally, do you make any use of external providers or external research?

David: Yeah, absolutely. So I think this goes back to my earlier comments around the high levels of information asymmetry around ESG. So if you are a third party ESG research firm - so some are looking from the outside in - it's sometimes quite difficult to be able to make a judgement as to the ESG quality of a company if you're looking simply at an annual report or other similar disclosures, and they can be fairly sparse. And that may result in a fairly low score for a company, which in some cases, or in many cases, could be quite undeserving, whereas we spend a lot of time with companies, understanding companies and doing our research. So we've developed our own ESG score for companies, whereby we draw on our own experience and our own research to assess the ESG quality of a company. And there can sometimes be big disparities between the way we view our company and the way external researchers view a company because we have a better understanding of the company through our research process. And again, part of the work we do with companies is to improve disclosure to bring the perspective of third party providers up to the level at which we see companies.

Host: I wonder if you could both talk about how ESG is integrated into the investment processes at ASI?

David: Well, the understandings we have of ESG as part of the investment process, take their inspiration largely from the work we do on different sectors. So we look at sectors in some detail, we will sketch out our understanding of where a sector is going over the next, let's say, three to five years, what are the attractions of a sector, what are the drivers of value in that sector? And what are the risks in that sector to achieving that value? And part of that is, is these fundamental trends we see in a sector and part of that is ESG. If you look at the real estate sector that would obviously have different ESG risks and opportunities from for example, utilities, which would be different again, from information technology. And then the people who are doing the research on the companies themselves, so what we would call a stock owner or the stock analyst, integrates those perspectives from the way we look at a sector into the questions that we ask a company. So if you meet a company in the real estate sector, then it's very easy to see, for the analysts that we've got in the region, what are the big ESG risks and opportunities in that sector? And therefore, what are the key issues for that company? And what should we be looking out for in terms of the way they're managing their ESG. So for every research note we do on a company, we're asking questions around ESG, we're trying to understand the ESG quality of the company, and the way they're positioned for long term sustainable growth. So it’s fully integrated into the investment process in as much as it’s the stock analysts themselves who are doing this research rather than a separate team in a separate region, or relying on third party research providers to tell us how to think about ESG.

Host: Okay, and you mentioned that you’re involved with the engagement with companies. Could you just talk a little bit about what that looks like in practice?

David: Sure, there are probably two components of engagement that I'll talk about, we usually divide engagement into either protecting the value of our clients assets, or enhancing the value of our client assets. If you look at protecting the value of client assets, then those tend to be engagements where we are trying to ensure that the companies that we bought, which we think are high quality companies, continue to be high quality companies, and our engagements where we're continuing to get more information around the way the company manages its ESG risks. So these engagements could be around better understanding the way the company manages, for example, its risks, if you look at semiconductor manufacturing, and one of the companies we own across a number of funds is TSMC, a semiconductor manufacturing company in Taiwan, obviously, semiconductor manufacturing is a very water intensive process. And we think that the ability to manage water stress and water risk is a competitive advantage in terms of your ability to operate over the long term. So that discussion is ongoing and helps us better understand and better protect the value of our clients’ investments. The other part of engagement is around enhancing the value of investments. And that's where we work constructively with companies around structures or processes, or around capital allocation, to better understand why decisions are being made. And also to provide constructive feedback as to ways we think that processes or structures or cap allocation could be improved for the benefit of minority shareholders. Now, that's not to say that, that we know everything about running a business, but it's about asking provocative questions around capital allocation, around return hurdles, around why companies continue to invest in in x business or y business, and also drawing on our expertise around this region example where we've got around 50 fund managers on the equities team to say, well, look, we're seeing this trend in this sector in another country, is that something that you're seeing in your sector, or by saying we're seeing this trend or this development at this part of the supply chain - is that something that's affecting you? And how do you think you can manage that? Or even drawing on the work we do globally. So we may own a competitor to an Asian company, in an American fund or European fund, for example, and be able to say, Well, we've seen this happen in the US or in the UK, for example. Is that something that we're seeing in your market? And is that something that you seem to be well positioned to take advantage of? So we can see those two types of engagement, both protect and enhance engagement, and obviously these should be of interest to fund managers and stock analysts, because these have the potential to impact the fundamental value of the companies that we're looking at. So obviously, this is something you do collaboratively with the people that cover the stocks in our portfolios.

Host: Okay, and David, just finally, from you. I mean, what do you think is unique about the approach that you've helped build at ASI?

David: I think what's unique is the degree of integration ESG has into the investment process, both in terms of the process itself, and the individuals who are embedded within the equities team around the world. So as we've mentioned, there are three of us in Singapore who work with the 50 or so fund managers across the region. I think what's unique is the degree of integration we have into discussions and understandings of companies around the region. So it's not easy to discuss ESG from a knowledgeable perspective and an experienced perspective, understanding a company's unique position in an industry, position in a value chain, what are the key drivers of value, and competitive pressures that that company may be facing? It may be easy to send the odd letter to a company to say, we think you should do X or Y better, otherwise we're going to sell you, as in, it's a lot more difficult to fully understand the way that the company makes money, what the risks are around that company, what the competitive pressures are that that company is feeling, how industries are going to evolve, and how positioned that company is for these changes to the industry. So it's a lot more hard work than having a separate ESG function. But we think ultimately, it gives us a richer insight. I think the other unique facet of what we do is just the length of time we've been doing it. So this isn’t something that we've been doing just over the last couple of years. We've been doing this for the last couple of decades, and we've been able to build on the experience we've gleaned looking at ESG for the last two, three decades to iterate forward to where we are now in terms of our industry understanding. So a few things have been unique. But I think I would certainly point to the degree of integration we've got both in terms of the people and the way that it's looked at in terms of investment process.

Host: Great. Okay. Thank you, David for those insights today. And thank you to our listeners for tuning in. And please do look out for future episodes.

This podcast is provided for general information only and assumes a certain level of knowledge of financial markets. It is provided for information purposes only and should not be considered as an offer, investment recommendation, or solicitation to deal in any of the investments or products mentioned herein and does not constitute investment research. The views in this podcast are those of the contributors at the time of publication and do not necessarily reflect those of abrdn. The value of investments and the income from them can go down as well as up, and investors may get back less than the amount invested. Past performance is not a guide to future returns. Return projections are estimates and provide no guarantee of future results.