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Audience

ESG in practice - the first year in Review

01/11/2018

The M&G Global Listed Infrastructure Fund is not explicitly labelled as an ESG fund, but ESG is central to our investment process. As investors in long-life, immovable infrastructure assets, we endeavour to ensure asset and business sustainability by incorporating ESG factors in our fundamental analysis. In the following note, we re-cap on our ESG approach and reflect on our first year of ESG investing.

The value of investments will fluctuate, which will cause fund prices to fall as well as rise and investors may not get back the original amount invested.

ESG as an input

By their nature, infrastructure assets can be inherently impactful on the environment and on the communities in and around where they operate. As such, we integrate ESG in our investment process to limit risks and improve economic outcomes for our investments.

We integrate ESG into our investment approach using a four-step process:

1) Pre-screening
2) Quality scorecard
3) Quantification of ESG risks
4) Monitoring of ESG issues

 

We begin by applying limits to coal-fired power and nuclear energy and by screening our universe for any worst-in-class ratings or flags from certain third-party ESG providers. These ratings and flags are inputs into the process but, crucially, we do not rely on them. We do all of our research independently in the subsequent stages of the process, conducting deep due diligence on each of our holdings and investment candidates. This process comprises independent research, modelling ESG-related risks, and monitoring ESG issues within a structured framework.

Societal benefits as an outcome

While we are clear on the fact that we integrate ESG considerations in our investment process for economic reasons, an outcome of our approach is that many of our investments deliver positive benefits for society and the environment. In the figure below, we see some of the benefits delivered by our renewable energy, water, social and digital infrastructure holdings, based on a hypothetical £1 million investment in the fund. The value of investments and the income from them will rise and fall. This will cause the fund price, as well as any income paid by the fund, to fall as well as rise, and you may not get back the amount you originally invested.

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These are just four of a range of positive outcomes – others include the support of the roll-out of electric vehicles, school facilities, or energy-efficient public transit. These selected outcomes are significant for more than just ‘feeling good’ – they also link closely with some of the long-term thematic tailwinds that are driving listed infrastructure’s performance, such as society’s shift to renewable energy sources, the increasing need for clean water, and the digitalisation of emerging markets.

Ørsted – a new holding with exemplary ESG characteristics

A holding that is harnessing one such tailwind is Ørsted, the energy company and global leader in offshore wind power, which was added to the portfolio in December. The company is domiciled in Denmark but has its largest asset footprint in the UK, where it currently operates 11 wind farms and is in the process of constructing two more. Its operational wind farms produce enough green electricity to power over 2 million UK homes annually; this will rise to over 4.4 million homes when the company’s current construction projects become operational.

Ørsted is at the forefront of society’s transformation towards renewables, having once been a fossil fuel-focused business. It has now built more offshore wind farms than any other company worldwide. This position as global leader in its field comes with the tangible benefits of scale and expertise, allowing it to effectively capitalise on the expansion of offshore wind – the planet’s fastest-growing form of renewable power generation.

Not only are the company’s offshore wind assets underpinned by long-term contracts, but we believe they also have significant underlying growth potential – both for the project pipeline and for financial returns. The business has maintained a conservative balance sheet by historically ‘risk sharing’ on large projects and partially divesting fully-valued project stakes. We do not believe the growth potential or the balance sheet to be fully reflected in the stock’s valuation, making it a compelling long-term renewable energy investment opportunity.

The firm is still in the process of divesting its fossil-fuelrelated assets, with 36% of the company’s power generation still coming from non-green sources in 2017). The company aims to reduce this number to under 5% by 2023. In this way, Ørsted is an example of how we can consider a company’s direction of travel, as well as its current credentials, when assessing ESG factors in investment decisions.

Hydro One – our first test

The first holding to meaningfully challenge our ESG process was Hydro One, a Canadian electricity transmission business. In July, the company became the victim of a politically motivated governance breach when its majority shareholder (the Government of Ontario) exercised its right to remove the entire board and dismiss the CEO at the behest of a newly elected, populist premier of Ontario. We had substantially reduced the size of our holding in advance of this development as a result of our assessment of increasing governance risk (see Figure below). As such, our ESG process helped us to limit negative economic outcomes, but it was unfortunate to be forced into this position regardless.

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Please note, past performance is not a guide to future performance.

Despite this governance breach and its adverse economic consequence, the company’s robust ESG scores have yet to be adjusted by third-party rating agencies. This inaction on their part reinforces our conviction to not outsource ESG decisions or analysis to third parties, and to conduct our own due diligence and monitoring on all holdings.

Gibson Energy – engagement yielding results

Over the past year, we and other fund managers at M&G have spent considerable time engaging with the senior management and board of Gibson Energy. This energy infrastructure business now counts itself among the largest investments in the fund, and as one of our top performers since fund inception. On the back of our desire to see a more simplified, focused corporate structure, the company has committed to an asset-divestiture programme, cost reduction initiatives, and enhanced capital discipline. Our engagement with the company has included several senior management meetings, interaction with the Chairman and other board members, and visits to operating assets. We’ve been pleased to see our efforts rewarded, with the company’s recent strategic initiatives driving strong shareholder returns (see Figure below).

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Please note, past performance is not a guide to future performance.

Looking ahead

Our first year experience has underscored the importance of performing in-house, independent, ESG-related due diligence. While our process remains unchanged, we continue to learn from our numerous engagements. We also continue to learn about our clients’ reporting requirements on ESG, and are committed to keeping you upto-date on our company engagements and any ESG-related developments in the strategy. We look forward to sharing these updates with you as we move into our second year.

Please note that the fund invests mainly in company shares and is therefore likely to experience larger price fluctuations than funds that invest in bonds and/or cash.

The value of investments will fluctuate which will cause fund prices to fall as well as rise, and investors may not get back the original amount invested.

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The value of investments will fluctuate, which will cause fund prices to fall as well as rise and investors may not get back the original amount invested. 
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