The United Nations Principles for Responsible Investing are actions for incorporating ESG in portfolio management. This is how they are put into action in Evli.
Sustainable development is high on agenda across countries, within businesses and inside consumer minds. USD 86 trillion worth of assets are signatories of United Nations Principles of Responsible Investing (AUM data as of 2019 end). Evli Fund Management has become UN PRI signatory in 2010. UN PRI has six Principles for Responsible Investment. The first three principles state that we as a signatory and a responsible asset manager 1) will incorporate ESG issues into investment analysis and decision-making process, 2) will be active owners and incorporate ESG issues into ownership policies and practices and 3) will seek appropriate disclosure of ESG issues. Let me illustrate how Principles for Responsible Investment were implemented at Evli Fund Management researching and selecting portfolio candidates in 2020.
ESG and financial analysis combined
The first principle states that a responsible investor integrates ESG issues into investment decisions. In 2020 I have researched iron ore producer. The company has been generating positive free cash flow over several years and is debt free. Thinking of ESG issues probable liabilities related to environmental issues were considered during research process. The question was asked if the company is due to pay this probable obligation how its financial position will look like. Similarly, total guarantees issued towards Department of Mineral Resources as possible cash outflows for environmental closure liabilities were tested. Once these ESG related probable and possible cash outflows were considered the company still had a very solid financial profile.
Ownership policies can give a strong signal
The second principles states that we incorporate ESG issues in ownership policies and practices. Early in Spring 2020, I was researching a nickel mining company that looked “OK” financially. Since the company was on UN Global Compact fail list due to violation of environmental principles, Evli Responsible Investment team was asked to analyse the company. After Responsible Investment team considered historical monitoring and engagement efforts on ESG issues as well as current situation, decision was made not to invest in the company. Later in spring this company faced an accident, significant amount of diesel was spilled into the river from the company’s fuel tank. As a result, the company created substantial, mainly short-term provisions on the Balance Sheet as of 30.06.2020. If these non-cash expenses that were put aside to deal with probable consequences of this accident are to become due, ca 65% of company FCF generated in 2019 will be used to repay them. This company case illustrates that ownership policy based on ESG issues gives a strong signal to companies to improve ESG practices. It might also serve as a risk mitigation tool for investors.
Appropriate disclosure means informed investment decisions
The third principles states that responsible investors shall seek appropriate disclosure on ESG issues. Indeed, today one of the issues for investors and asset managers is the big discrepancy within ESG rating scores. There is still limited amount of raw ESG data reported by companies themselves. Asset manager should undertake intentional activities to effect companies’ policies regarding ESG data reporting and verification. As an example, EU Taxonomy regulation, affecting financial service providers like Evli Fund Management comes into force in 2021. Asset managers will need to disclose how much of the fund portfolio companies’ revenues and or capex are invested in environmentally sustainable activities. The challenge comes from the fact that companies themselves would be required to disclose their environmentally sustainable activities only in 2022 (for year ending 2021). Asset managers need to engage with companies to start disclosing information earlier than regulation stipulates. This is to result in more timely and more informed investment decisions across capital markets.