Understanding and integrating the impacts of ESG factors is a natural extension of our long-term modelling.
Mondrian believes that the inclusion of ESG factors is essential in understanding risk-adjusted returns for both dedicated ESG and standard strategies. Mondrian’s long-term, fundamental research process has always demanded that analysts strive to consider all material risks that could influence a security or market’s valuation, including those factors rooted in environmental, social and governance concerns.
The willingness of value investors to take a position in a broad range of companies and industries – including those that typically score very poorly with regards to certain ESG characteristics – has been taken by some to mean that a value investment philosophy is incompatible with the incorporation of ESG factors. This needn’t be the case as demonstrated by Mondrian’s integrated approach to incorporation in our equity and fixed income strategies. In particular, Mondrian recognizes that climate change must be considered as a risk to the long-term future of economies and individual business, and addresses these concerns through its bottom-up analysis.
Mondrian uses long-term investment models to evaluate the operating environment of each investment over an extended time horizon. To the extent that issues such as climate change, carbon emissions, water usage and energy usage have been identified as potential risk factors to consider in evaluating the investment case of a particular company, our analysts will conduct further investigation into the extent of these risks as well as risk mitigation. The findings from this questioning and disclosure will be incorporated into our overall investment evaluation of the company and highlighted in the ESG Summary Report.
Stewardship considerations are part of the initial purchase decision, subsequent monitoring of an investment and any ongoing dialogue with an investee company, including active participation through our proxy voting process. A key element of our process is actively meeting with and engaging with management and the board of current and prospective investments to discuss the:
Governance discussions will include governance policies, corporate structure, management and board experience and composition, remuneration policies, board oversight policies and procedures, climate change impacts, human capital concerns, and policies on shareholder returns.
Mondrian invests in bond markets that best compensate for inflation and sovereign credit risks, measured by a market’s Prospective Real Yield (PRY). We define PRY as the 10-year government bond yield less Mondrian’s inflation forecast and sovereign credit adjustment. Our approach to integration of ESG considerations in the fixed income investment process is consistent for both sovereigns and corporate credits in the explicit incorporation of ESG factors into an issuer’s proprietary credit rating.
Protection and maintenance of the environment for the wellbeing of future generations is essential for the long run viability of the economic activity that supports the sovereign. In the shorter term, undiversified economies based on commodities, agriculture or tourism are prone to environment-related shocks, such as flooding and storm damage that can place additional burdens on the sovereign balance sheet. In order to assess environmental strengths we compare countries using the Environmental Protection Index compiled by the Yale Center for Environmental Law & Policy. This ranks countries on twenty-four different environmental performance indicators along two dimensions of sustainability – environment health and ecosystem vitality.
Corporate credit analysis explicitly incorporates a proprietary environmental, social and governance rating. This contributes to our corporate credit rating for each issuer, which in turn directly impacts how much of that issuer’s debt can be held across our portfolios according to our issuer diversification limits. All corporate bonds in which we might invest are given an ESG rating. We consider the environmental policies, the social impact of the company’s activities, the governance of the company, and the strength of the active ESG policies the company is pursuing, and adjust our internal rating accordingly. Engagement with issuers forms an integral part of our assessment, raising factors identified in our ESG analysis directly with the company.
The impact on credit quality from environmental risk factors varies greatly by industry. Environmental factors can present both fundamental business risks, for example that posed by the shift to renewable energy on the oil & gas industry, as well as reputational risks. In order to assess environmental risks to credit quality, we reference MSCI ESG research in addition to information collated through credit analysis from sources such as annual reports, rating agencies, discussions with management and industry research reports. Our environmental assessment contributes to our corporate credit rating for each issuer, which directly impacts portfolio allocation.
Engagement is integral to the investment process on both the corporate and sovereign side, as we meet with debt issuers as a matter of course to further our understanding and highlight issues of importance. We raise the ESG issues we deem material to a company at the time of each credit review and follow up on at least an annual basis as part of a structured program of ESG engagement.
Mondrian’s firm-wide approach to integrating ESG factors is first and foremost a risk-based approach, but we also provide solutions for clients that would like to pursue principles-based capital allocation through our dedicated ESG products. Mondrian’s long-term, scenario-based approach to value investing is particularly well-suited to the integration of ESG factors, which are essential in understanding risk-adjusted returns. Our International Equity and Global Equity ESG products build on this value approach by combining risk-adjusted returns with principles-based capital allocation decisions:
Green bonds' proceeds are directed exclusively to financing projects that have a positive environmental impact. However there is still no one widely accepted definition of what constitutes green.
CEO and Group CIO, Clive Gillmore, shares what he sees as the difficult moral choices embodied in ESG investing and how Mondrian embraces ESG issues into our methodology.
Mondrian’s David Cudmore discusses with ESG Clarity the increasing importance transition bonds have in the growth of the green bond market.
© 2021 Mondrian Investment Partners Limited is authorised and regulated by the Financial Conduct Authority – Firm Reference Number 149507.
All information is as of March 31, 2021 unless otherwise noted.
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