IN FOCUS6-8 min read

Four snapshots that show how engagement can add value in credit investing

These four case studies highlight the value of active engagement with companies.

2023/08/15
pharma

Authors

Saida Eggerstedt
Head of Sustainable Credit

The world is changing and we’re facing major shifts in areas such as decarbonisation, deglobalisation and demographics. The challenges associated with these changes have highlighted the importance of ESG analysis when making investment decisions. However, analysis alone is not enough. To collect the necessary information, investors must engage with companies to understand their business models and identify areas for improvement.

In the best-case scenario, this engagement can lead to improved company practices, which can increase investor conviction and potentially lead to investment. It can also work as a useful due diligence tool when keeping tabs on companies already in an investor’s portfolio. For instance, if an investee company shows no improvement despite several engagements, investors may decide to divest and, in the worst-case scenario, blacklist the company.

Engagement is an especially helpful tool when looking to identify companies that can deliver alpha (i.e. returns above the benchmark). These are generally undervalued companies with potential for growth. In order to capture these companies, investors must be able to distinguish them from those that won't be able to innovate and improve their business models to withstand future challenges

Case study 1: Engagement as an aid for better investment outcomes

We recently added a company that demonstrated notable improvement after a series of engagements. The German pharmaceutical company Cheplapharm Arzneimittel specialises in distributing less expensive, well-established medicines through its international "buy and build" strategy, which involves buying the rights to medications that bigger competitors have divested from for economic or strategic reasons. However, the company lacked a detailed impact strategy mapping out its goals and making a unique impact proposition for its clients and society.

Our engagement with Cheplapharm Arzneimittel focused on guiding the company to formulate a solid impact investing strategy by suggesting key impact questions. This helped the team understand how the company’s services and products were contributing to clients and society. We also requested various impact and sustainability points to explore the eligibility of investment and better environment, social and governance (ESG) reporting to broaden the company's investor base.

Cheplapharm Arzneimittel responded quickly with detailed impact information, including an example of an objective second-party impact assessment, illustrating its intention to be assessed as an impactful issuer.

The company also provided various examples of products and processes to illustrate its lower cost and lower pricing proposition and its ability to provide medicines for rare diseases that bigger pharma companies might have discontinued. Furthermore, the company revamped its ESG reporting, raising its standards by producing a more structured and detailed explanation of its environmental and operational ESG targets.

Case study 2: Keeping tabs on portfolio companies

Successful engagements are also a part of ongoing due diligence within the credit portfolio. This was recently the case with an existing portfolio company, the Chinese multinational technology giant Lenovo.

While Lenovo had already demonstrated leading ESG credentials in both an Asian and global context, we wanted to find out more about the company's approach to responsible consumption and its material sourcing initiatives, as well as how its products can help a diverse set of users.

The Hong Kong-headquartered company accommodated our requests by organising an engagement call with sustainability and treasury personnel from different global locations. This was to answer our questions about circular and responsible consumption, among others, and to listen to our suggestions. Lenovo also followed up with a number of materials and information explaining, for instance, its efforts to decarbonise across the value chain as well as about its products being more user-friendly to a wider audience.

Furthermore, Lenovo shows that, in today's global business landscape, successful engagement is not limited by geographical or cultural boundaries. Most of the time, our team's experiences have been positive. Of course, it makes things easier to send out concrete points in advance, as well as to clearly state the motivation for the engagement. Over time, a relationship of mutual learning and longer-term dialogue will usually yield the best results.

Case study 3: Missing information

However, even a company with a relatively high ESG rating might not always be interested in engaging. Engaging with a company on deeper impact topics requires tactfulness to establish a trusting relationship with investee companies. Excluding a company due to violations of human rights or extensive damage to the environment remains the last resort in an investor's playbook.

An automotive technology company provides a good example of where lack of engagement from the company’s side led to divestment. We engaged with the company in the hope of gaining missing pieces of information needed to conclude our due diligence. In its sustainability report the company stated that it aims to encourage consumers to use electric vehicles. To do this it said it provided advanced electric systems that allow for quick charging and are designed to be smaller and lighter, to enable easier manufacturing.

However, the company did not offer detailed information on various topics, such as whether electric vehicle (EV) or internal combustion engine (ICE) manufacturers were the end users of its products. Also, no information was available on the company’s plans to move on to servicing mainly EV manufacturers in the future.

Despite several enquiries, the automotive technology supplier would not release information on what percentage of its sales was to electric vehicles, which was a requirement for the company to be approved for an impact fund. When this happens we might engage with the company again to encourage it to disclose the missing information.

In this case, the company scored well in terms of ESG metrics. For instance, it employs a high percentage of women relative to other firms in the sector, which is an operational impact metric we look at for greater equality. This means that we will try to find an optimal way of engaging again, to motivate the company to disclose the missing information so we could re-consider our investment proposition.

Case study 4: Improvement still needed

Another example where engagement assisted in making a divestment decision was in the case of a US-based waste management company that recycles used oil and waste. After an extensive research and engagement to better understand the company's business practices, we decided to divest under “do no significant harm” considerations. After probing the company further, we determined that its current business model did not meet all the criteria we required to feel confident enough to invest. We continue to engage with the company, and hope to see improvements over time that will enable us to re-evaluate our current stance.

Any reference to sectors/countries/stocks/securities are for illustrative purposes only and not a recommendation to buy or sell any financial instrument/securities or adopt any investment strategy.

Authors

Saida Eggerstedt
Head of Sustainable Credit

Topics

Credit
Bonds
Fixed Income
ESG
Sustainability
Active Ownership

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