Katherine Davidson (KD): What convinces you that sustainability is a durable trend?
Peter Harrison (PH): “It’s something that’s required of business leaders today. If you’re not with the sustainability programme, you don’t have a licence to operate. It was my kids that convinced me first by badgering me on my car’s emissions.”
KD: How easy has it been to convince senior management and the board of its importance?
PH: “One of the many advantages of running a family-owned firm is that they genuinely want the business to be around for the next 200 years for the benefit of future generations. So they are fully aligned with our focus on long-term sustainability.”
PH: How much of a trade-off is there between sustainable investing and returns?
KD: “There’s just been a big study released by Harvard Business School – MIT Sloan [School of Management] that shows that there is no evidence of a trade-off between performance and sustainability. At worst most studies have found that it's neutral, but in general it seems to have a positive impact, especially on corporates’ operational performance.”
PH: Would you avoid something like tobacco stocks even if they seemed a good investment prospect?
KD: “I feel quite strongly that simply excluding companies on the basis of the sector in which they operate doesn’t make sense for an active manager. An exclusionary approach is a blunt ‘old school’ way of investing sustainably.
“But the commercial reality is that there are lots of clients, especially those in the charity sector, that want to know you're never going to hold any tobacco or fossil fuel stocks.
“That said, tobacco and fossil fuel stocks generally have declining cash flows and a high cost of capital. So I can’t see that I’d be very excited about any of them as a fundamental investor, even if I were allowed to invest in them.”
PH: What are some of the advantages to having built our own impact measurement tools?
KD: “Sustainability is seldom a black and white issue – it’s shades of grey. For example, a ratings agency could score a company that makes electric vehicles well because of its positive environmental impact, but this score could mask the company’s use of forced labour (negative social impact). Ratings agencies tend to boil everything, including subjective measures, down to a single score.
“With our own tools, we are involved in the design and theory behind them. We've just undergone a big review of our impact measurement tool SustainEx. It involved about a hundred investors and saw us review all the academic studies that underpin the tool, stress test our assumptions, and audit the outputs. It’s incredibly powerful that we get investor buy-in into how the tool works.”
KD: Should these tools be made open source?
PH: “There’s a case to be made for doing so. For example, Harvard has done so with some of its impact-adjusted profit data, and making some of our impact data more accessible could be beneficial. The more data that’s available, the easier it is to hold companies to account over sustainability issues.”
KD: “More data isn’t necessarily the panacea though. While the environmental side of things is easy to measure, assessing social impact requires more of a qualitative approach. I rely heavily on the relationships I’ve built with companies and their stakeholders to really get conviction about their social impact rather than just on data.”
KD: What about measuring the impact of assets like natural capital?
PH: “This isn’t being properly measured, but Natural Capital Research, a data-led science-based organisation which specialises in measuring natural capital assets globally, and in which we own a stake, is making progress here.
“Over the next five or 10 years we're all going to spend a huge amount of time getting up to speed with natural capital. In time we'll all go to the supermarket and have a choice between the carbon-free and the carbon version of a product.
“The bottom line is that carbon will be taxed and that’s going to change the competitive advantages of various products. I think this represents a huge investment opportunity.”
KD: What are some of Schroders’ carbon targets?
PH: “It’s our goal to set science-based targets for our business aligned to a pathway that limits global warming to 1.5°C above pre-industrial levels. We’ll be saying more on this very soon and have submitted our data and targets to the Science-Based Targets initiative for validation. It’s a high hurdle. But that which is measured is managed, so ideally we need to see carbon emissions form part of our management accounts.”
KD: How important is the publication of diversity and inclusion measures like ethnicity or gender pay gaps?
PH: “We’ve worked really hard to get an ethnicity declaration so we can publish ethnicity pay data, because again, that which gets measured, gets managed. While it’s a blunt tool, it’s incredibly important that firms focus on the issue and we see improvements.”
KD: “It’s very useful to us as investors and asset owners. When I’m looking at a company’s reported data, I’m not necessarily looking for whether they’re above or below the average pay gap. I’m looking more at the company’s direction of travel and being able to open up these tough conversations is very powerful.”
KD: How does the industry deal with “sustainability scepticism”?
PH: “I think this is going to improve as reporting does. For example, Mrs Harrison and I sat down recently to look at our investments and I was asking all the financially-based questions on stocks and portfolio composition. It was when we got to the sustainability reporting, where we were told how many cars had been taken off the road and how many trees had been planted, that she became much more interested because it suddenly became relevant to her.
“The industry has been really bad at speaking about sustainability in terms that people understand. But this will change as we orient ourselves more towards mass personalisation.”
KD: “There’s a perception that sustainability is a new phenomenon, but as investors we are always looking for companies that can achieve supernormal growth and returns over the long term. At its core, sustainability is about just that: the ability to maintain performance over time. And the companies that aren't aligned with things like net zero, or that are contributing to climate change, just won't have those sustainable cash flows. Probably in the next 10 years or so we'll see a complete breakdown of the divide between sustainable investing and investing, because it will all be sustainable investing.”
Do you have to be more flexible in assessing ESG risk in emerging markets compared to developed markets?
KD: “There are times when local context is relevant, but mostly we hold our investee companies to the same standards because there is an financial and moral imperative. For example, having women on boards has been shown to have positive relationships with performance as well as obviously being the right thing to do. Just because I'm looking at, say, a Japanese company and culturally they've been much slower to introduce women on boards, doesn't mean I'm going to give them a pass for that. I'd rather just not own those companies even if that means a big geographic disparity in my portfolio.
“If you can get past the disclosure barrier, the actual corporate behaviour in emerging markets is often extremely good. Many are used to operating in an environment where stakeholder management is really critical to their businesses, not least because there’s not necessarily great infrastructure or rule of law. Companies become part of the solution and are so deeply embedded in their local communities – providing employment, building out infrastructure. I can think of many emerging market holdings that have far better ESG standards than some of the blue chip companies in the FTSE.”
- This is a write-up of Fireside Chat: Sustainable Investing: from the boardroom to the factory floor, a session from a Schroders event.