“We try to stay away from the word ethics, because ethics means very different things to different people. Nor is there an exclusionary list of companies that we cannot invest in” Senior Portfolio Manager, Grant told Portfolio Adviser the day after the group launched its Global Equity ESG fund.
Rather, he says, while the E and S are important, it is the governance that generates the performance.
Lode, head of global equities at Hermes, explains that, according to Hermes’ research, well-governed companies have outperformed poorly-governed counterparts by an average of over 30 basis points per month since the beginning of 2009.
But he says: “It is not about finding the best companies, but rather avoiding the worst performers; the ones that have no intention to change or improve.”
Lode adds, the manner in which Hermes defines ESG is slightly different to other funds. Where others tend to go with the ‘best in class’ approach, only looking at those companies that are considered as the best performers from an ESG point of view, Hermes looks not only at the level of ESG, but also at the rate of change.
In a recent Thought Piece, Hermes explain the process further: “We observed the behaviour of companies in relation to a large number of ESG metrics identified by Hermes Equity Ownership Services as the most important key performance indicators in each sector. We measured each company’s current behaviour and – importantly – we measured how each company’s behaviour changed. We believe it is crucial to identify not only companies who have favourable ESG characteristics but also to spot those companies who are improving their behaviour.”
“Companies with the lowest-ranked governance scores have tended to underperform the average, as opposed to the higher-scoring companies outperforming. This suggests that it is not good governance that leads to outperformance, but poor governance that leads to underperformance,” it says.
According to the research, companies with a poor standard of corporate governance underperformed in 62% of the months during the time period examined.
Asked whether or not such a stock picking feature has a limited life span, as companies improve corporate governance and investors increasingly demand both better engagement and more transparency, Grant agrees that that might well be the case. “You already see a much smaller good governance impact in developed markets like North America, than in emerging economies. But, you are always going to have some companies that are better and some that are worse.”
