Hermes Investment Management: Responsible Investment | In Practise

Hermes Investment Management: Responsible Investment

Current Head of Investment at Hermes Investment Management

Why is this interview interesting?

  • The key drivers of the growth in ESG capital inflows
  • The difference in passive and active investment approaches to ESG
  • How Hermes engages with companies on ESG issues
  • The importance of incentive structures in the asset management industry

Executive Bio

Eoin Murray

Current Head of Investment at Hermes Investment Management

Eoin is Head of Investment and a member of Hermes’ Executive Committee. Eoin also leads the Investment Office, which is responsible to clients for the investment teams’ consistent delivery of responsible, risk-adjusted performance and adherence to the ESG processes at Hermes. Eoin joined Hermes in January 2015 with over 20 years’ investment experience. Eoin joined from GSA Capital Partners, where he was a fund manager. Before this, he was Chief Investment Officer at Old Mutual from 2004 to 2008 and also held senior positions at Callanish Capital Partners LLP and Northern Trust Global Investments. He began his career as a graduate trainee at Manufacturers Hanover Trust (now JPMorgan Chase) and subsequently performed senior portfolio manager roles at Wells Fargo Nikko Investment Advisors (now BlackRock), PanAgora Asset Management and First Quadrant.Read more

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Interview Transcript

In your opinion, what are the core pillars of responsible stewardship of capital?

There are two key pillars for any investment activity and those are the way in which we, first of all, traditionally think about investment, which is the allocation of capital. These days, when we talk about that activity, we automatically assume that we are taking account of environmental, social and governance factors. The second pillar of responsible capital investment is around stewardship of that capital. What that means is, when we buy into a company, either through its equity or through a debt or a loan or, indeed, buy into a real asset like a building, when we eventually come to sell that asset, many years later, we would like to be assured that we will be leaving it in a better place than when we first bought the asset.

That means, we are going to be very active in voting, where we have the ability to vote. We’re going to attempt to improve the asset, in conjunction with the management of the company, through a process of engagement and nudging them, to take account of, what are the real material issues that affect all stakeholders in that company.

What’s Hermes’ core value proposition to clients today?

We want to help our clients retire better. We use that language very carefully, because better doesn’t just mean wealthier, in financial terms. It means that the environment, in which they are living and spending their pension or their savings, is better too. If, for example, we’re invested in a company that provides bus services, and we’re not engaging with the company and they are cutting back their rural service, it could well be that we produce a great financial return, for a pensioner living out in the country, but they’ve no longer got a bus service that allows them to get to shops. It’s a silly example, but it’s a classic of, unless you are taking account of the full holistic picture, you’re missing a trick for the benefit of the end client.

The index companies recently reported that around 25% of total ETF inflows were driven by ESG. What do you think is the real underlying driver of this?

There’s a massive inflow of capital from active management to passive management. A significant amount, roughly around 25%, is going into a particular variant of that, which incorporates environmental, social and governance information. I think there’s a number of things going on here. The move from passive to active itself, I believe, is largely fee driven. This is the notion that, over the years, to be brutally honest, active managers, in aggregate, have disappointed with the outcomes that they have produced for savers and beneficiaries. Particularly, the movement towards incorporating ESG factors is driven by savers’ and clients’ desire to ensure that their capital is trying to achieve a broader, holistic return, beyond a simple financial outcome.

Is this growth mainly driven by the actual owner of the asset?

Yes; this is really being driven, I think, by the end beneficiaries, which are pensioners and savers. I think there’s also a little bit of government incentive to move in this direction. We see various regulations where asset owners are not quite mandated, but getting very close to that. But they are certainly required to take account of ESG factors, as they make their investment decisions.

What is your view on the ESG ETFs that we’ve seen today? I think there has been a lot of negative press claiming that eight of the top 10 ESG funds still hold fossil fuel companies, which seems a bit counter-intuitive to the concept.

I think the future of asset management is going to see three different strands of asset management. Clearly, passive is going to be a growing and increasing component and that’s going to carry on for decades to come. Secondly you move into, what I would call, a systematic or alternative beta management, which is recognizing that, whereas passive only observes a strict market factor, systematic beta says that there are other factors out there, which I can replicate, in a systematic way, for low cost. Then there will be a much smaller rump of active management that we have today.

Those three strands lend themselves, very well, to three different types of ESG integration. Passive, for example, fits very well with simple screening strategies. That is where, either in a negative basis, a manager screens out whole sectors or industries or, perhaps, even specific companies, that are believed to be non-ESG. For systematic beta, there is more of a quantitative approach. Here, there will be a trade-off between the potential reward of the factors, alongside these ESG elements, which will drive the construction of the portfolio. Lastly, for active management, you’re moving into this world of stewardship, of active engagement with the companies. Those two activities go very well together, as well.

Coming back to this idea that many of the largest ESG ETFs will contain fossil fuel companies, I think that’s okay, if there is an active stewardship program behind those ETFs that is seeking to transform and nudge those fossil fuel companies towards renewable energy as being the future. That movement has to be fast; it has to be at least in line with Paris and it has to be absolutely transparent to end investors and I think there is a lot of difficulty around that.

So I’ll go back to my original comments there. Passive probably lends itself better to a screening approach, where either there is a positive, best in class, approach or there is a negative screening approach, where they simply cut out vast swathes of the market altogether.

So, it’s the business model? Take Vanguard, for example, or any of these large passive managers. They compete aggressively on price and, therefore, it would seem that they don’t have the resources to put behind the engagement with companies on these stewardship factors?

I think that’s true, to some extent. Up until recently, my firm Hermes, had probably the largest engagement team available, but I think we have probably been overtaken by BlackRock, one of the biggest passive managers in the world. Of course, there is a cost to engagement and stewardship activity and if one is simply selling management on the basis of low fees, if you’re going to put passive and stewardship together, you need to add back the cost of the stewardship activity. I guess, that makes it slightly more difficult to sell passive, purely on a cost basis.

How do you think that business model will evolve?

I think there will be different flavors. On the one hand, there will be very low-cost screening strategies and they will be in the five to 10 basis point range. Then you move up to, perhaps, a more quantitative approach, where you’re trading off financial factors for ESG factors. Then lastly, there will be active management aligned stewardship activity and that stewardship activity, I suspect, costs roughly around 15 to 20 basis points, on its own.

If you’re going to maintain a stewardship team on the passive side, doesn’t this have to be baked into the price of the product?

Yes, and it’s expensive, that’s exactly right. One of the problems that passive investing has, when it comes to engaging with companies and being an active steward, is that the end corporate knows that, as a passive investor, you are not going to sell that holding. You have to hold it, because it’s part of the index. You can threaten, all you like, to exclude or divest from that company, but they know it’s not going to happen. In the minds of corporates, it could well be that that passive voice is somehow less credible. I think it’s also the case, and the empirical evidence suggests this, that historically, passive investors have not been particularly good at voting against companies, when it comes to resolutions at AGMs. It tends to be the active managers that lead the protests and they are more inclined to use their vote to simply alert companies that they are, perhaps, not happy with a particular issue.

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Hermes Investment Management: Responsible Investment

November 29, 2019

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