ENVIRONMENTAL, SOCIAL & GOVERNANCE POLICY
Background to the investment strategy
Asset Value Investors (AVI) follows a unique strategy of investing in quality assets held through unconventional structures that tend to attract discounts; these types of companies include holding companies, closed-end funds, and cash-rich Japanese operating companies. Through over three decades of managing the AVI Global Trust (AGT), AVI has generated consistent, market-beating growth in its net asset value. The strategy is benchmark-agnostic and global in scope.
AVI undertakes detailed research on its existing and candidate holdings, and environmental, social and governance (ESG) factors form part of this research process. Our process does not involve the use of a filter to screen out negative-scoring ESG stocks, or a filter to only include positive-scoring ESG stocks. We assess each potential investment on a case-by-case basis to identify potential strengths and weaknesses in a firm’s conduct and operations. We believe that firms which score highly on ESG metrics have a beneficial impact on society and, as such, we work hard with the companies we invest in where we see deficiencies that can be reduced.
AVI regularly engages with managers, directors and other stakeholders through various means, including meetings, letters, and attending AGMs. We strive always to maintain a cordial relationship, and to be a constructive partner. Our aim is to provide expertise and guidance on how to improve a company’s operations or policies, particularly in relation to governance factors, where we believe we can add significant value for a company.
ESG analysis – the theory
The aim of ESG analysis is to incorporate alternative perspectives into financial analysis, with the goal being to enhance and expand the insights provided by the traditional financial toolkit. There is increasing evidence that a greater focus on ESG analysis can improve a portfolio’s risk-return profile through various mechanisms.
The evidence for enhancing returns is somewhat mixed, with papers produced by Hermes Investment Management in 20181 highlighting that firms which scored in the top decile for ‘G’ (governance) outperformed bottom-decile peers by 24bps per month. Evidence of a similar, smaller effect for ‘S’ (social) has also been found; however, evidence for ‘E’ (environmental) remains weak. Interestingly, a 20142 study by Hermes found the majority of outperformance was generated by the bottom-decile stocks underperforming the average.
This leads to a 2019 paper by MSCI3 which conducted a meta-survey of 2,000 papers written on ESG and found convincing evidence that companies with high ESG ratings tended to experience lower financial drawdowns and avoid major ESG-related risks such as litigation, scandal and government action. This might explain why low-rated ESG stocks tend to underperform their higher-rated peers.
The theoretical explanation that we believe fits the data is that low-rated stocks have higher tail risk as poor practices increase a firm’s exposure to adverse outcomes.
Therefore, the inclusion of ESG perspectives is, in our opinion, a productive undertaking insofar as it can incorporate new information that traditional financial analysis, with its greater emphasis on quantitative elements such as profitability and returns, might miss.
An internal assessment has identified the most relevant ESG aspects to Asset Value Investors as a company that is an owner of companies and the impact these aspects may have on AVI’s ability to create long-term value for its stakeholders.
|Factor||Relevant Aspect||Boundaries or tools for implementation|
|Governance||Good governance has always been at the core of AVI’s investment approach. The two areas of focus are:
||AVI’s strategy includes an active approach to governance and accountability which includes the following:
|Social||We try to understand the social system that an investee company operates within. The areas of focus are:
||As a minority shareholder, AVI will advise and guide its portfolio companies. Areas of focus include:
|Environmental||As a responsible owner, AVI fully supports policies and actions implemented by its portfolio companies to support a sustainable environment.||Our influence is limited as AVI is not involved in the day to day activities of its portfolio companies. However, we look to understand a company’s stewardship of the environment to ensure that there are no egregious practices.|
AVI’s engagement in any one of these aspects will vary depending on the type of portfolio company (i.e. holding company, investment trust or operating company) and the level of AVI’s shareholding.
Asset Value Investors has always made good governance one of the core tenets of its investment approach. When it comes to analysing a company through the lens of ESG factors, our greatest strength lies in understanding governance strengths and weaknesses. AVI has been building expertise in governance for over three decades, and it is here that we feel most confident in engaging with companies to suggest remedies for issues that we identify.
We believe that the tenets of good governance are universal, and that all companies irrespective of geography should strive to adhere to them. Governance factors in general describe two things: (a) how managers and directors administer and guide a business; and, (b) the set of rules that describe the company’s governing mechanisms.
In the first set, we are mainly concerned with capital allocation policy, and how directors and managers view the optimal mix of capital returns and capital investments. Specifically, we consider dividends, buybacks, tender offers, capital expenditure requirements, and the potential for further M&A or investment activity.
In the second set, we consider various factors including: board independence, director compensation, management incentives and compensation, tenure policy, shareholder rights, investor disclosure and conflicts of interest. Other factors may also come into play – most importantly poison pills, which are common in certain jurisdictions where we find many of our companies – which we consider on an ad hoc basis.
In contrast to governance factors, we believe that environmental and social factors are unique to each company. Recommendations which would be appropriate to one company may not necessarily make sense for another. Each company will have internal and external stakeholders with whom it will interact. AVI assesses its portfolio companies to ensure that its stakeholder relationships with employees, suppliers and others are transparent and that potential conflicts of interests are identified. Any signs of collusive behavior is also highlighted.
AVI understands that human resources can be a significant factor to the success of a company. We support the ethical and fair treatment of employees and encourage portfolio companies to be attractive employers. We believe employee incentive schemes help to build a high-performing workforce with an incentive to create long term value for the stakeholders. We would in general be aware of and look for any abuse of human rights or contributions to child labour that may exist in investee companies. Through our engagement with management and boards of companies we develop a view on whether the company’s social values and respect for human rights are in line with our own.
AVI respects the potection of the environment. Our assessment of a portfolio company will include the evaluation of any environmental risks specific to the industry in which that company operates and how the company is managing those risks. Our engagement includes an understanding of how companies are run on the ground. We seek to understand the operational practices of the firms in which we invest, which includes an understanding of the risks inherent in those operations. In particular, we look to investigate a company’s stewardship of the environment to ensure that there are no egregious practices. However, our influence is limited in that we are not involved in the day to day running of the business.
Where our analysis encompasses these factors, it analyses if and how they can affect a company’s financial performance. As a result, we tend to focus on material, quantifiable issues which include (but are not limited to) energy efficiency, labour relations, selling practices, environmental practices, and executive conduct.
Responsibilities and roles
Our investment process places an emphasis on detailed research, with the aim of becoming one of the most knowledgeable investors about any given company that we scrutinise. Where possible and appropriate, we strive to include ESG factors into our analysis insofar as this inclusion will enhance our understanding of a company. We believe that this approach is the best way for us to safeguard our clients’ assets, which we view as our prime duty.
Our focus at any point in time will tend to concentrate on governance factors, which we believe is the area where we have the greatest experience, and therefore the area in which we can make the greatest difference.
Where we find issues or weaknesses in any of the factors, we aim to remedy this. Our approach is to engage with the company in a constructive and cordial manner in order to address the inefficiencies that we see. Our engagement can take many forms, including meetings, letters, and research papers that argue our point of view. Our engagement is usually behind closed doors and rarely turns public, as we consider this to be a measure of last resort. We believe that this type of engagement is the most conducive to communicating views, and it forms the bedrock of our approach to advocating for change.
Stewardship of capital – voting rights
As stewards of third-party capital, we take our duty to exercise voting rights seriously. We vote on all matters for which we are eligible and, where necessary and conducive to our goals, we attend AGMs in person. In all cases, we vote in the manner that we think best enables us to achieve our aims and improve the companies in which we are invested.
1 ESG Investing: A Social Uprising. Hermes Investment Management (2018)
2 ESG Investing: Does it just make you feel good, or is it actually good for your portfolio? Hermes Investment Management (2014)
3 Giese & Lee. (2019). Weighing the Evidence: ESG and Equity Returns. MSCI ESG Research LLC.