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This episode, Jeremy Richardson, Senior Portfolio Manager, Global Equities RBC Global Asset Management (UK) Limited, joins Dave for a detailed conversation about the growing consideration of environmental, social and governance (ESG) factors in investing throughout history, particularly from a European market perspective. Jeremy also discusses the role of active stewardship on behalf of asset managers, and the importance of taking on an “ownership mindset” to ensure that companies are held accountable for the environmental and societal impacts of their operations. [19 minutes, 26 seconds] (Recorded November 24, 2021)


Hello and welcome to The Download. I'm your host, Dave Richardson. I am joined today by Jeremy Richardson. And, no, we're not brothers. We may be long lost cousins, but Jeremy works with RBC Global Asset Management at their London offices as senior portfolio manager with the Global [Equities] team there. Jeremy, welcome to the podcast today.

Absolutely. Thank you, Dave.

You're going to see very quickly that genetically, Jeremy got a little bit more than I did, and that's why we've got him on because we're going to talk about something really important and that is ESG, environment, social and governance investing, and responsible investing. Jeremy and the team that manages a lot of global portfolios for RBC Global Asset Management are strong adherent to the ESG process. It's been a real differentiator in their results for a long, long time. Jeremy, one of the things that I wanted to get you on today, along with some of the other guests we're going to have talking about ESG in this series that we're doing on ESG and responsible investing, is the different place that Europe is in relative to North America and really the rest of the world around ESG and the adoption of ESG in the investment process. Can you talk a little bit about where Europe is relative to the rest of the world and when in your career you became aware of ESG, and when you started to embed it into the processes that you use with your team?

Sure. Gladly. I think you're probably right in your assessment, Dave. It does feel as though Europe is at the vanguard of implementing ESG and has been for a while. When we look at the way in which the rest of the world approaches this, I would say that we probably got the United States, which is lagging behind Europe, and then Canada is somewhere between the two. And then when you get outside of those main regions, you start moving into Southeast Asia, Australia, and so on, you have patchy levels of adoption, some very strong, others just beginning in the footsteps, trying to understand and adopt principles of ESG. I think that difference between the European point of view and perhaps more so, the North American point of view, arguably goes back to many decades. You can look at perhaps principles around partnership, around some of the ways in which the industrial capitals of the 19th century put businesses together, looking after workers building their factories and so on, almost like a very ethical approach towards business. We never really lost that, I think, in many parts of the European sphere, whereas in North America there was a new idea which appeared in the 1970’s which is all around about shareholder value. For Milton Friedman, I think, was perhaps often misquoted in terms of his famous 1971 article with The New York Times saying that the social responsibility of business is to maximize its profit. I think over time that basic idea— and to be fair, to be clear to Mr. Friedman, he was not saying that it should be maximized at the expense of other providers, other stakeholders—, but that's how it became interpreted with this idea of shareholder value creation. And so, that has woven its way into the way that there's collective thought, backed up by legislation such that there's now a duty of care to maximize profits as an investor. There is perhaps an inherent contradiction and that's discomfort, therefore, between the principles of ESG and actually doing the right thing for your investors. I think when we are talking to investors, there's still, within North America, a tension there between investing with this long-term approach, trying to look after not only the financial returns, but the extra financial returns, realizing that both can be complementary and you're not achieving one at the expense of another, with this very almost black and white view that actually, if I do ESG, if I implement it, actually, I'm actually compromising the financial returns, which we would disagree with. I think pleasingly it feels as though that whole debate is beginning to move. We're seeing adjustments, and actually there's a greater appreciation and more mature appreciation that shareholder value is great, but not if it comes at the expense of other stakeholders, because then all you're doing is you're shifting wealth, you're shifting capital from one group of stakeholders to another. That is not wealth creating, that's wealth transference, and eventually you run out of other people's capital. So those types of business models ultimately proved to be unsustainable. I think that's increasingly appreciated now. So we're seeing this development is a blossoming of interest in ESG everywhere. But I would say that in terms of the breadth of the adoption, yes, for the moment, at least, Europe still seems to be a little bit ahead of North America, as I say with Canada, sort of somewhere between Europe and the U.S.

So, Jeremy, you perhaps do as good a job as anyone I've heard in terms of articulating how ESG is a value add to your investment process. You were just covering off that it's not that black and white trade off, that sometimes people think of; if I worry about a company's way of managing environmental concerns or treating their employees well or adhering to particularly strong governance within that, there's not a trade off in terms of the bottom line. You actually view it the other way. It can be additive. And if you can go in and identify those companies that are doing this well, they tend to do a better job over the long haul of giving value back to their shareholders. Maybe you could expand on that in terms of your view of ESG and why it's so important in your process.

Absolutely. I think it all really rests upon a very simple foundational concept, which is all about having an ownership mindset. I think this ownership mindset is so important, because if one thinks like an owner, then you'll behave differently. You'll accept the responsibilities of ownership. It means that you'll be interested in stewarding that asset and making it better. By the process of stewardship and making it better, you're actually adding value to it. We do this in our private lives all of the time. So, for example, I don't know, maybe we clean the car on a Sunday morning or when it gets to seasons change and there's leaves in the gutters, we get out there and we clean them up. And we do these things because we are invested in the assets, we're invested in the communities in which we live. We care about the long-term consequences. When it comes to investing, I think many of us have got long-term objectives. So there seems to be a perfect marriage between the long-term needs that we have, our desire to have financial security in the long term with the way in which we invest. Because if you've got a long-term objective, then it's in your interest, I would argue, to care about the stewardship of these assets because you're going to be around probably as an investor when the benefits of this actually accrued to you. So we would heartly disagree with the famous actor who said that the fastest car in the world is a hire car. That's a very short-term way of approaching thinking about what you can get rather than actually what you can build. And so actually thinking like an owner we think is so important. We do this, as I say, probably all the time. ESG is just a way in which we can get better information to make more holistic, more complete assessments of investment opportunities. Once we've made those investment opportunities, we can be part of the active stewardship of those companies. So, for example, let's picture this scenario, Dave, if we were thinking about buying a property together, or maybe we were thinking about making a big investment. If I came to you with this picture of this condo, it's a terrific location. Let's do it. You would be quite within your rights to say, no, wait, we need to do a survey. There is some basic due diligence we want to do. Has it been well built? Are there any obligations in terms of what the ground rents are, servicing charges? All this sort of thing? Has it been left in good repair? You want to check all that stuff out before you actually take ownership? The reason why I think ESG could be so powerful is because you're actually getting a more complete, more holistic set of information, than to be able to implement your investment decisions. With that better information, the chances are you're going to make better results.

You firmly believe, and it comes back to what you've just been sharing that this adds alpha in your investment process. Maybe as well I'm going to lean on you because, again, you're so good at explaining things. Maybe explain what alpha is, and then how this adds alpha into the portfolios that you manage? What's the direct connection between the process you follow and adding alpha in your investment management?

In our industry, many people think about alpha as being an excess return. It's how better your investment return in your portfolio is compared to a relevant opportunity set, and that might be described by a benchmark. So this is excess returns. This is what the industry looks like. Of course, beating the market, having an investment return, which does better than the benchmark is not an easy thing, there's a lot of smart people out there trying to do this, and there's a card of opinion that maintains that it's almost impossible, on average, to be able to beat the market. We would heartly disagree with that because we think actually the market isn't totally efficient. In fact, there is a lot of opportunity for a stock picker to beat the market. All you have to do is look at the number of that share prices moving up and down every day to realize that if I was only able to own the things that go up and avoid the things that go down, that would lead to a significantly better investment outcome than investing in the benchmark. But of course, the secret is identifying which one is more likely to go up in the long run and avoiding those which are more likely to go down. Actually, we think that ESG is a really good tool with which one is able to make a better assessment over time of those types of opportunities. The reason why we think that is because what ESG is doing is allowing an investor to tap in to some of the things that make businesses special and different and be able to beat the market, but which are poorly explained, and I would argue poorly understood, by investors using traditional financial reporting. I used to be trained as an accountant many, many years ago, and so I've had the pleasure of auditing lots of different types of businesses, but never once I've had to audit human capital or culture or innovation or speed of decision making. Yet these are all characteristics we would argue that are supported by strong ESG practices, the support you have from your suppliers, your customers, and your community, how well you'll be able to utilize the world's natural resources. These are all things that we think contribute towards healthy, sustainable businesses that give you healthy forms of extra financial capital, as we say. But none of these things would you find in the P&L balance sheet and cash flow. Because of that, the computers don't see them, the computers don't try and value them. They're often overlooked by investors. And actually, I think that is where that sort of persistent form of market inefficiency really resides. By using ESG as a tool, a magnifying glass to try and identify these really important extra financial components of value, we can hopefully identify those companies which enjoy healthy forms of capital, which therefore will in time move, turn into sales because of the support of customers, attractive in markets, less emissions, which means often associated with costs, and so you end up supporting your profits. That actually gives you a better investment outcome. And you're less likely to tread on those landmines. There are bad businesses who are borrowing from stakeholders in creating weakness; business models that have got an inherent weakness within them. That when they become realized, they're going to hit shareholders in the wallet. Lots of examples over the years of companies and business models that have fallen foul on those issues. You can think about things like drug pricing issues. We can think about things like emissions scandals. I would argue even things like social media today, where you've got some profound questions being raised in public places and inquiries and so on, challenging some of these things. All examples, I would argue, of where not-strong ESG practices are undermining perhaps some of the health of these extra financial components. So that's how we see ESG, to try and support alpha rather than limit it. Through those remarks, you'll see that we do passionately believe that there is no conflict between this idea about integrating ESG into a portfolio and generating alpha.

So if it's very difficult to identify these things through traditional accounting metrics and financial metrics, how do you identify the companies that are stronger in these areas than others? How do you differentiate between investment choices?

For us, we start with the business model. We're looking for businesses which are doing something different, have a competitive edge, and that's going to vary from industry to industry. So that's the thing that really excites us. The antenna gets twitchy. And we're sort of sniffing out a new opportunity. We go off and start doing our due diligence, and part of that due diligence, actually, is we want to understand not only how this company has found a better mousetrap, a way of actually beating its competitors, but it's how it does that business that's also important to us because we believe that there's a right way and a wrong way to run a business. These are choices, and management teams should be held accountable for the choices that they make. When we are doing our due diligence, we want to understand that the company, like we often talk about, is thinking like long term owners of businesses. We like to coinvest with management teams who also think like owners, who would behave as if it's their own money. If you think like you're investing your own money, you're going to do that with care and attention. You'll be thinking about that hopefully for the long term. And so, you're less likely to cut corners. You're more likely to invest in staff training and working conditions, tidy up after yourself. You care about your community relations, think about the next generation. These are all things, therefore, that incrementally contribute to a more sustainable business. We think that actually provides an edge, which over time allows these better businesses to be able to outperform those that are weaker because, as I said, if you construct a business where you are borrowing from these other stakeholder groups, for a time that might make your financial capital look a little bit better, but ultimately, you can only borrow so much before that debt has to be paid back. When that happens, there is a reckoning and that's when we see the share prices respond. Focus on those businesses that got these great business models. They've got a business model which is delighting its customers, delivering a product or service which customers really appreciate, but they're doing it in a way which means that it's sustainable, that makes it a good long-term investment. Avoid those that are perhaps borrowing from other stakeholders to make the numbers look better, but ultimately, that proves to be unsustainable.

Yes. Again, I always love the way you position this because so many people get bogged down as soon as you mention ESG or responsible investing, that I'm making some kind of trade off. Whereas your philosophy that it's just another tool that you can use as an investment manager to identify superior businesses that are managed more effectively. There's almost a passion for that ownership and driving returns again, not just to the bottom line, which ultimately we're going to find that connection, but across all stakeholders, and it's made for better investments for you. It's such an interesting evolution of the way we think about investment management.

Yes, it hasn't always been like this. There was a time I remember a colleague— we've been working together as a team now for over 15 years—, and towards the beginning of that period, we were sort of told by people that ESG— not within our firm, I’m please to say, Dave, but external partners—, that ESG is something that people wouldn't understand, that we shouldn't necessarily go out and talk to people about it. But I'm enormously heartened that the way in which it's now become part of the general investing landscape. But actually, there's still a long way to go, we believe, there's still a lot of opportunities to identify great businesses and to partner with them to the betterment of portfolios. We're still in the early innings.

Excellent. Well, Jeremy, great catching up with you. Always great to see you. Say hi to Grandma for me back over in the UK, and hopefully you can join us again in the near future and we'll dig even deeper into this topic. Thanks again.

Thanks, Dave. Always a pleasure.


Recorded: November 24, 2021

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