By Hamlin Lovell, NordicInvestor

NordicInvestor interviewed Skagen’s Head of ESG, Sondre Myge Haugland, to identify how the firm applies and prioritises ESG considerations in the context of its value investing philosophy for equities and fixed income. (Skagen’s online platform for external managers, and its fund of funds allocating internally and externally, have been covered in a separate Nordic Investor interview). Skagen managed €7.3 billion across eight active, fundamental, global equity and fixed income strategies, as at the end of 2021.

Superficially, ESG can be easily associated with “growth” style investing since some firms with high ESG scores are on high valuations, while many of the companies, sectors and countries most often excluded for ESG reasons often trade at a discount (and sometimes a deep discount ) that might attract certain value, and deep value, investors.

“There is a binary perception that value conflicts with ESG. But ESG and value investing are not oxymoronic. We have always considered topics like stranded assets and reputational headline risks as part of our moral and fiduciary duty,” says Haugland.

There are over 40,000 listed companies globally and a variety of different value investing philosophies and processes.  

Top down or bottom up?  

Skagen’s conceptual framework of “Dual” or “Double” materiality means that both companies’ impact on environment and society, and in turn how this impacts their financials, are important, but this is not so unusual. What differentiates asset managers is how their ESG framework defines, prioritises and weights ESG criteria.   

Skagen emphasizes pragmatic company-specific analysis and dialogue.

“The public discussion is focused on top-down perspectives including overall portfolio exposures whereas we emphasize bottom-up analysis where governance and disclosure are the starting points for ESG disclosure and performance. Our aim is not to avoid all ESG risks but rather to manage and navigate them at the industry and individual level. We have skin in the game in the real economy,” says Haugland. 

ESG disclosure versus ESG performance  

Governance metrics, such as shareholder democracy, and staff diversity, equity and inclusion, are not only important ESG factors at investment level.. Good governance also provides the foundation for credible ESG disclosure and improvement across E, S and G, and SKAGEN sees a wide variation in practices here.

“Some firms disclose opportunistically and others disclose strategically. ESG scores are not necessarily correlated with the quality of ESG disclosure. Some firms with a high ESG ranking make limited disclosures while others with a lower ESG ranking make much more extensive disclosures. And the large quantity of disclosures that often come from larger companies does not guarantee quality information. Smaller companies need more research,” says Haugland. 

Moreover, a glamourous and obvious green sector such as wind turbines still requires bottom up ESG analysis.

“There are issues around sourcing, supply chains, and dealing with discarded blades. It is oversimplifying to talk about solutions. We want to avoid binary buckets of brown versus green and ESG versus non-ESG,” says Haugland.

(Notwithstanding this philosophy, some companies are off limits due to sustainability and other ESG concerns. SKAGEN does have an exclusion list that goes beyond its corporate parent Storebrand in areas such as gambling and adult entertainment. SKAGEN’s list, which is reviewed quarterly, is also longer than the published list from the Norges Bank Investment Management (NBIM) oil fund). 

Forward looking transition and de-carbonisation  

SKAGEN’s corporate parent, Storebrand, has long term targets for alignment with the Paris agreement, and SKAGEN stresses a forward looking approach.

“It is very easy to report a current snapshot of carbon footprints, and we do this on request, but we do not invest on that basis. Our approach to carbon and climate risk is to focus on material exposures to climate change and decarbonization efforts. We want to proactively influence change and are aware of the reflexivity of our goals. We seek long term decarbonization pathways, using the Transition Pathway Initiative (TPI) to monitor the delta of long term change,” says Haugland. 

This could be reported according to a variety of climate reporting standards; such as UNPRI, UN Global Compact and CDP. 

Miners do often raise a range of ESG controversies, and currently have relatively high carbon footprints, but they are vital for long term electrification and can improve their own operations.

“Ivanhoe Mining is not only bringing minerals such as copper to the green transition, but is also committed to net zero at the mine level, which includes vehicles, and renewable energy. It is, in essence, a quintessential ESG investment for value strategies” says Haugland. 

Incremental innovation  

Skagen’s longer term view on decarbonisation is also value-conscious:

“we are more a tortoise than a hare. EV makers Tesla, Rivian and Nikola could be hares but some ESG stocks are too expensive. We prefer under the radar ESG opportunities, such as South Korean car maker, Hyundai, which has already sold 15 hydrogen trucks to a joint venture”.  

Skagen can own some reasonably valued companies pursuing radical new technologies.

“Swedish steel maker, SSAB, has developed a process for using hydrogen to make “green steel” instead of coking/metallurgical coal. This can bring down emissions. There has been a collaboration with Vattenfall and the initiative promotes ESG compounding since Volvo has bought the green steel as part of scaling their EV truck ambition,” says Haugland.

SKAGEN would not traditionally invest in a “blue sky” startup with no sales, and only usually have exposure to “future” or “unproven” ESG technology via a pilot within a larger company.

“For instance, Canadian Pacific is testing a hydrogen trainset, as part of their long-term science-based decarbonization effort” says Haugland.

This involves hydrogen locomotives and fueling stations. 

Benchmarking, data and reporting  

Some ESG benchmarks, as well as most conventional market-cap weighted indices, have a bias to larger and growth companies and use a predefined ESG framework. SKAGEN does not use ESG benchmarks for performance measurement purposes, but its ESG reports do attempt to qualitatively compare its ESG performance, risks, active ownership and stewardship with Sustainalytics benchmarks. This is not an easy exercise.

“ESG data is a babble of many tongues, with a plethora of norms. We see potential conflicts of interest within data providers where Chinese walls are not as good as they could be. Data can use a mix of actual and estimated figures, and may not be consistent. We use third party providers including Bloomberg. We may challenge providers and alert them to improvements, so that disclosures can become more informed,” says Haugland.

“We cannot realistically micromanage down to the level of investigating each company’s water intensity metrics. We would like to see some standardization on units of measurement, and metrics, but not on prioritizing disclosures, which is a materiality choice,” says Haugland. 

The EU Sustainable Finance Framework  

Data conundrums and complications are not going to be solved by the SFDR or taxonomy;

“The SFDR will increase transparency, but it could also cause confusion for retail clients. A broad ecosystem of norms and best practices, with some of them aspiring to fossil fuel free portfolios. may differ from the SFDR,” Haugland says.

For instance, some asset managers want to exclude gas altogether while others view it as being cleaner than coal or oil and essential for energy transition.  

EU SFDR: 6 and 8  

SKAGEN has not offered any products with a broad explicit ESG investment objective mandate, nor any thematic strategies focused on specific areas of ESG.

“There are clearly recurring themes around minerals and electric vehicles, but we are not labelling products as thematic,” says Haugland. 

SKAGEN’s approach currently fits into some, but not all, aspects of the evolving EU sustainable finance framework. 

Fixed income and multi-manager products are currently reporting under article 6 while awaiting clarity on correctly interpreting some details

“Our initial focus has been on the equity funds for two key reasons; the first is a credible pathway to document and evidence an Article 8 categorisation. Assessing this for the fixed income funds in the future is an open and realistic opportunity, the second are  strategic and commercial reasons,” says Haugland.

All of Skagen’s equity strategies are reporting under SFDR article 8.

“We find this is integral to good risk adjusted returns, and in line with how we have consistently integrated and developed ESG into our investment process,” says Haugland.  

SKAGEN does not currently have any SFDR article 9 products. “We stick to a pragmatic investment case and know our companies inside and out,” says Haugland. SFDR 9 is one framework for “impact investing”, and SKAGEN is among many asset managers that are cautious on defining their products as impact.

“There are different opinions about whether impact implies a trade off, sacrificing returns for impact. The EU rules might encourage people to talk more impact investing, but the early indications are that most SFDR assets are article 8,” says Haugland.  

Awaiting clarity on the taxonomy  

 SKAGEN has not yet committed to any products that anticipate being aligned with the evolving EU taxonomy, based on current eligibility criteria, and has several concerns about the new rules.

“We are waiting to see how the taxonomy develops including for level 2 rules and whether there will be a binding minimum percentage of taxonomy alignment for SFDR. We are concerned about politicization. The taxonomy started being science-based but is now becoming very politicised based on countries’ national energy agendas in areas such as nuclear and gas,” says Haugland.

“A prospectus commitment to the taxonomy might rule out some forms of transition investing,” he adds. Valuations are another possible obstacle: “the taxonomy will likely attract capital to certain companies, which could also increase their valuations”. 

Europe-centric? 

Another problem for global investors is the Europe-centric nature of European regulations, which should eventually require larger listed European companies to make the necessary disclosures. Yet it is not clear whether companies outside Europe will be willing to make the required disclosures.

“It remains to be seen if European initiatives will scale internationally. There are plans to cooperate with China to harmonise overall Taxonomy purposes,” Haugland concludes.