By Hamlin Lovell, NordicInvestor
Skagen’s conceptual framework for ESG has not changed since the manager started running active value equities in 1993.
Cosmetic “sustainable” labels
“We use ESG principles to make good decisions. We do not split companies into binary buckets of sustainable and non-sustainable,” says Sondre Myge, Head of ESG at Skagen. The argument that exclusions incentivize positive change through companies’ cost of capital has been questioned by academic research suggesting that selling shares in “brown” firms just makes them more “dirty” without making “green” firms any cleaner.
He finds that the regulatory labels for fund disclosure are not helpful: “SFDR 9 market share peaked at 9% and is now down to 2%. SFDR 8 is popular in the Nordics but most of them are not doing fully sustainable investments. Only a handful of funds qualify for the new UK SDR label. And the taxonomy is more political than scientific”.
In fact, all of Skagen’s equity funds are SFDR 8 while its funds of funds are article 6 awaiting clarity on rules, but there is no attempt at taxonomy alignment and the SFDR framework is not helpful for Skagen’s own ESG process. For instance, in SFDR reporting, Myge finds huge data quality issues especially around PAI (Principal Adverse Impact) disclosures and statements.
“We are very cautious on naming or labelling funds as sustainable. “Sustainable investing” is a misnomer on many levels. The process of attaining real sustainable outcomes is being sacrificed for perceived sustainable footprints, such as ESG scores and ratings, without showing any real outcomes,” explains Myge.
Defining metrics for carbon measurement
Skagen finds that carbon footprint data can be upset by basic issues of interpretation. “What gets measured gets managed, and what gets mismeasured gets mismanaged. If a company does a merger its C02 goes up,” points out Myge.
And some methodologies may be fundamentally flawed. Reporting carbon footprints relative to revenues introduces essentially random volatility into the time series: in an economic boom companies may appear to decarbonize while in a recession that reduces their revenues they might appear to become more carbon heavy. Skagen find it is more meaningful to analyse carbon intensity relative to production output: tonnes of C02 per tonne of output, compared against peers and over
time. Skagen also seek credible decarbonization transition pathways. And the appropriate carbon metrics should be recalibrated on an absolute rather than relative basis: a 1% reduction in carbon from a heavy emitter is more valuable than a 10% reduction from a light emitter.
Thus what Myge dubs the “C02 placebo effect” can be unhelpful – and may even create perverse incentives for both investors and companies.
Carbon reporting and targets
Skagen has a different philosophy and approach, but nonetheless follows some industry standard reporting standards, such as TCFD under UNPRI. “We do not find much demand from clients to go beyond this,” says Myge.
Bottom-up company-specific targets
Skagen itself does not have a fixed target for net zero by 2050 (though its corporate parent Storebrand does). “A fixed rule would complicate our stock-picking. Only two or three years into the race for net zero, companies are already reneging and readjusting their commitments. Therefore, we do not have visibility over 20 years,” explains Myge. “We are more contextual based than rule based and more bottom up than top down. We do a deep dive on transition plans for each company. We may only get one data point a year from some companies,” he continues.
Dual materiality is increasingly formally mentioned in more ESG policies but for Myge it is just common sense: “You do not need morals or politics do be an ESG investor. If companies lack social intelligence about their environment they are less adaptable”.
Gathering raw data and questioning rating methodologies
Skagen tries to collect raw data from companies’ financial statements and materiality assessments, rather than relying too much on external data. “We try to do as much internally as possible because external ESG ratings can be full of subjective assumptions and may be factually wrong. We actually prefer unstructured raw data that we can make sense of and compare with peers. Once the data has been structured it may be harder to compare”.
External data can present various problems: “So many methodological avenues complicate reporting of data. We need to adjust data for materiality and useless reporting. Climate transition is not relevant to software firm Adobe, and labour issues are more relevant to retailer Wal Mart. ESG ratings agencies can be very slow to update controversies”.
Technology is not a silver bullet for these nuanced questions: “AI and web scraping can be helpful, but it may also duplicate what we can easily find from the news”.
Transition and decarbonization
“Sustainability needs to converge to the real economy. We are more interested in long term decarbonization than current carbon footprints. We are more interested in a long-term journey of improvement and engagement than anything else,” says Myge.
Independent engagement
Skagen and Myge have a long history of directly engaging with companies based on long term relationships: “We see a lot of value in these constructive dialogues. We find emerging markets can offer more potential for improvement. They get a lot of undeserved flak for ESG risks that are actually more pronounced in developed markets. I spent a week in Asia in February and this led to some useful dialogues, including in Korea”.
With a spirit of Norwegian independence, Skagen is happy to act alone. “Collaborative dialogues can be more about surveillance. We are not formally collaborating,” confirms Myge.
Independent voting
Skagen’s approach to voting is similarly independent minded. “We often support AGM resolutions but will disclose reasons for voting against them very clearly. We form our views case by case on a company specific basis. Even if two resolutions are similar we may vote for one in one AGM and against another one. We explain our reasons to investors and boards, and we may vote differently from other shareholders,” explains Myge.
Value criteria and case studies
As passionate value investors Skagen cannot contemplate owning some companies with high ESG scores as a decisive reason. “Best in class ESG may not be a good investment opportunity if it is expensive. We have to see sustainability and value. We do not want to trade off returns for sustainable improvements,” says Myge.
Two current portfolio holdings show how value investing can go hand in hand with positive ESG stories.
Canadian Pacific is a core holding in Skagen’s global equity fund, SKAGEN Global, which demonstrates ESG and long term return credentials. “Moving transport to rail has a direct positive impact on carbon emissions and Canadian Pacific has expanded from coast to coast Canada, to Kansas City Southern, down to Mexico City to take advantage of NAFTA,” says Myge.
Raizen is a sugar-based ethanol spin off from Shell. Second generation ethanol (E2G), using waste from the first generation (bagasse) converts to ethanol gas and then to electricity. This increases output by 50%. Myge authored a posting on this firm, held in the SKAGEN Kon-Tiki fund, here
Postcard from Brazil Part III: Raizen and bio energy – SKAGEN Funds
Some common ground remains
Having outlined important differentiators, it is important to note that Skagen’s ESG approach still has some things in common with other Nordic managers.
Of course, Skagen still has an exclusions list that is partly based on conduct and behavioural exclusions. This rules out companies involved in activities such as deforestation, active lobbying against the Paris agreement, and deep sea mining.
And of course, Skagen has changed some details of its policies in response to recent events. “After NBIM excluded Russia that filtered down to most Norwegian asset managers. And the war in Israel and Palestine is leading to ongoing work divesting companies with exposure to the occupation, in conjunction with the UN Global Compact. But the overall philosophy has remained constant but continuously evolving,” sums up Myge.
This article will feed into NordicInvestor’s upcoming special report on Sustainable Investing
