This article is sponsored by Hermes Infrastructure
Q: What are your views on the correlation between responsible investment practices and long-term stakeholder value?
A responsible investment approach is essential to delivering sustainable, risk-adjusted outperformance over the long term. Our parent institution’s ESG heritage dates back to the early 1990s, with a demonstrable record in responsibility and a pioneering engagement service. Since Hermes Infrastructure’s establishment in 2011, we have continued to build on these strong foundations.
The public-service nature of infrastructure assets demands the highest standards of ESG are adhered to. The long-term nature of the assets, the wide range of stakeholders involved, including large workforces, as well as the interaction with the natural environment, all mean that a portfolio company’s approach to tackling ESG matters will impact the prospects and long-term value of that business. We place a strong emphasis on governance, because we really believe having a robust governance framework better equips a company to positively address its environmental and social responsibilities. As an infrastructure manager, we have a very clear responsibility to our investors, to society and to the businesses we invest in, to ensure that these issues are addressed in a sustainable way.
Q:Is sustainable infrastructure investment primarily about tackling climate change?
Over the past few years, the ESG debate has been somewhat redirected towards the climate change crisis. While this has risked lowering the priority of other aspects of ESG, it has actually led to several concrete, easy-to-implement actions across the industry, with clear and immediate benefits. In our portfolio, this has led to a change in energy mix and consumption patterns and improved waste optimisation strategies, benefiting the environment and cutting costs.
There is, however, still a lot to do on the social aspects of ESG. Issues can be quite localised, making it more challenging to develop a common language around how best to bring these considerations together beyond simple compliance with health and safety or other legal and regulatory requirements. In our portfolio, we have been active in promoting diversity and inclusion and looked to expand the more traditional definitions of health and safety by reviewing mental health processes and practices in each of our investee businesses.
Q: Who, or what, is driving infrastructure’s increased focus on sustainable investment and ESG in particular?
Over the past decade, we have witnessed a step change in the industry’s approach towards ESG. There has been a tectonic shift in societal attitudes and increasing evidence-based recognition of the impacts of climate change have brought responsibility and sustainability very much into the mainstream. With an increasing number of millennials entering the workforce and investor universe, greater importance is also being ascribed to making a positive contribution to society through the workplace. Political and regulatory scrutiny has also reinforced the link between ESG practices and investment performance, while legal changes have also had an impact; for instance, the requirement for public pension scheme trustees to consider financially material environmental, social and governance matters, including climate change, as part of their fiduciary duties. With the increased importance attached to ESG, LP sophistication has grown and we find that LPs are now driving an agenda that was previously more manager-led.
Q How does that manifest itself in terms of how LPs approach due diligence in this area? What questions are they asking?
Investor attitudes towards ESG have definitely evolved, consistent with society’s increasing sophistication towards sustainability practices. Investors want to see more evidence of integration in our processes, thought leadership, active engagement leading to improved performance and transparent reporting of outcomes. Investors have now gone way beyond a simple box-ticking exercise, driven by a genuine passion for sustainability considerations. Sustainability now needs to be part of a manager’s DNA. In fact, we believe that sustainability will ultimately become as important as financial returns in driving LP allocations.
Q: What changes have you seen in terms of ESG reporting?
The tracking of ESG metrics has moved away from a pure monitoring approach to becoming a key feature of strategic and operational company decision making. Over the years, we have observed an increase in the breadth, depth and quality of ESG reporting, as well as increased focus on quantitative, rather than just qualitative, information.
We believe you can’t manage what you can’t measure, so we have encouraged our portfolio companies to invest in resources to focus more on measurement of ESG metrics, which has enhanced the quality and consistency of reporting. Several of our investee companies are now publishing their own annual sustainability reports.
This evolution has been driven by more active engagement from LPs and asset managers as ESG has risen to the top tier of everyone’s priority list as well as increased disclosure requirements and growing importance being placed on ESG benchmarking and validation tools.
Q: What tools are available and what level of standardisation is realistically achievable?
There is no shortage of ESG frameworks to choose from. In fact, the problem is more deciding which one to adopt. As well as the United Nations-backed Principles for Responsible Investment, there is the Global Reporting Initiative, the Sustainability Accounting Standards Board and the Global Real Estate Sustainability Benchmark, among others.
Many companies also report against the UN’s Sustainable Development Goals, while others report based on industry mandated standards. The irony is that most of these frameworks are trying to address the same need for harmonisation, but the industry has yet to reach an agreement on which one everybody should use.
The push for standardisation is also hindered by the challenges of a highly fragmented asset class. The informativeness of fund-level reporting is somewhat diluted by sector-specific nuances, which mean ESG considerations that are extremely relevant to one asset, are not as relevant to another.
“Increasing evidence-based recognition of the impacts of climate change have brought responsibility and sustainability very much into the mainstream”
Where there has been success in creating standardisation is in a common understanding of an ESG value set, with responsibility and sustainability principles now being broadly aligned. The PRI has played an instrumental role in this process. The harmonisation of reporting frameworks is the next step on this journey and is critical to being able to effectively and objectively benchmark performance and driving continuous improvement.
Q: What other challenges, beyond standardisation, remain in place regarding the measuring and reporting of ESG performance?
Resourcing can be a challenge. Companies may not have the capacity or the budget to dedicate resources to ESG reporting, which can be quite onerous. In addition, robust ESG data is, in many cases, only available annually, making it challenging to report on progress more frequently.
Q: How would you characterise your approach to ESG?
At Hermes Infrastructure, we have carefully assembled a team where all members embrace the societal and environmental impact of infrastructure and contribute to a culture where sustainability is front and centre of everything we do. ESG is deeply embedded in our strategy and fully integrated in our processes throughout the investment lifecycle. As part of our reporting toolkit we undertake several important initiatives including UN PRI, GRESB, portfolio company engagement and KPI monitoring. Additionally, this year we will launch our inaugural Responsible Investment report.
Culture and context also play a role. There will inevitably be differences in the way companies and investors approach ESG. Some may be country specific; certain jurisdictions seem to place less relevance on ESG factors than others. Company and sector specific factors also add complexity. For example, a regulated company is already required to publicly disclose a range of ESG data. These challenges show that the infrastructure industry is on a journey when it comes to implementing and reporting on ESG practices. As a manager, our role is to continue making meaningful contributions to industry wide initiatives such as GRESB and the PRI, whilst also actively engaging with our portfolio companies.
Q: How far has the industry come in terms of improving its ESG or sustainability credentials?
Compared with 10 years ago, ESG is now a two-way conversation, front and centre of our interactions with investors, co-shareholders and portfolio companies. The focus is as much on concrete, measurable, short-term actions as it is on longer term goals.
This has driven a refinement of investment strategies and risk management frameworks, as well as changes to recruitment practice and team composition amongst many managers and companies. The ongoing legitimacy debate around private investment in public infrastructure, and the requirement for a social licence to operate has further reinforced a commitment to ESG considerations and, most importantly, the desire for substantive action.
“We believe that sustainability will ultimately become as important as financial returns in driving LP allocations”
This is most visible in the quest for ESG measurement and reporting, which initiatives such as the PRI and GRESB have positively contributed to. At portfolio company level, those frameworks are useful for driving change and identifying areas for year-on-year improvement.
Whilst we are pleased at how far the industry has come, there is a long road ahead. We see two short-term priorities. First, investors and fund managers must engage to define a common coding system to standardise reporting, recognising the collective advantage that would drive. Second, we should expand the ESG conversation beyond the realm of holistic risk management systems to grasping more of the opportunities which will inevitably foster financial innovation and new products coming to market.