ESG & Alternatives: Taking flight with LGT Capital Partners

In this interview, Tycho Sneyers, Managing Partner at LGT Capital Partners (LGT CP) and board member at UN PRI, discusses what ESG means to LGT CP, the global alternative investing specialist, and how it is taking an active role in shaping the ESG agenda within the asset management industry.

Can you give us some background into LGT CP’s engagement with ESG and responsible investing?

It starts with our belief that we can only invest successfully for our clients by taking a long-term approach, which includes a strong commitment to environmental, social and governance (ESG) principles. This applies to both the investment solutions we deliver to our clients as well as to our business overall. Consideration of ESG issues is an integral part of our investment process, which we have developed to align with the Principles for Responsible Investment (PRI). Our investment teams are responsible for taking into account ESG considerations when performing due diligence on investments. Any opportunity that is pursued will have been vetted for such issues. These assessments form an important input for the portfolio manager and into the discussions held by the investment committee in reaching a decision whether to invest. We then monitor our portfolios for a wide range of risks, including those related to ESG, and we engage with managers by offering advice on further ESG integration. In addition, we conduct bespoke monitoring for certain clients to confirm compliance with their specific ethical frameworks.

LGT CP is a key global player in the alternatives space. What unique challenges and/or opportunities do you see for this asset class regarding ESG integration which sets it apart from more traditional securities?

The opportunities and challenges of ESG integration in alternatives differ according to the asset class. For example, private equity is especially well suited to addressing ESG issues, whether by mitigating risk or adding value to companies.  The typical buy-for-control investment model in private equity means that fund managers have the greatest scope for mitigating negative impacts and driving positive outcomes. While many other types of investors are largely limited to “buy/no-buy” decisions at the outset, with scope for engagement activities afterwards, private equity managers can directly build ESG factors into their value creation plans.

At the same time, private equity managers face certain challenges, especially in terms of obtaining consistent sources of high-quality ESG data. They do not have the benefit of the many well-established sources of ESG data available to managers of listed assets, so they have to measure and collect data largely on their own. This poses problems for comparability across managers for investors wishing to analyse large, diverse portfolios.

Investors in liquid alternatives can select assets from a very broad and liquid universe, allowing them to overweight securities of issuers with better ESG profiles. This often enables investors to benefit from lower overall risk and better-performing companies.  In addition, in some strategies, portfolio managers can overweight long positions in ESG leaders and short positions in ESG laggards. This enables them to build up an ESG-focused portfolio that fully reflects their ESG insights on assets.

How does LGT CP practically integrate ESG into its investment process?

We take a holistic approach to assessing ESG factors in investment decisions. Our approach considers a company’s operations, its products and services, and potential ESG controversies. Taken together, the three dimensions provide us with a holistic ESG overview that identifies both risks and opportunities.

We create ESG indicators using original source data to identify best-in-class investment opportunities. We integrate the ESG indicators as value drivers into classical financial analysis to select individual assets for our portfolios.

We also take a holistic approach to assessing external investment managers on ESG. We focus on selecting the best managers that share our commitment to high standards on ESG issues. Our due diligence process seeks to assess managers’ overall commitment to ESG and the sophistication of their approach. We examine whether managers have institutionalized ESG processes in place and whether their stance on ESG reflects our ESG philosophy. Wherever possible, we also evaluate the portfolio holdings in light of material ESG factors.

Is there anything about LGT CP’s approach that you feel differentiates it in the market?

We were early to commit to sustainability, as long-term thinking and actions have always been among the company’s core values. For example, since 2003, many of our investment programs have had a responsible investment clause written into their governing documents, authorizing us to exclude investments that are substantially exposed to arms-related activities, violations of human rights, irresponsible treatment of the natural environment or other non-ethical conduct of business. We have also been a member of the PRI since 2008, having joined just two years after its founding.

Another differentiator for LGT CP is the breadth of our ESG offering. We have developed asset class-specific approaches to ESG integration that fit together into a single holistic framework, but speak to the needs of each asset class. For example, in our direct equity and fixed income portfolios, we focus on evaluating individual securities with a proprietary tool called the “LGT CP ESG Cockpit.” It integrates dozens of key performance indicators (KPIs) on companies to assess their ESG profiles. At the same time, in our multi-manager portfolios, such as private equity and hedge funds, we focus on evaluating and engaging with our underlying managers on ESG, encouraging them to the raise the bar higher over time. We have even applied an ESG framework to less obvious asset classes, such as insurance-linked strategies, as we believe all asset classes can be invested through a meaningful ESG lens.

Has the pandemic changed this approach at all at LGT CP? Do you think it has impacted, or will impact, the wider industry’s approach to ESG integration?

The pandemic has not changed our approach to ESG, but we are seeing increased interest on the topic from clients. We are convinced that ESG considerations are now more important than ever due to the significant environmental and social consequences from the COVID-19 pandemic. Furthermore, we believe that a strengthened focus on ESG is an effective way for investors to respond to the COVID-19 pandemic, as well as to the many other global challenges we face today and will face in the years to come.

What do you think will be the key developments in the ESG agenda in 2021?

As people and planet are facing an increasing number of challenges – global warming, the COVID-19 pandemic, increasing inequality – it has become clear over the past years that ESG integration and sustainability have to move to the next level and increase their positive impact on real world outcomes. We did achieve a lot with ESG in the last 15 years. It is now part of almost every investor’s process and most organizations have dedicated substantial resources to this end. But it was difficult to exactly define success and the outcomes we want to achieve. This has become easier since 2015 when all nations agreed on combatting global warming with the Paris Agreement and the unanimous approval of the UN Sustainable agenda 2030 with the 17 Sustainable Development Goals (SDGs).

This gradual shift from process orientation towards outcome orientation is the most important trend in ESG. The implementation is not easy and many institutions at the forefront of sustainable investing are working on and often also struggling with finding solutions to implement this.

Secondly, as governments have agreed to actively implement these international agreements they signed up to, the number of policy interventions is rapidly increasing. This encompasses laws, regulations but also guidelines. The most important set of sustainability laws and regulations is currently being issued by the European Union (EU). The EU has put sustainability and especially green finance at the core of its plans and the first concrete obligations will come into force on March 10, 2021.

This leads me to the third trend, and that is the quest for data and information. To accurately assess the positive or negative outcomes of an investment, and to fulfil the growing number of laws and regulations pertaining to sustainability, investors have a huge need for data to assess the sustainability footprint of their portfolios and to file the required reports. This in turn is putting pressures on companies to capture and report this information. The ultimate solution will be standardized corporate sustainability disclosures that are mandated by the accounting standard setting bodies. This, however, will be a medium-term rather than a short-term objective as it is a very complex topic with too many cooks in the corporate sustainability disclosure kitchen.

Undoubtedly, the most important and the most urgent topic for investors is climate action. The vast majority of investors are currently working to minimize CO2 emissions from their investments, as well as trying to assess how climate change is affecting the riskiness and the return expectations of their holdings. This is also a big topic for us at LGT CP, and over the past years we have spent significant time on “Paris aligning” our largest investment portfolio, the Princely Strategy. We have established a dedicated team to design and implement this climate strategy.

What role do you think LGT CP can play in the acceleration of the ESG agenda within the industry?

LGT CP has taken an active role in shaping the ESG agenda within the asset management industry over the years. In private equity, for example, we have published two ESG best practice guides, one already in 2017 and another more recently in 2020. The new publication, “Implementing ESG in private equity 2.0,” highlights the latest developments in ESG integration, ranging from climate change, diversity and data security to active management of ESG value creation. The new guide is a follow-on to our 2017 publication, “A guide to ESG implementation in private equity,” with eight new case studies. In the latter publication, we again highlight examples of ESG best practice through the lenses of manager commitment, investment process, ownership and reporting. We look at two examples from each area of ESG practice, with case studies from leading private equity managers, including AEA, Summa, Genstar, NewQuest, Hg, Triton, GenBridge and KKR.

We have also worked to raise the profile of the SDGs within the investment industry by publishing two pieces of original research on the topic, one from the point of view of institutional investors and the other focusing on private equity managers. In both publications, we surveyed a large, global group of investors about their expectations for the SDGs as an investment framework, a topic that has been growing in importance in recent years. Both groups expressed significant interest in the SDGs as a way of leveraging private capital to address pressing environmental and social issues around the world.

In addition, we have taken an active role in the PRI over the years, with members of our private equity and hedge fund investment teams taking leading roles in two Working Groups on ESG best practices in the two asset classes. In each case, their work culminated in the publication of standard industry questionnaires for ESG due diligence, for each private equity and hedge funds.

And of course, I have served on the Board of Directors of the PRI since 2018, where I have helped to shape the ESG agenda since joining.

Tycho, you are serving your second term on the PRI Board. What are the most important topics, you have been and are dealing with as a board member?

In my first board term that ended in 2020, I focused on promoting the SDGs within the PRI signatory community. As chair of the SDG Advisory Committee, I oversaw the work on the new 5-step framework laid out in the recent report “Investing with SDG outcomes.” The work is far from over, but developing the framework was a very important step for the PRI.

In my second board term, I am closely following the development of the recently revised Reporting & Assessment framework and minimum memberships requirements. I want to ensure that the new framework reflects the latest best practice in ESG, but it should not become an unreasonable burden for signatories nor so onerous that it jeopardizes the “big tent” nature of the PRI.

I am also advocating for expanding asset manager representation on the board by adding an additional board seat for them. Currently, investment managers hold just two of the eleven board seats, which does not adequately reflect their significant contribution to the organization. While I think the ultimate balance of power between investment managers and asset owners should stay the same, I think it is important to allow for better representation and more diversity of investment managers on the board.

In 2020, BNP Paribas Securities Services published a report on the integration of ESG in the hedge fund industry. Click here to download.

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