At AllianzGI we have a fully dedicated Global ESG Team. The fundamental role of the team is to identify factors as an integrated component of mainstream company analysis by identifying risks and opportunities that have yet to be priced by the markets.
We firmly believe that our holistic and integrated approach to ESG supports superior stock selection1.
AllianzGI ESG research analysts are global sector specialists, focussing on ESG risks and opportunities within their sector.
Team members are located in London, Paris and Frankfurt where they collaboratively work with the fundamental research and portfolio management teams.
We have built a proprietary in-house ESG ratings model for an extensive global universe of companies including sovereigns, supranationals, agencies and local authorities. The model weights material ESG factors in each sector and is fed by third party ESG data to generate sector relative “Best-in-class” ratings which are visible to the majority of investment professionals across AllianzGI.
The ESG ratings are scaled from 1 “worst in class” to 5 “best in class”. In addition to being used in portfolio construction, they also provide us with a global snapshot of how corporates ESG practices are trending across regions.
_______
1 A study on “ESG in Equities” carried out by risklab aims to determine the relevance of ESG factors for the performance and risk of this asset class. Please see Risklab section for further details.
Regional Characteristics:
Europe: Disclosure and reporting on ESG factors is well established among European companies leading to better ESG ratings relative to peers. Early and strong support from asset owners has encouraged investment managers to integrate ESG in their investment processes and drive companies to disclose on material ESG.
North America: Overall performance is broadly in line with the global average. This is driven by strong performance on governance and poor performance on environmental and social issues. Regulation post corporate scandals at the end of the 1990’s forced companies to adopt more rigorous and transparent governance standards. Environmental and social performance largely lags due to weak reporting on these issues.
Asia Pacific ex Japan: This region’s universe made up largely of Chinese companies underperforms the global averages across all metrics. Disclosure and historically limited appetite from companies and investors in the region to manage ESG issues are key factors on this score. However, China’s 13th Five-Year Plan shows commitment from the region to address the social issues that arise from corruption and environmental pollution.
Latin America & Africa/Middle East: These regions display ratings on par with global averages with the sample of companies from these regions being smaller than other areas and dominated by large cap companies in South Africa and Brazil. Both of these regions have been early adopters of the Sustainable Stock Exchange Initiative requiring listed companies to provide reporting on ESG issues. When a metric is measured and reported, management tend to attempt to demonstrate good performance from their company.
Japan: Strong performance on environmental issues is largely driven by focus on technology leadership. The notable rating is governance where Japanese companies score much lower than the global average. A number of factors drive this shortfall, from a lack of board independence to significant numbers of cross-shareholdings. Recent actions from Prime Minister Abe have sought to improve corporate governance of Japanese corporates notably through the introduction of a Stewardship Code which since has been adopted by more than 100 institutional investors. Recognizing companies that have begun this transition to better governance offers investors with an investment opportunity.
To support the generation of ESG ratings which build up the company’s quantitative profile, the Global ESG team conducts in-depth issuer-specific ESG research, providing further analysis and commentary on the material ESG issues affecting the issuer.
The case study opposite shows an example on how a stock profile is built up by one of our in-house ESG analysts.
Quantitative Profile2
Global Relative ESG Rating: 3.14
Qualitative profile2
This company has consistently and strategically integrated sustainability within its core business model. Its focus in sustainability and its continued expansion into new territories will offer competitive advantage over competitors. The ESG analysis below exposed supports the overall investment case.
Business behaviour: The company is exposed to significant reputational risks as its customers can easily change buying preference. Sustainability practices are well integrated into the company’s culture: ESG performance and policies are monitored from the board level. ESG performance is part of the executive’s remuneration. Bribery and corruption policies, including whistleblowing mechanisms are considered strong. Exposure to tax avoidance theme and related criticism is a distraction from the otherwise, strong business behaviour profile. To manage increasing reputational, regulatory, financial and legal risks, we would expect the company to increase tax transparency going forward.
Environmental factors: Exposure of the company to environmental related risks is considered low, as operations are not considered energy intensive compared to other sectors. The company is running a number of initiatives to reduce environmental footprint including improving energy consumption and has plans to build 100% of its new stores according to sustainable building standards. Climate change related risks along the supply chain are likely to increase going forward, and increasing scarcity of land, water related risks, and deforestation could have an impact on the company’s supply chain. However, robust supply chain program, high degree of traceability and long standing relationships with raw material suppliers give us confidence that the company is well positioned compared to peers.
Going forward, we would welcome more disclosure on company’s progress of sourcing 100% certified sustainable palm oil.
Social factors: The company has a high exposure to labour related challenges which it manages well. We consider supply chain management practices to be strong given companies well integrated ethical sourcing standards especially for coffee, which is the main raw material used. As the company is expanding into other food categories and markets such as China where food safety risks are considered high, we would like company to demonstrate and disclose in more detail, how it rolls out its robust quality control systems more broadly, including diary and backed goods.
Corporate Governance factors: Corporate governance requires improvement. Chair/CEO roles are combined, but risks are somewhat mitigated by the majority independent board and board committees. A refreshment of the board is a topic the company should address going forward. In terms of remuneration, despite high pay of executives well above median of peers, pay and performance appear to be adequately aligned but it is a topic we monitor closely.
ESG drivers also take place within ESG analysis, and this company is succeeding well. The wave of empowered Millennials is becoming an influential force on corporates as they seek to align their values with those who they buy from. In response to these new generational needs, the company has adapted its business to the millennials generation, which are becoming the next big demographic that companies are targeting, by adopting new innovative strategies such as mobile ordering and payment systems.
All these factors together will translate to better growth and revenue numbers, which will ultimately translate to better performance for the stock. Only in 2015, the company’s stock rose more than 45%.
2 Source: AllianzGI as at 30 April 2016.
ESG research for sovereigns is conducted on 180 countries for which we provide quantitative ratings and, where more depth of insight is needed, qualitative analysis. To feed our ESG rating and analysis, we use a broad range of information sources, including the World Bank, the OECD (Organisation for Economic Co-operation and Development), United Nations and related entities. We also rely on information from NGO’s (Non-governmental Organisations) such as Transparency International and Freedom House.
ESG ratings are a complementary signal to sovereign analysis. They help to assess:
The ability of governments to generate revenues in the future by looking, for example, at the quality of the education system or the level of R&D (Research & Development) investments
The ability of governments to face their obligations by looking notably at the healthcare and pensions systems or policies related protection of the environment
The ability of governments to implement reforms and to run effective institutions by looking at the corruption level or at the organisation of the judicial system.
We collect data on a broad range of indicators to compute absolute ratings on 3 domains:
Environmental responsibility
Social responsibility and solidarity
Institution responsibility.
For SRI funds, this is completed by a Human Rights screen based on Freedom House scores for political rights and civil liberties.
Quantitative Profile3
Global Relative ESG Rating: 3.98
Qualitative profile3
Environment: Natural resources represent an economic asset and are a source of wealth for a country. As such, developing a coherent set of policies to protect the environment and natural resources is the key to reduce future risks and to strengthen a country’s ability to repay its debt.
Robust environmental policies on carbon emissions, renewable energies, transport impact mitigation and waste management have led to per capita carbon and waste reductions below the Organisation for Economic Cooperation and Development (OECD) average. Enhanced accountability for national and subnational environmental programmes would result in a higher rating.
Social responsibility and solidarity: People are the driving force behind any country. To achieve a harmonious and sustainable economic development and to enourage individuals to participate in its growth, a country must provide its people with access to education and health and create an environment where people feel secure and integrated.
Infant mortality is among the lowest in the world – Lowest in world compared to any other country. Gender equality remains unbalanced despite an increase in female labour participation. Commitments to improving education levels have resulted in an increase in school attendance.
Institutional responsibility: a country with low corruption and good political stability has a higher ability to adapt to changing economic and geopolitical conditions and will get higher investors’ confidence.
Political instability has historically been a key destabilising force with 60 different governments holding power since 1945. As of 2014, there has been a greater focus on reforms. Corruption remains a concern. Organised crime is still highly prevalent and corruption scandals arise regularly. The powers of the national agency to prevent corruption have been reinforced, which could improve thes rating.
3 Source: AllianzGI as at 30 April 2016.
The ESG rating of agencies and supranational issuers takes into account the actual purpose of these entities. For this type of issuers, indirect impacts are given a more important weight than direct impacts in order to focus on the actual impact the entity has on its environment.
Environmental risk management: Particular focus on the integration of environmental issues in projects financed by the entity (i.e. buildings, infrastructures), protection of biodiversity and natural resources, requirements on environmental issues from goods and services suppliers and contractors.
Social responsibility: Social dialogue, career management and health & safety conditions are also data we collect when carrying out the ESG analysis, with a special focus on human resources management by goods and services suppliers and contractors.
Corporate governance: focus on the transparency of the governance within the entity, corruption risks and how they are addressed, as well as conflict of interest issues.
Business Behaviour: focus on the actual impact of projects financed by the entity on the broad society, development projects, social inclusion, housing projects, education projects, responsible relations with beneficiaries and with goods and services suppliers and contractors.
All these issues can be very different depending on the actual purpose of the entity being analysed.
While the ESG ratings show how a company performs relative to its peers, ESG investment drivers focus on identifying long term trends that have a high potential of turning into material risks, that can have an impact on the investment case of a stock.
Each ESG Investment driver assesses the sensitivity (on a scale of -3 to +3) to the trend by taking into account the extent of exposure of a stock to the risk. The driving force behind the ESG Investment drivers is close collaboration between the ESG Team and fundamental analysts which provides a reality check on the relevance to the investment case.
Background: Demand for healthy, fresh and unprocessed food is rising and is expected to grow. Eating trends are changing as individuals are starting to take greater control over their diet having been warned for years on the risks of unhealthy foods, obesity and related health risks. Social media is playing an increasingly important role in shaping and influencing companies directly. At the same time, Millennials, generation born between 1980 and 2000, are entering their prime spending years. They are the smallest group in spending today ($2.45 trillion) but could be the next largest in 5 years ($3.39 trillion).
More so than previous generations, Millennials typically make ‘wellness’ a daily part of their lives and are more likely to maintain healthy eating habits. The emphasis on freshness, quality and ingredient transparency is growing, leading to a shift away from ‘processed’ to ‘fresh’ categories. Millennials are less brand-loyal but are value conscious and are willing to pay for specific attributes; they seek fresh, greater choice, more flavours and variety with a focus on natural and organic.
Eating on the go and snacking are important but these must be real and less packaged.
Conclusion: Those companies which are slow to innovate and adapt to changing consumer attitudes and preferences, will suffer from volume growth and a loss in market share. Companies that are investing in innovation, reformulation and a product offering that are able to cater to the greater push for health and wellness, via healthier production options, acquisitions, greenfield investments, new products, overhauling existing products to improve the nutritional profile and promote health and wellness message and a shift from processes to fresh categories stand to benefit.
Sensitivity analysis:
Food manufacturer: Company obtains approximately 85% of its revenues from snacks with chocolate and biscuits making up 68% of that total. Despite the product portfolio catering to the increasing trend in snacking and eating on the go, products are less ‘natural’ and ‘healthy’. Sensitivity -1
Beverage manufacturer: Company main product has a high sugar content which has been linked to obesity and poor diets. Sensitivity -2
Food manufacturer: Company has a relatively balanced product portfolio with some products leveraging well into the health and wellness theme. Sensitivity 0
Background: Investors are slowly reacting to the fact that climate change can and will have significant financial impacts on investments. The research of the Carbon Tracker Initiative, a non-profit organization working to align capital markets with the climate change policy agenda, highlights that if global warming was limited to the suggested two-degree level, then a limited amount of fossil fuels could be burned, which is below the level of reserves held on the balance sheets of global oil, gas and coal companies. These reserves would therefore become “stranded”.
Investment banks and rating agencies have embraced Carbon Tracker’s work and started considering what a carbon constrained world would imply for valuations of Oil & Gas companies.
Conclusion: There is a risk for institutional investors if parts of the fossil fuel assets become stranded in a low-carbon economy scenario. Stranded Assets Risk is defined as the percentage of total reserves with a potential write-off on reserves because of regulatory and economic risks that are likely to materialize and to shrink fossil fuel demand. Since Oil & Gas companies are still valued on their ability to replace reserves, the capital invested today into future Oil & Gas production is at risk of being stranded, which would translate into shareholders not getting the returns expected.
Our ESG energy analyst mapped the specific exposures and sensitives to major oil & gas companies around the global to gauge those businesses with the most risk exposure.
The objective of this ESG driver is to stress-test the sensitivity of the reserves of the underlying companies to impairment if there were a stricter carbon regulation implemented to limit global warming to 2°C.
Companies exhibiting a risk above 50%: Sensitivity -3 Companies exhibiting a risk between 50% and 20%: Sensitivity of -2 Companies exhibiting risk between 20% and 10%: Sensitivity of -1
This ESG Driver provided portfolio managers with a framework to understand and assess the risk exposure of companies held in their portfolios or potential holdings and manage this risk accordingly.
Background: We expect norms regarding sport sponsorship to shift going forward, exposing companies to increasing business ethics risks. Recent investigations and controversies regarding sponsorship deals of sport teams and criticism surrounding high profile events such as the Olympic Games or FIFA world cup (bribery and corruption but also human rights issues) indicate that norms are being challenged by regulators as well as NGOs (Non-Governmental Organisations).
Conclusion: As a consequence, corporate sponsors could suffer both reputational and legally/financially within the possibility of being involved in corporate bribery payments to gain sponsor contracts, and we therefore have a responsibility to evaluate company’s ability to manage this risk exposure by taking these into account.
Company specific sensitivity assessment is based on:
Risk exposure i.e. significance of sponsorship deals for driving business and connection of the business model to the relevant sport; use of media monitoring tool to assess association of company with high risk sporting events/ organisations.
Risk management i.e. controversies in the past; corporate governance practices and internal control processes.
Apparel Company 1: Significant risk exposure as key sponsoring partner of an international sports organisation & sports event host which has been under strong media and legal scrutiny. Sponsorship deal closely connected to company’s core business segment. Media monitoring tool shows strong correlation between sponsoring partner and company, indicating high reputational risk which could potentially negatively impact customers’ buying decision going forward. In terms of risk management, corporate governance and internal control processes show room for improvement. Sensitivity: -3
Apparel Company 2: While not a key sponsoring partner for the discussed sports organisation, allegations of corruptions surfaced in 2015 for sponsorship deal with a national team. Although this company is in strong competition with Apparel Company 1 to grow in the same sport segment, media monitoring tools indicate limited public scrutiny for this company’s sponsoring activities compared to Apparel Company 1. Risk management systems related to sponsorship are considered robust, including an extensive code of ethics. Corporate governance and board oversight are considered adequate. Sensitivity: -1
This ESG Driver provided portfolio managers with a sensitivity analysis of those companies most exposed to this risk.
Grassroots studies exemplify our commitment to going beyond traditional fundamental research and provide a unique source of information advantage to AllianzGI analysts and portfolio managers.
GrassrootsSM Research is a unique division within AllianzGI that uses a global network of journalists, Field Force investigators and industry contacts to conduct interviews with consumers, distributors, manufacturers in an effort to help AllianzGI to identify important stock and sector trends.
Using innovative market research and investigative journalism, GrassrootsSM Research gathers information on under-researched marketplace trends, the competitive environment and global business developments that affect our investments over different investment time horizons.
By going directly to the source, GrassrootsSM Research gives our investment professionals timely access to solid, research-based insights that help them make informed investment decisions.
The cases overleaf show examples of GrassrootsSM Research carried out in 2015.
Summary: The study focused on potential legislation changes to lower particle pollution values in major cities in France.
Objective: to identify plans that would lead to the implementation of legislative changes to lower particle pollution values for 2016.
Sources: 15 sources responsible for the environment/quality of air in major metropolitan areas in France.
Key findings: Particle pollution varies widely among the surveyed metropolitan areas in France, with half in line with or better than EU targets and half citing worse levels, with regional specifics (not only traffic) playing an important part as well (e.g. weather conditions, topography or polluting industries in close proximity). Nearly two-thirds are planning legislative changes directly affecting the transportation sector in 2016, while two-thirds are not planning any legislative changes for the passenger car sector—with metropolitan areas generally trying to make public transportation more attractive, introducing eco-stickers, offering free parking for eco-friendly transportation alternatives and establishing distribution zones to limit large delivery trucks in the city.
Summary: After the E. coli epidemic in the US in 2015, we requested a study of the effects of this on the restaurants chain Chipotle.
Objective: Examine the possible consequences and effects in the company at certain locations in the US.
Sources: This project was conducted via an online panel by interviewing 1,145 Chipotle Mexican Grill customers who visit at least twice per month in the six E. Coli – affected states: California, Minnesota, New York, Ohio, Oregon and Washington.
Key findings: 72% of respondents were aware of the recent E. coli outbreak at Chipotle restaurants, and among those who were aware, 57% said their visitation frequency will stay the same, while 22% said it will decrease.
Eighty-eight percent would recommend Chipotle to a friend or family member. Food taste/quality (43%) and convenient location (27%) were cited as the top areas in which respondents rated Chipotle completely superior to competitors.
This study gave our investment professionals research-based insights that helped them make informed investment decisions.
After another food safety incident in China in 2014, Grassroots completed a study on the sales and food supply recovery efforts of Pizza Hut restaurants in the country.
The objective was to assess current year-to-year sales comparisons at Pizza Hut restaurants in China and examine potential effects of the current economic slowdown and recent currency fluctuations on same-store sales.
Sources: 25 managers at Pizza Hut locations in China.
Key findings:
Half said Pizza Hut (Yum! Brands) sales in third quarter (June–August) 2015 vs. third quarter 2014 increased—by an average 3%—and three fourths said sales in August 2015 vs. August 2014 increasedby 5%. Two-thirds mentioned sales in third quarter 2015 were in line with expectations, one-fourth mentioned below, and a few said above.
Half of the managers thought sales in September 2015 to date are trending upan average of 2%and half said flat. Three-fourths said sales in September 2015 are in line with expectations.
The most expected overall sales took place in the fourth quarter (September–December) 2015 compared to the fourth quarter 2014. 2016 compared 2015 to increase by an average of 5% and 4%, respectively.
Three-fourths said sales returned to normal/pre–Husi scandal levels early this year, and two thirds said customers are no longer concerned with food safety issues. One-third said sales remain slow due to the Husi scandal, increasing competition and the economic slowdown.
This study provided first-hand information which helped us confirming that competition, the economic slowdown and an overall momentum shift in the Western fast food industry are the most important factors currently negatively affecting sales.
In response to new generational needs, Starbucks has adapted its business to the millennials generation by adopting new innovative strategies such as mobile ordering and payment systems.
Grassroots completed a study on the sales impact that the new mobile ordering/pay app has had on store sales.
Sources: 25 managers/assistant managers of Starbucks locations in the US where the Mobile Order & Pay app is currently offered.
Three-fourths said uptake of Starbucks’ Mobile Order & Pay app since the rollout is trending in line with expectations, while a few said uptake is trending above, and a few said below.
Almost all said overall store sales since the rollout of Mobile Order & Pay have remained flat due to its still being relatively new and mostly used by regular customers placing their usual orders.
All said the average transaction generated by Mobile Order & Pay is the same as an average in-store purchase, noting that most app users are regular customers placing their usual orders.
All said feedback has been positive regarding Mobile Order & Pay, with customers citing convenience and the capability to skip the register line.
Three-fourths said Mobile Order & Pay has made the average speed of service faster for customers by eliminating the need to wait in the register line, while one-fourth said the average speed has remained the same.
None has encountered technical issues with the implementation of Mobile Order & Pay capabilities in their stores. Half said the only downside is that currently it is only available for the Apple iPhone.
This study confirms the rollout of mobile order and pay is going well. It supports the thesis that it increases speed of service and shortens lines, which should eventually lead to higher sales.