Shape a Better World Societally and Environmentally via Impact Investing - Q&A with Nikko AM

FSMOne.com: With ESG investing gaining more attention from retail investors, what are the key differences between impact investing and ESG investing and why should investors pay attention to impact investing?

Nikko Asset Management (“NikkoAM”): Impact investors focus on the change that can result from what a company produces and sells.

ESG investors are concerned with how a company does business and treats its stakeholders – evaluating issues such as customer safety, employee relations, or board structure in the course of company analysis.

To be considered for our impact portfolio, however, a company must have a measurable positive effect on society or the environment through its core products and services.

With the impact universe, we believe companies with positive ESG have the potential to outperform the market and may do so with less volatility. ESG is incorporated as part of the Underlying Fund Investment Manager’s research mosaic for those same reasons, but their research starts with impact criteria. Ultimately, our intention is to invest in companies having a positive impact by virtue of what they sell and how they conduct their business operations.

These are the three reasons why investors should pay attention to Impact Investing:

Generalised ESG integration (into investment processes, practiced by most managers of institutional capital) is often conflated with impact investing, which is more targeted at achieving both financial returns as well as measurable improvement of ESG outcomes.

The tables below show a (non-exhaustive) summary of different approaches to sustainability investing:

FSMOne.com: To some investors, ESG and impact investing may be too restrictive as it limits the type of investments that they can make, do you agree with this statement? For the fund, are there any limitations brought about by impact investing, how does the fund identify opportunities given the seemingly narrower investible universe?

NikkoAM: By default, whether it is applying an ESG lens when choosing investments, or investing only into companies whose core products or services address some of the world's major social and environmental issues, it is screening down the broad universe of securities with some criteria. However, we believe we are actually screening in companies with better growth potential, yet underrepresented by indexes and have more market mispricing to capitalize on, with our impact criteria.

For the Global Impact Fund and Global Impact Bond Fund, we apply 3 criteria to screen down the broad universe to our impact opportunity set. These criteria are material, additional and measurable.

Although the Global Impact Fund is not an ESG fund, in that we do not try to pick the highest ESG-rated companies, 100% of our portfolio is sustainable investments, and tobacco, firearms, defense, nuclear, coal, petroleum, alcohol, adult entertainment and gambling are excluded.

Applying these criteria and exclusions, we are able to identify nearly 500 companies as our impact equities opportunity set. From this opportunity set, we typically pick 50-70 names with an investment process that the portfolio manager has been using for decades. We think that this opportunity set is large enough for us to pick 50-70 names from, and do not feel restricted from an incremental returns generation perspective. Our impact opportunity set has a better historical sales growth and projected earnings per share (EPS) growth than the MSCI All Country World Index.

By using the framework of Materiality, Additionality and Measurability and through the collaboration of our fixed income and equity research analysts, we have been able to identify not only labeled impact opportunities like green bonds, but we have also uncovered unlabeled opportunities. With this in mind, the bond market actually has even greater breadth than public equity markets for impact investing, and this is because there are a number of areas that are either driven by local municipalities, Governments, supranationals or their agencies, as well as the securitized debt space, which sit outside of the corporate bond market that would overlap with public equities. A great example is the mortgage market where affordable housing finance is being provided by government agencies and building societies. The broad impact universe defined by our framework is now over US$1 trillion, so we feel very comfortable in our ability to find opportunities where we can meet that double bottom line.

FSMOne.com: Are there are any globally recognised framework that the fund uses to assess and evaluate the ESG / impact performance of companies?

NikkoAM: Our exclusions as explained above align with common standard. Our impact measurement follows a framework we have developed, where we apply a key performance indicator ("KPI") logic chain, which is a linear path of capital from investment through desired impact outcome. We determine what should be measured at different parts of this KPI logic chain, and then measure who is impacted, how much is the impact, contribution to the world in terms of addressing social and environmental challenges, and potential risks.

FSMOne.com: What are the main risks that investors should be aware of when they start their own ESG / Impact investing?

NikkoAM: There are a number of risks that investors should understand, the most apparent is the breadth of what can be defined as ESG to impact investing. Frankly there is no single approach that fits every investor’s needs, so an investor should understand their own values and if a manager aligns with it. It is our view that when assessing a manager’s capabilities in this space you want to determine the overall commitment to sustainable investing as a firm, the metrics and criteria a manager uses to hold your portfolio accountable, and the level of engagement a manager has with portfolio companies.

Many impact companies have differentiated business models, smaller market capitalization, are in emerging markets, and do not have sell-side coverage. As such, the investment risk can be higher than investing into say a global equities fund with similar portfolio characteristics as the MSCI All Country World Index which has only 5% in companies with less than US$10 billion market cap.

Regarding our Global Impact Fund, we expect to see concentration in smaller cap and high volatility stocks that are susceptible to poor performance in significant “risk off” environments. In addition, the portfolio invests across 11 impact themes which generally results in higher representation to traditional Global Industry Classification Standard (GICS) sectors like health, information technology, utilities, telecommunications, and industrials; and less representation to the energy, materials, financials and consumer sectors. While we expect the Global Impact approach to outperform the broad market over full market cycles, bifurcated periods when the latter sectors drive equity returns may be unfavorable for the approach.

FSMOne.com: What is the impact investing scope that the fund is focused on?

NikkoAM: The Global Impact Fund and Global Impact Bond Fund invest into 11 themes under 3 areas that capture both demographic and economic trends:

- Basic needs that are essential for life, including access to affordable housing, clean water and sanitation, sustainable agriculture and nutrition, and health.

- Prerequisite or tools for human empowerment, including safety and security, education and job training, bridging the digital divide, and financial inclusion.

- Companies that help protect the environment, including those providing or contributing to alternative energy, resource efficiency and resource stewardship.

FSMOne.com: How different is the Nikko AM Impact Investing Multi-Asset Fund’s investment process when compared to a typical global equity/bond fund? How does the fund construct its portfolio?

NikkoAM: The differences include:

FSMOne.com: What sets the Nikko AM Impact Investing Multi-Asset Fund apart from the other ESG funds?

NikkoAM: We do not try to pick the highest ESG-rated companies but instead, we invest into companies whose core products and services address some of the world's major societal and environmental challenges. Unlike some sustainable investment funds that apply negative screening to screen out the so-called irresponsible or sin stocks, we apply positive screening based on our criteria as explained above. Compared to certain sustainable thematic investment funds, which focus on specific themes such as infrastructure, water scarcity or alternative energy, our fund is an all-in-one solution to help shape a better world from societal and environmental perspectives. The approach is designed to also generate incremental returns. We describe this as the “double bottom line”.

Nikko AM PSG’s dynamic asset allocation incorporating macro research and market views provides (1) incremental returns via medium-term asset allocation and (2) short-term risk management to reduce or prevent deep relative decline against reference benchmark.

FSMOne.com: What are the key considerations behind the asset allocation of the fund?

NikkoAM: Nikko AM PSG’s macro research framework comprises:

(i)                  Market Monitoring – provides understanding of market conditions, cycle awareness; tracks market trends, outliers and inflection points; helps generate both dislocated opportunities for asymmetrical return and priorities for risk management.

(ii)                Deep Dive Research into specific opportunities and risk-return drivers; covers position structuring and implementation; identify catalysts, investment horizon and exit strategies.

(iii)               Combining the above framework with regular, in-depth engagement with the Underlying Fund Investment Manager’s portfolio management teams helps Nikko AM PSG to better grasp the key risk positioning of the Underlying Funds and tweak the dynamic asset allocation accordingly under different market conditions.

FSMOne.com: Can you share some examples of the sectors and companies that the fund has been invested in and are good representations of impact investing?

NikkoAM:

Note: Reference to any particular securities or sectors are purely for illustrative purposes only and does not constitute a recommendation to buy, sell or hold any securities or to be relied upon as financial advice in any way. Any specific security identified is not representative of all of the securities purchased, sold, or recommended for the Fund. It should not be assumed that an investment in the security identified has or will be profitable. Actual holdings will vary and there is no guarantee that the Fund will hold any or all of the securities listed.

Global Impact Fund:

Global Impact Bond Fund

We have found impact opportunities across the broad spectrum of impact themes, from Affordable housing, Education, Financial Inclusion to Resource efficiency and stewardship. A few representations of these opportunities are below:

FSMOne.com: Are there any geographical markets / sector that the fund is more overweight or bullish on? Why?

NikkoAM: 

Note: Reference to any particular sectors are purely for illustrative purposes only and does not constitute a recommendation to buy, sell or hold any securities or to be relied upon as financial advice in any way.

Global Impact Fund:

Geographical and sector weight are a result of our bottom-up security selection, subject to our portfolio construction parameters on theme weight (typically no more than 25% for each sub-theme) and cap on emerging markets weight of 40%.

In terms of themes, we are able to include more companies in the health, resource efficiency, alternative energy and financial inclusion themes, and in terms of region more companies based in North America, followed by Emerging markets, that meet our 3 criteria into our impact opportunity set currently, but this may evolve over time. We then apply an investment process that our portfolio manager has been using for decades to select stocks out of this impact opportunity set. 

We believe that the infrastructure spend in the US will provide opportunities for companies within our resource efficiency and clean water & sanitation themes, in particular, to continue to innovate and create value, both for society and shareholders. Improving infrastructure is key to building climate resiliency to the increasingly frequent and severe adverse weather events. 

We also see attractive opportunities within the financial inclusion theme and health theme.

Global Impact Bond Fund:

Our portfolio positioning is a function of our consideration of quality and credit risk posture, interest rate risk and duration we are comfortable holding relative to the broader benchmark as we aiming to outperform the Bloomberg Global Aggregate Hedged to US dollar Index. We consider these factors in the context of the opportunity set of impact themes we can access and relative value in spreads across the different credit subsectors^[1].

Government and Government related represents the largest allocation of the portfolio. Lending to municipalities, governments and supranationals provide financing at compelling spreads to high quality issuers that spans a number of compelling themes such as, Education and job training, clean water and sanitation, and sustainable agriculture as a few illustrations. By looking at materiality, additionality and measurability combined with traditional fixed income analysis of spread, yield curve^[2] and default risk provides us a broader framework to identity issuers and securities that aren’t accurately priced by the market as yet, as such we are quite positive on this opportunity set.

Investors who are interested to find out more about the fund can click here to proceed to this article (Fund Launch: Nikko AM Impact Investing Multi Asset Fund - How to Subscribe & Exclusive IOP Promotion) to find more details on the subscription process and how they can enjoy an exclusive IOP promotion from 9 September to 11 October 2021.

These answers are provided by Nikko AM Asia Limited and Wellington Management Company LLP, the Underlying Fund Investment Manager. All views expressed are based on available information as of September 2021.

Important Information:
This document is purely for informational purposes only with no consideration given to the specific investment objective, financial situation and particular needs of any specific person. It should not be relied upon as financial advice. Any securities mentioned herein are for illustration purposes only and should not be construed as a recommendation for investment. You should seek advice from a financial adviser before making any investment. In the event that you choose not to do so, you should consider whether the investment selected is suitable for you. Investments in funds are not deposits in, obligations of, or guaranteed or insured by Nikko Asset Management Asia Limited (“Nikko AM Asia”).

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