Sustainability: integration focused on financial materiality
October 23, 2024
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7 min read
A small subset of active managers is able to deliver consistently high-quality investment performance. A different, equally small subset has developed meaningful sustainability capabilities
However, there is little overlap between these managers, meaning there is a gap for strong investment management that also incorporate ESG factors in a way that is financially material.
“A sizeable part of the institutional market is looking for this combination of capabilities,” says Colleen Denzler, chief sustainability officer at Loomis, Sayles & Co., an affiliate of Natixis Investment Managers. Loomis Sayles believes aligning investment skills with financially material ESG that adds value is a hugely underserved element of the market.
A differentiated ESG integration model
There are many ways for an investment firm to address sustainability issues. Loomis Sayles believes its ESG integration model is differentiated from the market in how it has been conceived and developed.
Under the leadership of Denzler, who has worked in investment, portfolio management and sustainability roles in the asset management industry for more than 35 years, Loomis Sayles embarked on a project to build on its existing sustainability capabilities. Denzler and her team, working with the investment teams, have developed a Sustainability philosophy, rooted in Loomis Sayles’ 100-year tradition of bottom-up research, and based on four key pillars.
The first, a proprietary research framework, utilizes forward-looking fundamental analysis, customized data capabilities, curated ESG information and proprietary technology platforms to aid in identifying and understanding material sustainability considerations.
Second, it is centred on valuation determinations. Loomis Sayles believes integrating financially material ESG factors is necessary to fully value securities and understand opportunities and risks. “Disciplined portfolio construction requires constant assessment of these considerations at both security and portfolio levels,” Denzler notes.
Third, engagement across all asset classes is a core component of the proprietary analysis. “We believe direct engagement promotes transparency, raises awareness of risks and opportunities, and can unlock investment value,” says Denzler. Within the equity space, exercising proxy voting rights is an important aspect of engagement.
Fourth, the Loomis Sayles integration model was designed to be client-centric. Denzler says: “As client sustainability preferences evolve, we must be nimble in providing customized solutions that reflect our clients’ specific goals and values.”
Genuinely integrated research
From the outset, Loomis Sayles set out to address sustainability in a way that was differentiated from the market. While some of its peers created ESG teams that operated independent of the main investment activities, producing their own lists of companies and drawing up exclusion lists, Loomis Sayles devised a genuinely integrated research process with no silos and no artificial restrictions.
“We have a large number of investment teams. My first job was to bring many of our investment leaders together to create a shared sustainability philosophy,” Denzler says. “It was important the process was collaborative and not top down.”
A collaborative exercise necessarily entails creative tension, but not the kind of long-lasting tension that exists in a “them” and “us” structure when investment and ESG teams sit in different parts of an organization. As a former portfolio manager as well as a sustainability specialist, Denzler knows the importance of bridging the divide. “Some of our ESG peers get burned out due to the tension between the ESG and investment teams. It is not like that here: it is not a fight; the way we have developed our approach means we are in this together.”
In the end, it’s all about adding value
Loomis Sayles’s overriding concept for its investment activities is to add value for clients rather than exclude entire industries or introduce similar artificial constraints on portfolios. Portfolios with exclusions are client-directed and tailored to meet client-specific investment objectives.
Denzler says: “Our teams understand this concept, and they also understand that the risks are changing fast. Climate transition risk is perhaps the biggest risk of my investment lifetime and we would be doing our investors a disservice if we did not address it head on.”
For this reason, Loomis Sayles’s ESG research efforts are focused squarely on financial materiality. Loomis Sayles believes the changing risks will not only impact the downside, but there is huge potential upside that portfolio managers don’t want to miss either. “At Loomis Sayles, we are investment people,” she says. “We want strong long-term performance for our clients.”
For Loomis Sayles, financial materiality is not about distant ESG risks and opportunities that may be present in the marketplace broadly, but factors that are likely to be material within a portfolio’s investment horizon. For fixed income portfolios, risks over three- to seven-years can be most relevant. Time horizons for Loomis Sayles’ equity portfolios are already far longer than industry norms, so longer-term ESG risks are integrated.
Engagement: efficiency through focus
The proprietary ESG framework lends itself to effective engagement since Loomis Sayles produces its own proprietary data, in addition to leveraging third-party data, giving research teams full command over the information used. Denzler says: “This is one of our biggest strengths as a firm. Many sustainability teams struggle to find and deploy the right data, but we have invested heavily in our data and this enables us to engage more meaningfully with companies.”
For some Loomis Sayles equity teams, engagement is carried out well in advance of the decision to include a company in the portfolio or not. In this way, engagement is an inherent part of the teams’ due diligence. When a company becomes part of a portfolio, engagement helps to maintain the quality bias that some of Loomis Sayles equity strategies seek in their investments. “Backing great management teams is critical there,” Denzler says.
Engagement is resource-intensive. Within their centralized fixed income credit research team, Loomis Sayles has created a “focus list,” currently less than 75 names, on which the deepest engagement effort is concentrated. “The companies on this list are those for which Loomis Sayles believes engagement will move the needle,” Denzler says.
Moving the needle need not involve grandiose goals, such as persuading oil majors to switch to renewables. Denzler says: “We think about what we can ask them to do in a reasonable timeframe, aiming for a tangible valuation improvement through spread tightening or better equity valuations.”
Loomis Sayles fixed income analysts track engagements by objective and timelines, escalating issues with management teams if necessary and within a dedicated proprietary framework.
Importantly for the co-creation of value, all analysts and portfolio managers have visibility over the progression of ongoing engagements using Loomis Sayles’ proprietary engagement database.
Client-centric: transition and reporting
As an investment firm serving mainly institutional investors, handling bespoke client requests is largely built into Loomis Sayles’ DNA.
Command of its own data has also enabled Loomis Sayles to help clients meet specific transition or net zero goals. Denzler says: “Some institutional investors make commitments and may not know exactly how to fulfil them, so we partner with them to set a strategy, identify opportunities and help them both overcome present issues and anticipate future issues.”
Loomis Sayles provides customised reporting to some clients too. “We are being asked to do this more and more,” says Denzler. “We have found that having control of your own data is essential to meet these needs.”
Build and evolve
The integrated ESG investment process Loomis Sayles has created is designed to be enduring and to be built on as the years go by and as ESG factors and analysis develop.
“We will constantly adapt our techniques as new information comes to light, and improve and expand our ESG reporting, as well as collaborate with leading-edge providers, Denzler says. “In short, we will evolve and invest to ensure we remain a trusted, and rational fiduciary partner to our investors.”
