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Supplements » ESG Report 2019

Sponsored feature: Hermes impact opportunities

In the ongoing effort to safeguard the planet, Hermes’ SDG taxonomy makes good use of the United Nations’ Sustainable Development Goals.

The Sustainable Development Goals (SDGs) are focused on addressing unmet and underserved needs. We believe companies whose activities contribute to achieving the SDGs are not only likely to create positive social and environmental impacts, but are also exposed to drivers of future growth. To identify investment opportunities directly connected to the goals, we have created an SDG taxonomy that is both precise and flexible, enabling us to target today’s – and tomorrow’s – impactful companies.

Why we need an SDG taxonomy?
The 17 SDGs are widely accepted as the key collective reference point for impact investing across asset classes. When they were agreed upon by the international community, they were designed to appeal to the broadest audience possible and were therefore not conveyed in a format tailored to investors.

For many investors, the default position has been to retrofit the SDGs within existing frameworks and processes, i.e. to relate them to current positions. This leverages the breadth of the 17 goals, but fails in achieving their objectives: to change attitudes and behaviours, and to attract incremental capital to address the goals. Given this situation, we believed that it was essential to develop a rigorous and structured taxonomy to demonstrate clear connections between the underlying targets of the SDGs and investment opportunities.

First and foremost, we aimed to establish which of the SDGs are actually investable through public equities or other asset classes. To deliver this, we delved much deeper than the 17 high-level goals, which are overarching objectives. Instead, we focused on the underlying 169 targets, which are much more specific in nature.

The Hermes SDG Taxonomy distils both targets and goals for sustainable development, and in doing so identifies the investable areas and themes on which investors should focus to support a positive contribution towards achieving the 2030 objectives.

The taxonomy brings integrity to our impact assessment, as well as full traceability of our portfolio investments back to the underlying SDG target. It also serves as a precursor to our thematic investment approach. Our nine sustainable investment themes, for example, can be traced back to SDG targets. It is through this taxonomy that we can demonstrate the complex interlinkages between the underlying SDGs and targets and ensure we only invest in areas that directly address these.

How we did it
We believe the SDGs are a valuable tool to identify investment opportunities and work towards the 2030 targets. The taxonomy can be a powerful source of ideas that address unmet needs and represent the beta of future growth.

Hermes’ SDG Taxonomy focuses on a detailed assessment of the targets underpinning the SDGs, analysing them through the theory of change (the sequence of events from inputs, outputs and outcomes that lead to impact) and the risks to the case for impact (the potential reasons why the theory of change may fail) as they relate to public companies. These are essential concepts in understanding impact potential.

We began with a deep examination of each of the 169 underlying targets, first assessing whether an SDG target was something that could be addressed through public equities. If it could, we moved on to consider the breadth of investable areas that could help achieve this target, thereby identifying emerging growth opportunities.

We then undertook a detailed theory of change exercise for each investable area identified. We used peer-reviewed academic research or reputable industry reports to validate the issues and contribution potential through investment in these areas. We concluded with a consideration of the impact risks i.e. the likelihood that impact will be different than expected through investment in the target area1.

What does the SDG Taxonomy tell us?
In our assessment, only 42 of the 169 underlying SDG targets, or 25%, are currently directly investable through public equities. This differs from a simple mapping of existing activities back to SDGs, where goals can be made to appear to be addressed, while in reality the investment decision-making process has not fundamentally changed.

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The taxonomy demonstrates that the SDGs are complex and interconnected: addressing them is more an art than a science. Without the taxonomy, there is no way of verifying with a high degree of certainty that impact investments contribute to the delivery of the SDGs in an expected way.

The Hermes SDG Taxonomy identifies all the investable areas captured by the SDGs, which, when collated and refined, produced our nine impact themes – a valuable source of insight for identifying future investment ideas.

How will it be used in the future?
The taxonomy can only be considered a starting point, albeit an important one, in identifying investment opportunities that can address the SDGs. We must then assess value chains and potential investments to look for impactful companies that can best deliver holistic returns, taking into consideration both financial merits and non-financial returns. This is followed by detailed impact-validation and measurement processes, and engagement with companies, before we make an investment decision.

The Hermes SDG Taxonomy is a living document, open to ongoing updates as and when we interact with academics, companies and research addressing the theory of change for each underlying SDG target. This is an adaptive process, not a prescriptive one.

As we continue to learn and interact with more parties, both internally and externally, the taxonomy will be refined to become a transparent resource in the development of impact investing.

The process is not asset-class specific. For illustrative purposes, only the public equities taxonomy has been presented here. The same approach can be applied to all asset classes, as well as in corporate engagement and stewardship, to determine how goals and tasks can be addressed irrespective of whether the asset is an equity or bond.

Over time, as we work towards targets and the investable universe evolves to reflect a constantly changing world, so too will the taxonomy. This will ensure it remains an essential component of our process for impact investing.

1 – Hermes is a member of the Impact Management Project. We integrated aspects of its outcomes, including the broad terminology used, for consistency.

For professional investors only. The views and opinions contained herein are those of the Hermes Impact Opportunities team, and may not necessarily represent views expressed or reflected in other Hermes communications, strategies or products. The information herein is believed to be reliable, but Hermes does not warrant its completeness or accuracy. No responsibility can be accepted for errors of fact or opinion. This material is not intended to provide and should not be relied on for accounting, legal or tax advice, or investment recommendations. This document has no regard to the specific investment objectives, financial situation or particular needs of any specific recipient. This document is published solely for informational purposes and is not to be construed as a solicitation or an offer to buy or sell any securities or related financial instruments. Figures, unless otherwise indicated, are sourced from Hermes. This document is not investment research and is available to any investment firm wishing to receive it. The distribution of the information contained in this document in certain jurisdictions may be restricted and, accordingly, persons into whose possession this document comes are required to make themselves aware of and to observe such restrictions.

The value of investments and income from them may go down as well as up, and you may not get back the original amount invested. Past performance is not a reliable indicator of future results.
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