Dunedin Income Growth | ESG

The board of Dunedin Income Growth believes that the incorporation of sustainable and responsible investment principles positions the company to deliver both faster dividend growth and enhanced risk adjusted capital performance as well as providing greater differentiation from its peers and widening its investor base.

The Company's investment manager, abrdn, believes that building a concentrated portfolio of high quality companies that meet its sustainable and responsible investment criteria will deliver both real income growth and attractive total returns over the long-term.

The application of sustainable and responsible investing principles enables abrdn to reduce risks in the portfolio by identifying and excluding companies whose business models it considers face significant threats from Environmental, Social and Governance (“ESG”) factors. It also enables abrdn to identify positive opportunities for companies to benefit from the same trends as well as giving the potential for engagement to improve companies’ performance and increase shareholder value.

A focus on high quality companies and sustainable and responsible investing principles is therefore well aligned with the generation of resilient and growing dividend income, and a capital return profile that is both robust in difficult market conditions and able to participate in upside opportunities, enhancing risk adjusted returns.

The investment manager's investment process has five stages:

1. Idea Generation
   abrdn’s teams of investment analysts generate investment ideas from their comprehensive coverage of the UK and European equity markets. This involves them considering the merits of over 1,000 listed businesses across the market cap spectrum.
2. Sustainability
   Companies with excessive ESG risks are excluded through a combination of pre-set screens and quantitative and fundamental analysis. This removes around a quarter of the companies monitored from abrdn’s consideration.
3. Quality
   Businesses that don’t meet the analysts’ quality criteria are then filtered out. Only around 20% of companies will meet this hurdle and abrdn particularly emphasises allocation to companies that are considered to be sustainable leaders.
4. Total Returns
   Focus is then placed on those companies that the analysts identify as having the most attractive total return potential as well as those that have compelling income generation characteristics.
5. Portfolio Construction
   abrdn then builds a concentrated portfolio that can deliver the income and total return requirements while matching the style and risk profile and meeting the sustainable and responsible investing principles.

abrdn believes that effective analysis of, and engagement with, the ESG risks and opportunities that companies face will enhance investors’ risk adjusted returns.

While sustainable and responsible investing principles were formally incorporated into the Company’s investment objective in 2021, a focus on ESG factors has been a long standing part of abrdn’s process, making the transition a relatively straightforward one

Those sustainable and responsible investment principles are integrated into the investment process through a combination of exclusions, positive allocation and ongoing corporate engagement. To deliver this, abrdn utilises binary screens, qualitative analytical assessment, proprietary quantitative tools and ongoing corporate access and voting policy.

abrdn draws upon three resources to assist it with the integration of ESG into the investment process; the team of approximately 30 equity analysts, on desk ESG analysts and the central ESG team.  Each plays an important yet distinct role in implementation. 

While deploying these resources, the ultimate responsibility for stock selection and portfolio construction lies with the Company’s portfolio manager

abrdn uses three different forms of exclusions. These are complimentary in form with binary exclusions providing assurance to shareholders that companies with certain types of business activities will not be invested in. Additionally, abrdn utilises both the judgement of its investment analysts and its own proprietary quantitative tools to exclude companies with poorly managed ESG risks.

1. Binary exclusions – these screens focus on areas where abrdn sees long-term risks arising from ESG factors to companies’ business models and, as a result, it chooses not to invest. These will be subject to ongoing review to ensure that they are consistent with industry best practice.

Norms-based exclusions

• Have failed to uphold one or more principles of the UM Global Compact.
• Are state-owned enterprises in countries subject to international sanctions or that materially violate universal basic principles

Tobacco

• Have a revenue contribution of 10% or more from tobacco or are tobacco manufacturers

Weapons 

• Are involved in controversial weapons including closer munitions anti-personnel landmines, nuclear weapons, chemical and biological weapons, depleted uranium ammunition and binding lasers
• Have a revenue contribution of 10% or more from the manufacture or sale of conventional weapons or weapons support systems

Environment

• Have any revenue contribution from thermal coal extraction
• Have a revenue contribution of 10% or more from unconventional oil and gas extraction or are investing in new unconventional extraction capacity in their own operations
• Are primarily involved in conventional oil and gas extraction and do not have a significant revenue contribution from natural gas or renewable alternatives
• Are directly involved in electricity generation which has a carbon emission intensity inconsistent with the Paris Agreement 2 degrees scenario
• Are directly investing in new thermal coal or nuclear electricity generation capacity in their own operations

2. ESG House Score – this is a proprietary quantitative tool that scores the companies in the investment universe on operational and governance risks. abrdn excludes the bottom 10% of companies from consideration for the portfolio.

3. ESG Quality Score – every company under research coverage is judged by the analysts on the quality of its management of ESG risks. Companies deemed to be below average are excluded from consideration for the portfolio.

The number of investible companies is reduced by 23% due to the effect of the three screens.

The Company also commits to having a carbon intensity of less than 80% of the FTSE All-Share Index, which constrains investment in high carbon emitting companies.

The Company’s portfolio currently has a Carbon Intensity on Scope 1 and 2 emissions of 64%, and 76% on Scope 1 to 3 emissions.

On a total emissions basis, the portfolio sits at 34% of the benchmark on Scope 1 and 2 emissions and 44% on Scope 1 to 3 emissions.

Further details of the portfolio's carbon intensity scoring can be found in the Annual Report.

Companies that investment analysts score highly on the quality of their ESG risk management are designated as sustainable leaders. Those sustainable leaders that have a high alignment of revenues or investment with the UN sustainable development goals will additionally be designated as solutions providers. The majority of the Company’s portfolio will be invested into sustainable leaders and abrdn will actively search for opportunities where it believes these attributes to be undervalued.

Companies that are scored as average in ESG risk management are designated as improvers. Clearly defined opportunities for improvement are identified by the team of investment analysts in conjunction with the abrdn’s on-desk ESG analysts and central ESG team, and these are closely monitored from initiation through to completion. abrdn believes that effective engagement presents a significant opportunity to add shareholder value over time.

During the year ended 31 January 2022, the Investment Manager had 72 separate meetings with portfolio companies where ESG topics were raised, covering 37 of the 39 holdings. 12 of these were dedicated priority engagement meetings, addressing areas of material improvement. By topic, Corporate Governance was the area most discussed, but there was also significant focus on Climate and Environment and increasingly, on Social Issues.

Engagement case studies can be found in the Annual Report.

Voting policy forms an important part of abrdn's corporate engagement approach. Every proxy is voted and, where needed, input sought from the investment and ESG analysts in conjunction with the expertise of the central voting team. Where direct engagement has not proven effective, abrdn is very prepared to vote against companies.

abrdn voted against management recommendations in 27% of the general meetings held by portfolio companies during the year, which it thinks is the most useful metric for measuring the level of its constructive engagement. The overall number of votes against was 2.3%. It is important to bear in mind that abrdn typically begins from a position of support for the select group of companies it invests in.

There is an extensive ongoing programme which allows abrdn to actively engage with investee companies throughout the year beyond the voting season.