Barings Emerging EMEA Opportunities | ESG

Barings Emerging EMEA Opportunities PLC (BEMO) delegates investment management of the Company’s portfolio to Barings Fund Managers. The below outlines Barings approach to ESG integration and active engagement utilised for each company held within the BEMO portfolio.  For further information please refer to the company’s annual report, which can be found on our website.

Barings has adopted an integration approach to ESG incorporation primarily because fundamental, bottom-up analysis is the heart of our investment philosophy. It is through fundamental analysis, which includes ESG factors along with a range of other potential risks and opportunities, that we evaluate factors that may impact companies and industries.

How ESG Adds Value

We consider ESG factors among some of the most important variables that can impact an investment’s risks and returns over time. As part of our overall commitment to delivering attractive risk-adjusted returns, we endeavour to construct portfolios that meet our clients’ risk-return requirements and this includes incorporating ESG criteria into our investment process.

Our Dynamic Approach

Our ESG assessment is a proprietary component of our fundamental research, which impacts both our valuation of the company being researched and our assessment of its quality. This ESG assessment is dynamic, as our investment professionals look for signs of improving or deteriorating ESG standards. Our dynamic approach enables us to uncover potential unrecognised investment opportunities, whilst also mitigating risks.

Proprietary Assessment

ESG is an integral step of our research and our proprietary ESG analysis is dynamic rather than static. We closely monitor the companies we invest in for improvements or deterioration in their attitudes to ESG and reflect this in our scoring of the quality of each business and the appropriate valuation. We use a summary sheet (see example below) to capture the ESG performance of the companies in which we invest. The following three main categories constitute the framework for our assessment:

• Sustainability of the Business Model (Franchise)
• Corporate Governance Credibility (Management)
• Hidden Risks – Including environmental and social (Balance Sheet)

Within each of these three main categories, we identify three further subcategories - giving a total of nine key topics - which are relevant areas of potential risk or opportunity. It is our view that ESG considerations should have an impact on two elements of our research: both the qualitative assessment of a company as well as its valuation.

ESG and its Impact on Company Valuation

Our ESG considerations influence the company-specific risk premium we allocate to each company, for the purposes of valuation and identifying share price upside. For every stock our analysts cover, each of the nine subcategories will be rated one of the following:

• Unfavourable
• Not Improving
• Improving
• Exemplary

Each subcategory is equally weighted and the sum of the nine ratings corresponds with a premium, or a discount, that is added to the company’s Barings Cost of Equity (COE). To explain how the COE for each company is adjusted to reflect the individual ESG score, a low ESG score would translate into an addition to the discount rate of up to 2%, thus penalising the stock and reducing its attractiveness by decreasing its current valuation. The rationale is that a company associated with poor ESG is likely to have higher risks that should be reflected in its discount rate. Conversely, a high ESG score can indicate an exemplary company that is lower risk and can result in a reduction of the COE of up to 1%. Hence the adjustment to the COE ranges between +2% to -1%.

Below highlights the key topics of our proprietary ESG framework.

Sustainability Of The Business Model:

• Employee Satisfaction (Staff Turnover; Strikes; Fair Wages; Injuries; Fatalities; Unionised Workforce; Training and Education)
• Resource Intensity (Water Usage; GHG Emissions; Energy)
• Traceability/Security In Supply Chain (Traceability Of Key Inputs; Investments In Protecting The Business From External Threats, e.g. Cyber Security; Backward Integration (Protection Of Key Inputs))

Corporate Governance Credibility:

• Effectiveness Of Supervisory/Management Board (Separation Of Chair & CEO; Size Of Board; Independence Of Board; Frequency Of Meetings; Attendance Record; Voting Structure; Female Participation on Boards.)
• Credibility Of Auditing Arrangements (Credible Auditor; Independent Audit Committee; Qualification To Accounts)
• Transparency & Accountability Of Management (Access To Management; Financial Reporting; Tax Disclosure; Appropriate Incentive Structure; Gender and Diversity Considerations)

Hidden Risks on the Balance Sheet, Including ESG consideration

• Environmental Footprint (GHG Emissions; Carbon Intensity; History Of Environmental Fines/Sanctions; Reduction Programmes In Place For Water/Waste/Resource Intensity, Air Quality)
• Societal Impact of Products /Services (Health/Wellness implications of Consumption of goods/services; Product Safety issues ; Community Engagement)
• Business Ethics (Anti-competitive practices; Bribery/Corruption; Whistle-Blower Policy; Litigation Risk; Anti-Slavery and Human Rights; Freedom of Speech)

We undertake active engagement to positively influence ESG practices and/or improve ESG disclosure. We engage with companies and prefer this approach over blanket exclusions of entire sectors, as we believe it not only has a greater chance of successfully effecting change, but also a greater chance of enhancing the performance of our investments, for the benefit of BEMO clients.

The prioritisation of engagement activities is driven by our proprietary assessment of the materiality of ESG factors affecting a company. This materiality is guided by the Sustainability Accounting Standard Board’s (SASB) research on material issues by sector, but fundamentally is determined by our investment professionals’ in-depth knowledge of the ESG risks facing a company.

Furthermore, we are signatories to the United Nations’ Global Compact and Principles for Responsible Investment (PRI). As such, our investment professionals engage with companies to ensure that ESG standards are increasingly adopted across the world, and which, at a minimum, meet fundamental responsibilities in the areas of human rights, labour, environment and anti-corruption.

When an analyst identifies specific ESG issues that need to be addressed, a formal engagement plan is prepared. This plan forms the framework for our interaction with companies on the identified ESG issues. Each engagement will have clearly defined objectives that address relevant areas of potential risk or opportunity for the company. We regularly monitor progress and review our engagements periodically for achievement of established targets. This is in line with our dynamic approach to assessing corporate ESG behaviour and, furthermore, makes it easier to identify whether there is a need for escalation.