Schroder Japan Trust | ESG

The Company delegates to its Manager the responsibility for taking environmental, social and governance issues into account when assessing the selection, retention and realisation of investments. The Board expects the Manager to engage with investee companies on social, environmental and business ethics issues and to promote best practice. The Board expects the Manager to exercise the Company’s voting rights in consideration of these issues.

The Company voted all of its proxy votes in line with the Manager’s corporate governance policy. This covered 835 resolutions, of which the Company voted against management recommendations or abstained on 5.5%. Voting instructions are considered on a case by case basis and are a result of continued engagement with the Company’s holdings. Where the Manager believes the interests of minority shareholders are not adequately protected, they may look to vote against a variety of issues. These can range from a lack of independence or diversity on Board’s pay packages which are not aligned with performance and capital issuance requests which are not in minority shareholder interests.

In addition to the description of the Manager’s integration of ESG into the investment process and the details in the Manager’s Review, a description of the Manager’s policy and its engagement with investee companies on these matters, can be found on the Schroders website at https://www.schroders.com/en/sustainability/active-ownership/voting/.The Board notes that Schroders believes that companies with good ESG management often perform better and deliver superior returns over time. Engaging with companies to understand how they approach ESG management is an integral part of the investment process. Schroders is compliant with the UK Stewardship Code and its compliance with the principles therein is reported on its website.

The Board has received reporting from the Manager on the application of its policy.

Schroders has been considering Environmental, Social and Governance (“ESG”) issues, and sustainability generally, for over 20 years. Schroders has a team of 20 dedicated ESG analysts within its Sustainable Investment Team, based in London. They analyse long-term trends and implications around sustainability and how this is likely to affect different industries and stakeholders. The team operates as a central resource to both disseminate trends and analysis to the rest of the group and also provides training and input to the Manager’s Japan equity analysts when they are undertaking their sustainability work as part of their industry and company research. Schroders uses research on sustainability to make more complete and informed investment decisions.

The Manager embeds this thinking on sustainability and ESG issues into the process for Japanese stock research and portfolio construction for the Company.

Idea generation is driven by bottom-up, internal research produced by the Manager’s analysts based in Tokyo. Investment views are structured around a long-term assessment of quality and, central to this is an opinion on the sustainability of a company’s business model. Meetings with management are the bedrock of this research process and ESG factors are integrated throughout. These views are explicitly quantified by each analyst within the proprietary Fair Value Model for each stock under coverage.

By forming a structural element within the Fair Value model, the positive and negative scoring applied to ESG factors contributes symmetrically to the portfolio manager’s views of both downside risk and upside potential for each stock.

Within the Japanese equity market, where disclosure and analysis of ESG issues is relatively new, it is critically important to identify, and differentiate between, early signs of positive change, even if some of these still appear modest in comparison to other developed markets. By identifying strengths, weaknesses and changes in these areas, especially in governance, the Manager can materially strengthen their understanding of companies and improve investment decisions.

ESG factors rank alongside other criteria for assessing the Manager’s view of a company’s fair value. As a result, provided there are no “red flags” which would prohibit investment, it is still possible for some companies with weaker ESG scores to be included in the portfolio, if other factors are sufficiently positive. In practice, however, the Company would only take such a position if the Manager also saw scope for the company to improve its ESG position. For some individual stocks, such as tobacco companies, the Manager’s views are strongly influenced by consideration of social externalities and regulatory risk, and it is increasingly unlikely that any new investment would be made in these areas.

Schroders aims to continuously evolve and improve the investment approach to ensure that these processes remain forward-looking, especially in relation to ESG factors. The introduction of the Japanese Stewardship Code in 2014 and the Corporate Governance Code in 2015, together with subsequent revisions, has underlined the Japanese authorities’ desire to drive improvements in corporate governance. Schroders’ Japanese office became a signatory to the Japanese Stewardship Code in 2014 and in 2015, established a Stewardship Committee to engage with companies on their ESG activities with the aim of encouraging best practice and influencing change over time. The Manager’s commitment to stewardship and corporate governance is evident in company research and in the debate that takes place both internally and when interacting with company management. Looking forward, further regulation on ESG disclosures is expected in Japan and the Manager has already begun proactively engaging with companies on these issues.

The Manager’s local Stewardship Committee is also responsible for all proxy voting and will discuss any contentious items with the relevant internal parties. The committee members are also in regular contact with the proxy voting team in London, to ensure that views are aligned and that consistent messages are being sent to companies. All voting records are disclosed as required by the 2017 revision of Japan’s Stewardship Code.

While E&S factors are an important part of the analysis, the Manager currently place most weight on the assessment of a company’s governance, and shareholder returns. In recent years the particular emphasis has been on sustainable improvements to return on equity and enhanced shareholder focus, where tangible results have been seen. Progress in these areas will increasingly be linked to whether a company also has the ability to adapt to the increasing risks from specific E&S factors, such as climate change and data security, as well as being able to demonstrate this clearly to stakeholders.