In the most part, a company’s valuation cannot be explained purely by its financial metrics. There are therefore a number of techniques that active managers use to assess the quality of companies and, in turn, seek to deliver added value to investors.

In carrying out deeper dive analysis of an opportunity, many managers at Henderson use a range of approaches. At an industry level, some of these techniques are grouped together under ESG (environmental, social, and corporate governance) investing. While most of Henderson’s investment teams do not explicitly manage products to ESG criteria, certain techniques help form a three dimensional view of a company, and may increasingly differentiate the make-up of active and passive portfolios across the industry.

At Henderson, we believe there is an underlying logic to the ESG ethos – companies engaging in unsustainable or unethical business practices, with short-termist or inexperienced management teams, are unlikely to make sustainable returns for investors. Indeed, research from Deutsche Bank, HSBC and Harvard Business School, suggests a more holistic approach helps drive outperformance and is an important part of investing that is missed by many passive funds.

The factors considered important when assessing companies are many and varied. They can range from the impact of climate change, the use of clean energy and technology through to shifting demographics, the use of artificial intelligence and assessing sustainability within the supply chain. Reputational risk carries significant weight in financial markets, and how investment managers engage with companies can have marked implications for portfolio returns. Incorporating these considerations within a passive approach is challenging. At Henderson the vast majority of managers take these factors into account and place significant value on meeting company management to properly assess the risks.

Here we explore some of the techniques employed by a selection of Henderson’s leading managers, and examples of putting them into practice:

In the technology sector, founding owner control is often mistaken for a lack of corporate governance. We take a broader view considering the founders’ track record and appreciating the founder-shareholder alignment in terms of long-term value creation. Facebook, one of our largest holdings, is an example of this. Facebook has a split share structure with the ‘A’ class shares giving founder Mark Zuckerberg ‘super-voting’ power, which allows him to maintain control over the company with public shareholders having no right to vote on corporate governance issues.

This arrangement would likely raise a red flag for certain companies we analyse. However, as experienced investors in technology who focus on longer-term drivers like barriers to entry, we believe that shareholders can often be better rewarded by being aligned with founders who have a strategic focus – rather than with other shorter-term investors who may have a different agenda. For example, in the early stages of Facebook’s evolution, Yahoo! offered around $1bn for its acquisition – Zuckerberg turned the offer down even though many of Facebook’s executives and investors wanted to sell. Since coming public, the company has focused on user experience over profitability and made what were, at the time, controversially-valued acquisitions, such as Instagram ($1bn) and WhatsApp ($19bn). These decisions may not have been agreed by shareholder vote, but it is these bold moves that have helped Facebook become one of the world’s most valuable companies (now worth over $400bn). This example shows we believe in being pragmatic when assessing opportunities and we continue to actively engage with Facebook’s management to understand their underlying thinking and approach to important responsibilities on privacy and the environment.

There are a number of studies on the impact of ESG investing in fixed income; one report in 2015 by Barclays¹ has shown that incorporating ESG criteria in the investment process can result in small, but steady, performance benefits. Others have indicated that corporate governance factors typically have the strongest correlation with a company’s creditworthiness. As ESG scoring becomes more commonplace, we are entering an era where companies that score poorly on the more visible ESG metrics, will incur higher financing costs compared to their competitors. Compounding this, those with poor ESG credentials could potentially be awarded lower credit ratings as ESG factors are now being integrated into the methodology of major credit rating agencies such as Moody’s and S&P.

One example of ESG in practice was our participation in Telia’s (telecommunications) inaugural Q1 2017 hybrid bond. While a corruption investigation was under way into Telia’s Uzbekistan unit, we were comfortable this was close to conclusion and the unit in question would be disposed of, which continues to progress as expected. However, in April 2017 additional concerns arose based on ESG considerations as Telia’s operations in the Swedish mobile market were investigated. We believed these concerns weakened the investment thesis and sold the position at a profit. Maintaining an ESG based perspective across all our holdings is therefore highly important.

¹Barclays, ESG Ratings and Performance of Corporate Bonds, 18 November 2015