Managing environmental and social risk
Banks are exposed to credit, reputational, legal, operational and market risks driven by environmental and social (E&S) issues that affect their clients and customers. Identification and management of these risks as part of their credit risk appraisal processes is, therefore, important for banks to manage their exposure to overall risk. This quarter we engaged with several of our holdings, including Bank Mandiri, HDFC Bank, Kasikornbank and Public Bank, to encourage them to strengthen their E&S-specific procedures, assessment tools and internal capacity allocated to managing these risks. In particular, we asked them to identify and report on portfolio-level E&S risks, monitor clients’ E&S performance and require them to implement mitigation measures for identified E&S risks, and develop specific guidance on industries with potentially high E&S impacts, e.g., extractives, coal-fired power generation, agriculture.
Several studies point to the significant impact on global greenhouse gas (GHG) emissions caused by the forecasted growth in milk consumption in China: according to one study4, global emissions from Chinese dairy production alone could increase by 35% and the land needed to feed cows for China would have to increase by 32% in the next 30 years.
Our holding, Yili, is China’s largest dairy company and now amongst the top 10 globally. During the quarter, we had a productive discussion with the company, during which we expressed our support for several initiatives it has taken over the past couple of years to mitigate GHG emissions along the entire value chain. These initiatives, which include energy efficiency measures and cooperation with farming partners to implement sustainable dairy farming practices, led to an 8% reduction in carbon emissions per ton of product between 2016 and 2018. At the same time, we encouraged Yili to step up its efforts to collect, measure and report emissions, and engage with suppliers and other stakeholders to drive increased efficiencies in milk production in China.
Portfolio actions and considerations
During the quarter, we initiated a new position in Bajaj Auto, a leading manufacturer of two- and three-wheeler vehicles in India. We believe Bajaj has a wide economic ‘moat’ (competitive advantage) with its strong global franchise, able management team and solid balance sheet, and superior profitability ratios. Bajaj has a large presence in India and has built a strong franchise across markets in southeast Asia, Africa and Latin America.
In India, Bajaj has historically been a leading player in the premium segment of the motorcycle market. Over the past eighteen months, the company has reset its domestic strategy in order to increase market share in the entry level and main commuter segments of the market, through new products and more attractive pricing points. This has enabled the company to increase market share, although further progress needs to be made in the main commuter segment. Interestingly, the company is the first major Indian manufacturer looking to launch electric two- and three-wheelers in India over the coming 6-12 months. Given concerns over increasing carbon emissions, we think this could potentially be an interesting long-term growth area for the company.
The key sustainability argument for Bajaj is around mobility. In rural India (or any rural emerging market) public transport infrastructure is often a mix between weak to non-existent. We see Bajaj as playing a key part in helping people’s mobility by providing a cheap and efficient method of transportation. Even in cities, the above statement is true as motorbikes generally don’t require as much fuel nor take up as much space (traffic) as cars. Combined with the fact that the business is strong (net cash), has a decent export element, and is led by a reputable trustworthy family, we feel comfortable in our initial investment.
We also initiated a position in Chile’s Aguas Andinas. Majority-owned by Suez, a leading water and waste management company, Aguas is a regulated water utility company that manages the whole water cycle, including: the catchment of raw water, water production, transportation and distribution, and the collection, treatment and final disposal of sewage. In addition to providing clean water, the company has built a circular economy by setting up a bio factory where the energy recovered from sewer sludge leads to the production of electricity, natural gas, and thermal energy, and bio solids from the wastewater treatment plants are reused as fertilizer to grow food.
The business is very well positioned from a sustainability point of view. It continues to improve efficiency through investments in minimizing leakage, invests in improving customer service, and has implemented water management programs to promote the development and social inclusion of the most underprivileged areas across Chile. In the context of the country’s exposure to increasing water stress from climate change, Aguas’ ability to efficiently provide clean water while also implementing a strategy focusing on the circular economy are key qualities for the long-term health and sustainability of the business whilst ensuring drinking water for the masses at affordable prices.
As it stands, year-to-date to the end of June 2019, our portfolio has caught up with the benchmark (the MSCI Emerging Markets Index) and has on an absolute basis managed to grow by more than 10% in USD terms; overall we feel the increase in absolute value is what matters for the most part. While valuations remain somewhat elevated we have been finding pockets of interesting long-term ideas. We will keep our investors informed as we dig deeper into the financial and sustainability elements of these companies.
These purchases were funded from reductions in HDFC Bank, Vitasoy, Bank Rakyat Indonesia and China Resources Gas, and the sale of Western Union, which is facing increased competition in the international payments and money transfer market, including from newly established financial technology companies.