Alternative Investment Market waking up to ESG

Alternative Investment Market waking up to ESG
  • Investment Insight
  • 7 minute read

By Tony Whincup

The Coronavirus pandemic has reminded families of the fragility of life; that taking stock and taking action on important issues can help reassert control, and possibly even make tomorrow better than today. Thoughts about one’s legacy and difficult conversations with loved ones – perhaps put off in happier times – have surfaced prominently. How can we plan for the future with certainty? What do I want my legacy to be? Does it matter how we invest?

Responsible investing naturally chimes with themes of fragility and legacy and much has been written about it1. What’s less well known is that one aspect – ESG or Environmental, Social & Governance – is also gaining traction in a part of the market hitherto not typically associated with it: Alternative Investment Market (AIM) shares, some of which are eligible for Business Property Relief (BPR) and thereby shelter investors from Inheritance Tax (IHT) after as little as two years.  

For the last 20 years, Close Brothers Asset Management have been running a service that capitalises on this relief. Whilst the Close Inheritance Tax Service (CITS) does not specifically target ESG as one of its objectives, many of our investee companies have been committed to reducing their environmental impact and, even before it was a recognised theme, improving their ESG standing.

This observation is reflected by running AIM-listed equities through an ESG screen. Currently, the third-party we use classifies approximately 70 of the ~800 companies listed on AIM with ESG ratings ranging from AA to CCC. For the vast majority of AIM-listed companies using this screen, there is still insufficient data and visibility for a score. But the direction of travel is clear: ESG considerations are no longer the sole preserve of large-cap companies with household names, such as Unilever or Astra Zeneca.

Hearteningly, many of our larger investee companies in CITS scored well under this this screen, including Jet2, the package holiday company; Watkin Jones, the build-to-rent property developer; and IG Design Group, a global leader in gift wrap and cards. Is this coincidental or a consequence of the quality of our proprietary research?

The answer is that understanding a potential investee company thoroughly has always focused on how well it conducts its business relative to its peers and the broader market. It is about identifying risks. A company with robust financial controls, strong stakeholder engagement and transparent disclosure, for example, is likely to be relatively less risky than a competitor which does not. High quality, forensic analysis of a business’s financials and culture ought to expose potential investment risks ipso facto. One is the corollary of the other.

The broadening coverage of third-party ESG data is undoubtedly welcome. It may independently validate or challenge our research findings and offers a handy additional filter. Yet given their often different methodologies and outcomes, they will only ever supplement our understanding and never be a short-cut for independent, proprietary research. Recent controversies in the media involving companies with strong ESG ratings show the subjectivity of disentangling and understanding complex supply chains, labour laws and social contracts in a hyper-connected world. And without doubt, some companies may view ESG as a tick-box exercise to achieve good PR – an approach whose elastic limit may stray into ‘greenwashing’. 

Notwithstanding this, many companies – with or without ratings – have been seriously considering ESG for many years. Senior management increasingly views ESG as a way to get a competitive advantage through the development and adoption of best practice – and in many cases it’s just good business sense to cut emissions or reduce waste. Given that the average ESG report may have hundreds of KPIs, some of which may only be loosely relevant to its business model, the more enlightened management teams are taking control of what ESG means to them and taking action. What do we need to disclose and how can we quantify it? Do we have accurate and sufficient data, and the resources internally to work on it? This approach tends to create a more authentic narrative to build on with customers, shareholders and wider stakeholders.

Within our CITS portfolios, there are many examples of such forward-thinking companies; to emphasise that maturity is no barrier to best practice, the businesses below have been trading for an average of 150 years:

  • Lighting specialist FW Thorpe: in 2009 it initiated its own carbon-offset scheme, to plant trees in Monmouthshire. At maturity, more than 200,000 trees will sequester an estimated 42,000 tonnes of CO2. (It notes that just one 326w light bulb may use enough electricity during an average 20 year lifespan to create ~17 tonnes of CO2)2.
  • Timber importer and distributer, James Latham, recognises its environmental responsibilities. It is a signatory, advocate and active member of several bodies, including Forests Forever, WWF and The Timber Trade Federation’s Responsible Purchasing Policy. Employees and suppliers commit time to woodland husbandry3.
  • James Halstead’s Sustainability Report conveys an array of metrics over 111 pages, including energy consumption (84% renewable), diesel forklift trucks being replaced with electric ones (sparing 56 tonnes of CO2 per year), employee retention rates, gender diversity and sustainable new product development4.

And there are many others, not least Augean whose very business is the clearance and safe disposal of hazardous waste.

Whilst these examples emphasise mostly the E or S of ESG, traditionally it is digging deeper on the G where our smaller companies team often identifies material risks to an investment case. This may result in declining to invest, engaging with the board prior to investment or seeking to help boards attain and maintain the highest standards. The topics of engagement are broad: lobbying against the regular use of exceptional charges in stated accounts in favour of more transparent reporting; discussing the structure of management incentive schemes, which may result in a dilution to investors’ interests, to ensure that they are stretching and proportionate; seeking assurances that companies have adequate and accurate financial controls to improve forecasting and mitigate risk; working with companies to improve their board structures through (say) gender balance or the appointment of independent non-executive directors to enable effective oversight.

Our investors seldom hear of these interactions but they are essential. Part of our financial stewardship is to bring a collective voice to your clients’ best interests. We chose specialist third-party company Institutional Shareholder Services (ISS) as our voting platform and research partner, and our internal voting panel of research analysts and investment managers determine how we vote according to our voting policy. In FY 2019/2020, CITS voted on over 200 resolutions from 20 different companies: 7 of these (3.5%) were against resolutions, 21 (10.5%) were against ISS’s recommendations and 10 (5%) were fully against Management – the latter comprising non-salary compensation, reorganisation and mergers and director-related matters. This trend continues into 20215.

Active voting remains the one aspect of responsible investing where investors in AIM-listed companies have a tangible and proactive voice to promote best practice, corporate governance and sustainability; it is increasingly essential that they use it. We use our full expertise: our smaller companies team works alongside the Head of Responsible Investment and Research; we are a signatory to the UN PRI and the Close Brothers Group itself has attained the highest ESG rating possible6.

There is a rather neat and intuitive simplicity about the relevance of ESG to inter-generational equity, Responsible Investing and wealth planning. And it is doubtlessly true that many companies have always done ESG well, long before committees were formed and specialists created - just as our analysis of companies in CITS portfolios has always identified risks and opportunities. Whether a portfolio is an ESG offering or not, it’s heartening to know that there is a growing link between conscionable investing and legacy in the IHT arena.

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Terminology breakdown
  • ESG stands for Environmental, Social, and Governance. These are categories of typically non-financial factors that can be material to a company’s business. ESG goes beyond what a company does, and looks at how it conducts itself, and whether it is doing so responsibly. As part of our financial analysis, we analyse ESG factors to identify and assess material risks and opportunities for a company.
  • Responsible investment is the practice of incorporating environmental, social and governance factors in investment decisions and active ownership.

1CBAM’s response to responsible investment is to integrate the evaluation of ESG factors within our investment research process and to reinforce the focus on ESG issues through active engagement. See our Responsible Investment Policy.
2FW Thorpe Carbon Offsetting project, 21 May 2021.
3James Latham as at May 2021.
4James Halstead Sustainability Report 2019.
5CBAM figures via ISS, FY2019/2021, and 2021 year-to-date. A full breakdown of our voting record is available upon request.
6UN PRI is the United Nations Principles for Responsible Investment. CBG is the FTSE250 company of which Close Brothers Asset Management is part.

Important information
This article is only intended for use by UK investment professionals and should not be distributed to or relied upon by retail clients. Please note there is no guarantee that the CITS investment objective will be achieved. The value of investments will go up and down and clients may get back less money than they invested. Past performance is not a reliable indicator of future returns. The information contained in this document is believed to be correct but cannot be guaranteed. Opinions constitute our judgment as at the date shown and are subject to change without notice. This document is not intended as an offer or solicitation to buy or sell securities, nor does it constitute a personal recommendation.

Specific information
CITS is a tailored discretionary investment portfolio management service that invests in both the Alternative Investment Market (AIM) and the Aquis Stock Exchange Growth Market (AQSE), with the benefit of major tax advantages introduced by the Chancellor of the Exchequer in his budget of March 2000. CITS is an Inheritance Tax mitigation service based on current tax law and practice. The tax treatment depends on the individual circumstances of each client and may be subject to change in the future. CITS invests in ‘qualifying shares’ in smaller companies which may be more volatile than investments in more established companies. Such companies can be subject to certain specific risks not associated with larger, more mature companies. Consequently this can make the CITS portfolios more volatile as the value of an investment may fall suddenly and substantially. CITS is considered suitable only for informed and experienced investors.

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