Overview
I recently attended the inaugural Milan Sustainability Day, a whirlwind event where the Milan Stock Exchange brought together over 30 Italian companies to be quizzed by people like me and FIL portfolio manager Alberto Chiandetti.
It’s always fun to return to my home country and mentally check off how things have changed since my last visit, but what struck me this time was just how much progress Italian companies are making on addressing sustainability issues. Of the seven vastly different companies we met, almost all were thinking deeply about how their operations impact the environment and wider society and how their business model will need to adapt to evolving industry trends. But an ESG rating agency approach won’t always pick up on the nuances of their progress.
I found that companies are increasingly viewing sustainability as a forward-looking opportunity rather than merely a way to cover themselves in an incident. This is a mindset shift that we have been urging for some time, and it elevates ESG and broader sustainability considerations into something that can add material value to a company instead of only protecting the downside. For example: Hera, an Italian multi-utility company that I met, is shaping its corporate strategy around the efficient management of scarce resources, promoting the circular economy. For Hera, this means achieving cost reductions, but, more importantly, finding new revenue sources such as from their recent entry into plastic recycling. Ratings providers don’t always make a distinction between managing ESG risk and pro-actively leveraging ESG trends to create new business opportunities, and often end up anchored to backward-looking disclosures.
There can also be a size bias when it comes to sustainability ratings. It’s logical to expect that smaller companies are less prepared to report on ESG issues given they have fewer resources, but a lack of disclosure doesn’t always indicate poor practice. I met some small and mid-cap companies that are busy refining the sustainability of their business models and who feel that ratings agencies spend less time and effort engaging with them versus the large-caps. That’s partly understandable, since rating providers are limited in time and headcount and choose to prioritise the bigger companies that appeal to the bulk of their clients. However, this leaves large swathes of the corporate world under-researched and misunderstood.
But even for the large-caps, interaction with agencies can be complicated. Different ratings providers apply different criteria and assessment methods and may lack a detailed understanding of a company’s strategy, business model and how ESG considerations relate to financial considerations. For some companies, this can cause confusion around how best to co-operate with ratings providers and fulfil the criteria.
We have to be the drivers
None of this is to undermine the important function of ESG ratings providers in setting market-level expectations and comparability. We work with them and they are an input to our investment process. But we should acknowledge where we can do our own analysis to confirm findings, fill in blanks and correct misconceptions, uncovering opportunities in the process. For example, Davide Campari, the Italian drinks maker, has weak disclosure of environmental data and is marked down by ratings agencies accordingly. However, the company has been working hard to improve its sustainability profile. So far, those initiatives haven’t aligned with what the ESG ratings agencies are looking for, but if and when they do, we could easily see an upgrade in its rating and the resultant investment attention that brings.
As an asset manager, Fidelity is busy ramping up coverage of companies for which we have proprietary sustainability ratings on, and we now have scores on over 750 companies. ESG analysis has always been a part of the investment process, but a distinct and comprehensive rating standardises the workflow for analysts across the company. These ESG scores play an important part in highlighting the sustainability characteristics of an investment and where we have different perceptions to the market consensus.
It’s great that we have this tool in our investment armoury, as it allows us to drive sustainability ratings rather than hand over the keys to a third-party.
