An interview with Christoph Klein, Founder and Managing Partner at ESG Portfolio Management
UN Principles of Responsible Investment (PRI) recently released their Leaders’ Group 2020 - a report showcasing PRI signatories who are at the cutting edge of responsible investing. The 2020 Leaders Group theme was climate reporting. Only 36 signatories were featured in the coveted Leaders Group, and ESG Portfolio Management was the smallest firm to make this list. ESG Portfolio Management is a Germany-based asset manager for investment funds and segregated accounts. Embedding the Sustainable Development Goals (SDGs) of the United Nations is at the heart of this firm’s investment strategy. This year, the firm has been a recipient of several awards and honours, including the Sustainable Investment Awards’ ‘Multi-asset manager of the year’ title.
We had the immense pleasure of speaking with Christoph M. Klein, the founder and managing partner of ESG Portfolio Management, about how this small team became one of UN PRI Top signatories.
Q: What led you to founding ESG Portfolio Management?
Christoph: “I have been doing portfolio management for more than 20 years and for over 10 years, I have been doing sustainable investing. In 2009, we started the first ESG credit fund, and from 2010, I was a part of the PRI Fixed Income working group. Those were still the early days - we brought in case studies, made some handbooks and so on. I always liked to publish and speak at conferences - and I had developed internal credit rating models. In 2015, the CFA Institute invited me to talk at their annual conference about ESG implementation and fixed income. They liked my work and chose to publish it in their quarterly review. This was quoted by the Japanese Government Pension Investment Fund (GPIF) and the World Bank. It was nice to have this international reach and positive feedback. This finally gave me the self-confidence that I am on the right track with the investment process, data management and analysis in order to start my own company. The company was founded in 2018.
With this firm, we wanted to achieve a maximum of sustainability. The company went even beyond ESG very quickly. When we founded the company in 2018, we realised that SDG impact measurement is very important as well. We wanted our portfolios to have the highest ESG qualities, a very positive SDG impact, and the lowest climate risk. If we see that there are any problems with an asset, or think that a company is not good enough, we simply don’t buy it. In addition to all this, we also made sure that we are very transparent in our own reporting too. And we did all this from the very start of our company. However, in being this ‘extreme’, we did not want to compromise ourselves. I would also like to say that it is easier for a smaller company or a boutique, like ourselves, to act like this and have a super strict investment process.”
Q: Can you tell us a little bit about ESG Portfolio Management and how it differs from traditional asset management firms?
Christoph: “As I said before, we aim to go to the extremes, in many dimensions, in a positive way. We have a clear process for this and I think of this as a puzzle. First, we started with a list of 20,000 companies. After going through a long exclusion list, only about 3,800 companies remained. In this exclusion step, we ensured that we did not buy oil, coal, nuclear etc. Out of these 3,800 companies, roughly around 1,500 had a high ESG quality. Next, 400-500 of these had a positive SDG impact. Going even further, 250 of the 400/500 companies were Paris Aligned given their forward-looking TCFD compliance and climate risk assessment. From these, we narrowed down to about 100 companies whose equity or corporate bonds were attractive. This is important because, in the end, we still need to ensure that we have returns and performance. If we just buy ‘the very best’ in terms of ESG, sometimes these are expensive or do not have a chance for further performance.
We are also strong believers in active engagement and proxy voting. We believe in constructive dialogues - if we push companies to become better, encourage them to have an even higher ESG rating, or improve their SDG impact, then the price of the equity or the corporate bond will increase as well. The risk will go down and they have higher potential. Such engagement is where we spend a lot of our time.”
Q: Why, in your opinion, is it important to integrate ESG into the investment process?
Christoph: “So there is a big Meta study which has gotten a lot of fantastic feedback, and rightfully so. It is written by Gunnar Friede, Timo Busch and Alexander Bassen. It analyses around 2000 research papers on the relationship between ESG and investment performance. Their outcome was very significant and clear - the relationship is not negative. Many people still think that if you are sustainable, you need to sacrifice returns. This is simply not true. Personally, I understand ESG as an extension of risk management, and it helps reduce the downside of an investment. On the other side, the SDG impact assessment, is about improving the upside. For us, ESG is risk management, but SDG is what drives us at this firm and is the reason we get up in the morning. We want to have a positive impact on the lives of many people.”
Q: Can you tell us more about your engagement and proxy voting process?
Christoph: “In our research, we go beyond looking at just ESG scores or ratings. We look deeply at individual factors like incidents, controversies, weaknesses, what the NGOs are saying etc. We try to dig deep. Normally, we start the engagement by writing an email to the company with 3-4 points that we feel the company can improve on. Then, it depends on what the company does. If there is a response, we follow up. We see if we can measure what they are claiming. We want to find out whether it is just talk or can we actually see some actions. If we do not find anything, we try to communicate further with the investor relations team and so on.
Engagement can be very powerful. Let me give you an example. Once when I was in the US, I saw a Kellogg’s corn flakes package which was meant for one, individual person. The bottom of this was plastic and on the top, there was metal. So I decided to take a picture and wrote to Kellogg’s asking them what their packaging strategy is and when will this box be compostable. I did not receive an answer. I wrote again and again - yet did not hear back. This was important to me. The oceans are filled with plastic and we need to do something about it. So I wrote a one page letter on the UN PRI’s collaboration platform explaining why this plastic waste was an issue and why it made sense to target Kellogg’s. Overall, they are a very good corporation in terms of sustainability and have a very high ESG rating, but this specific packaging, in my opinion, could be improved. We sent an invitation to all PRI signatories to join this engagement and we ended up getting a reply from several investors, who have around $60 billion in AUM. Now, Kellogg’s is reacting and we have been speaking to not only their investor relations team but also their global head of sustainability.
Such discussions are very positive and encouraging. It doesn’t matter if you are a small company, if you try hard and you are motivated - you can achieve something. This is a good message. It is not only the big guys that can move things forward. Everyone has a responsibility, and together with the help of organisations and networks, we all have the ability to do something.”
Do you think the COVID-19 pandemic is helping accelerate developments in the ESG space?
Q: “ The pandemic is certainly a very sad event. People worldwide are affected. The only upside is maybe that people are considering more and more how their habits and lifestyles can have an impact on the planet and other people. One example is textiles. Think about the labour conditions in countries like Pakistan and Bangladesh. Why do we buy plastic shirts manufactured in these countries, wear them 2-3 times, and then throw them away? The plastic is often of such quality that it cannot be recycled - it is super awful for the environment. Instead, we should be buying better quality textiles, paying these workers more, and giving them the freedom to be creative. They do have the experience and they want to express themselves, instead of following designs made in Germany or the US. Why not let them do this and create something beautiful, which has the quality that we could wear and love for a couple years! This type of consciousness - of better consumption, of impacting other people’s lives - has been increasing in the past few months. We can also see this in the food industry, where people notice the harms to the animals or the burning down of rainforests for agriculture of products such as soya. People are understanding the dangers of loss of biodiversity and their impact on the climate. Covid has intensified and sped up this process.”
Q: What led your firm to becoming an UN PRI signatory?
Christoph: “For me, this was an absolute necessity. If I want to be sustainable, this gives me a rock solid foundation. What PRI is really doing is thought leadership. They are reaching out to politicians, creating working groups and doing some fantastic research. I attended their conference in Paris last year and it was so so powerful, it was just unbelievable. I wouldn't want to miss this, so I joined PRI immediately.”
Q: Are there any other initiatives you are a signatory to? What made you join these?
Christoph: “We are a part of CDP. Climate change is obviously a major threat and we really need some reporting standardisation in this area. I understand from companies that they do not want to fill out 500 forms in order to measure their emissions. This is why I really think CDP is doing a good job. They have a global standard and thousands of companies are getting full transparent data. And they help us, the investor society, to analyse and judge. Some other initiatives are the Montreal Pledge and Climate Action 100, where we target the biggest companies to have a meaningful impact. I am also quite an active member of the CFA Institute, and I have just been elected to be within their ESG technical group which will start soon.
Here in Germany, I teach classes for analysts and portfolio managers. I have also been involved in designing and running seminars for Moody Analytics globally. I really enjoy constructive discussions, and I am delighted to be involved in such initiatives.”
Q: ESG Portfolio Management is the smallest firm to have made it to UN PRI’s Leaders’ Group 2020. What do you think made your firm come out as a leader?
Christoph: “As I said earlier, we try to be as transparent as we can. We have nothing to hide and we publish all our reports. This is key. Content-wise, we know that climate change is super important. For our diversified portfolios we look for sector leaders with strong commitment for transformation to reduce climate risks. We spend time in looking for the right measurement and methodologies to be TCFD compliant - this is very important to us, it helps us be forward-looking. We started using this company, “right. based on science”, who do great research and publishing. What they have done for our funds is that they help us relate emissions to EBITDA and personal costs. They also have sector targets because, for example, it is very clear that a cement company will have more emissions than a telecom company. They help us understand what worldwide emissions would look like, if every company acted like company X. We can then finally see how much warming would be caused by such a scenario. This allows us to link specific companies in our portfolio to a measure of ‘warming in degree celsius’. They have helped us calculate that all our funds are below 1.75 degrees - making them all Paris aligned. By comparison, the German equity index (DAX), has a warming of 4.9 degrees.”
Q: What excites you most about ESG Portfolio Management’s future?
Christoph: “I would like us to hopefully be a signatory with a message that everyone can achieve something if they try hard. In the future, in 3-5 years, we are convinced not to be the smallest firm in UN PRI’s list anymore! This is certainly our hope. We would like to hire super motivated people and diversify our team better. We are also very grateful to have made it to the Leaders’ List 2020, and hope this will open new opportunities for us.”
Q: What is your top key lesson for the investors and asset managers of the next generation?
Christoph: “It makes sense for analysts to spend time in selecting methodologies, examining the data quality, and not only take ratings or scores at face value. Look a bit deeper on the single factors. And don’t be shy! Be transparent - share and report as much as you can, and you will get feedback! It is a learning curve. Remember that mistakes happen and try to learn from them. Network. One thing that I would like to say is that this year, I published a case study on EU Taxonomy. This will be the big thing next year. I gave this a try and my work got published! Only 40 case studies worldwide were published. Such case studies help you form opinions and learn from how others do things. So, even if you may not be perfectly right at the start, reading such case studies will help you form opinions and do things better in the future. Keep learning. Attend conferences and also share your own work!”
Q: Is there anything else you would like to add?
Christoph: “I would really like to thank everyone who has supported us. Without this, we wouldn’t have gotten so far!”
You can find out more about ESG Portfolio Management on their website here.