Turning caterpillars into butterflies: SDG Engagement Equities

RobecoSAM Global SDG Engagement Equities uses 100% engagement with investee companies to improve the contribution they can make to one or more of the 17 UN Sustainable Development Goals. Launched in September 2021 for UBS, it is now publicly available to other investors.

The strategy is highly differentiated in that only a narrow band of stocks are eligible for inclusion – and some of them are laggards that others won’t touch. In this way it seeks companies that are a work in progress rather than the finished article, offering upside in both their SDG contributions and their share prices.

It does so by targeting companies that score between -1 and +1 on the proprietary Robeco SDG Framework that ranges between -3 for a company making a highly negative impact on the goals, to +3 for a company making a highly positive impact. Standard SDG strategies target companies that are already on the positive scale, usually seeking only +2 and +3 scores.

In order to know which companies offer the best potential, the strategy includes an engagement expert as one of its portfolio managers – an arrangement that is unique at Robeco. Experienced investment managers Michiel Plakman and Daniela da Costa are joined by Peter van der Werf, Senior Manager for Engagement, in the stock-picking process.

“These are in principle good companies in terms of return on investment and free cash flow generation, but they are not there yet in terms of sustainability,” says Plakman, Head of Global Equity at Robeco. “Therefore, SDG Engagement Equities applies a unique engagement strategy to each of the companies in the portfolio.”

“We think that by actually speaking to them, engaging on sustainability topics with them, and really partnering with those companies, we can materially improve the contribution that they can make to one or more of the SDGs. And so that’s really the vision and the idea behind the strategy.”

It means turning the traditional ‘best in class’ model on its head. “Those that are currently best in class have already understood what they need to do in terms of contributing to the SDGs,” says Plakman. “There’s also a group of companies that will likely never get it right – the minus twos and minus threes – what you might call the worst in class.”

“But there’s a whole host of companies with good potential that are in the middle, and we concentrate on them because that’s what offers the most opportunity for improvement. We believe that by focusing on this narrow group of companies, our impact as an asset manager can actually be the largest.”

Ironically, making the intended impact means a company falls out of scope. “When the SI mapping is done, we’ve had companies that were actually promoted from a +1 to +2 and so have they have fallen out of the eligible range for our portfolio,” Plakman says.

The investment and engagement strategy lead to a highly concentrated portfolio of just 25-35 stocks. Having such a small – and highly contrarian – portfolio does not mean being constrained in any other way.

“The beauty of it is that we try to explore all the aspects of being able to contribute to the SDGs, and the 17 goals are highly diversified,” says Da Costa, portfolio manager with the emerging markets team. “It means we have a very diversified portfolio.”

“It’s a global strategy where we try to assess which companies have the best potential, and then try to guide them. In the end it’s about engaging with companies that we believe have the potential for good sustainability in the long term.”

“It’s very much a bottom-up approach. We look at the bottom-up ideas and therefore sometimes there will be deviations from shorter-term performance because we are seeking a return over three years.”

Experience has shown that some of the 17 SDGs are more investible than others, given the strategy’s restricted scope. As can be seen in the chart below, the portfolio has 31% of its assets in companies contributing to SDG 9 (industry, innovation and infrastructure) and 25% targeting SDG 8 (decent work and economic growth).

Conversely, it’s more difficult to find listed companies contributing to wider issues such as education, poverty and inequality, since these spaces tend to be dominated by not-for-profit organizations, while the few listed companies that are investible already have high SDG scores.

“One of the things we’ve learned over the past six months is that sometimes it’s really difficult to find KPIs that are meaningful in terms of a company’s contribution to specific SDGs, even when the company is willing to engage,” says Plakman.

“SDG 9 for economic growth and infrastructure is an easy one because of all the banks and financials that can be targeted. Innovation is also quite an easy one. But it’s difficult to find companies with a direct link to ‘no poverty’, given our limited scope.”

“Similarly, issues like life below water (SDG 14) and life on land (SDG 15 ) are very important for the planet, but it’s quite hard to find suitable candidates for the portfolio. And education (SDG 4) is also a perennially difficult sector to invest in. But we keep looking.”