Sustainable investment objective
As a key pillar of Triodos IM’s Global Impact Equities strategies, Triodos IM selects sustainable investments as described in article 9 of the SFDR to invest in through its managed portfolio’s . The overall objective of these strategies is to maximise positive impact by investing exclusively in investee companies that contribute to one or more of our seven sustainable transition themes.
Under the Triodos IM’s Global Impact Equities Strategies, Triodos IM mainly focuses on investements in:
- Shares of listed companies and/or
- Units or shares of UCITS and/or UCIs.
Any type of asset selected for investment under a mandate (i) are expected to deliver attractive returns, (ii) do not harm society and/or the environment and (iii) comply with the applicable investment strategy.
Methodologies, screening criteria and relevant sustainability indicators
The Triodos IM’s Global Impact Equities strategies entail the management of investors portfolio’s through the purchase of shares of listed companies (or UCITS or UCIs) in investee companies that have been selected for the Triodos investment universe. In order to be included in the universe, investee companies are screened in a specific sustainability assessment process.
Triodos IM has identified certain types of products and services that contribute to the transition to a sustainable world. These sustainable activities, which are aligned with the 17 Sustainable Development Goals (SDGs) that the United Nations have set forth to act on, address the global challenges posed by structural trends such as ageing population, resource scarcity, inequality and exclusion.
Seven transition themes
Triodos IM has identified seven transition themes that are instrumental in the transition toward a sustainable economy. These seven transition themes, as a lens to select investments, are Sustainable Food and Agriculture, Sustainable Mobility and Infrastructure, Renewable Resources, Circular Economy, Prosperous andHealthy People, Innovation for Sustainability and Social Inclusion and Empowerment.
The strategies’ objective to maximise positive impact in alignment with the investment guidelines is incorporated in these transition themes. Triodos IM measures the strategies’ exposure to the transition themes (positive impact) and quantifies their relative exposure towards SDGs, emmission of CO2 and water and waste footprint. The relative positioning on the SDGs, CO2, water and waste footprint is an outcome of the investment process rather than an objective.
Triodos Bank’s minimum standards
An investee company that materially contributes to one or more of the seven transition themes through its products, services or processes, is eligible for an investment if it also meets Triodos Bank’s minimum standards. The minimum standards ensure that the eligible investments do not significantly harm the sustainable investment objectives.
The sustainability assessment is conducted in-house by Triodos IM and includes both internal research as research from external parties.
Every company within the Triodos investment universe is continuously monitored. If an investee company no longer meets the sustainable investment criteria, or is in danger of no longer meeting the criteria, Tridos IM may deploy various dialogue methods to motivate the investee company to compliance with the relevant criteria. If the dialogue does not result in the desired change in behaviour and a company is found in violation of the minimum standards, the company will be removed from the Triodos investment universe and subsequently the stock of the company will be divested from all Triodos IM managed portfolios within a period of three months after removal from the Triodos investment universe.
Risk management is embedded throughout Triodos IM’s organisation since risk awareness and management are an integral part of the organisation and culture. Risk management provides the structural means to identify, prioritize and manage the risks inherent in its business activities. The intention is to embed risk management in such a way that it fits the complexity and size of the organization and is designed to also allow it to grow.Triodos applies the Three Lines of Defence integral risk management framework. We have industry recognized internal control review reports such as ISAE 3402 II control statements. We also require ISAE 3402 reports of our strategic vendors.
Non-financial risk: Operational risks include the risks that arise from human error, process or system failure and from external events. It includes the improper handling of confidential information and the so-called compliance risk of regulatory requirements not being met. Triodos IM identifies, monitors and mitigates operational risks through a risk management program that includes a periodic ‘risk and control self-assessment cycle’.
Pre-trade and post-trade compliance checks are in place and taken into account in the Portfolio and Order Management System (POMS) to ensure that proposed orders do not constitute a possible breach against the risk limitations as agreed with individual clients. Furthermore, every proposed trade is to be accorded by at least two Triodos IM employees with investment responsibilities, before being sent to the trading desk.
Market risk: The portfolio is subject to market risk, which is the risk caused by changes in the price of the investments. Market risk includes to a large extent interest rate risk, currency risk, credit risk and country risk since publically transferable asset classes can continuously valuate risks into the price volatility of the publically traded security. The underlying financial or operational risks in companies included in the portfolio must also be considered an integral part of the market risk. Market risk and factor risks are managed using parameters that include, but are not limited to, VaR, tracking error and beta. In case of excessive risk resulting from portfolio construction decisions, portfolio managers alter portfolio positioning to mitigate risk or to bring risk back into acceptable tolerance levels. This can relate to tracking error, but also style and/or factor risks.
The biggest risks identified in Triodos IM’s Global Impact Equities strategies are:
- Style risk: Refers to our bias towards quality companies and no outspoken growth or value tilt in the strategy.
- Sector & System risk: As a result of the company screening on the transition themes (positive impact) and the minimum standard, the investment in the portfolio implicitly excludes or invests in the minority of certain sectors such as not having any big US Information Technology sector exposure (due to lack of theme fit or violation of Minimum Standards), no hydrocarbon sector exposure (zero Energy sector weight, hence no stranded asset risk and low carbon risk), and little Financials exposure (many financial institutions not selected due to lack of theme fit as not meeting Triodos positive screening on ‘financing the real economy’ GABV criteria). Consequently, the portfolio can be tilted towards other sectors.
- Currency risk: Currency risk arises because investments in the portfolio may be denominated either in euros or in foreign currencies. We consider these risks an outcome of our bottom-up process driven by positive thematic screening, negative Minimum Standards analysis and integrated financial & sustainability modelling. In principle, the investment manager does not hedge the currency risk of these investments.
- Country risk: In the market situation when the divergence among regions and countries emerges, a country can be more exposed to a certain risk than other countries, for example, due to cold war, the speed of pandemic recovery, the labor demand & supply state, and the government monetary policy.
- Liquidity risk: A risk when a position held on the portfolio cannot be liquidated in time and/or at a reasonable price.
Sustainability risks: Sustainability risks are an environmental, social or governance event or condition that, if it occurs, could cause an actual or potential material negative impact on the value of the portfolio investments . Investors should be aware of the fact that the approach to sustainable finance and sustainability can be subjective, and may evolve and develop over time, also due to legal and regulatory requirements. Also, despite the thorough screening process, there is a risk that an investment is made in a company that does not meet the sustainable investment criteria (anymore). Triodos IM has a process in place to mitigate such a situation, and to ensure that the portfolio complies with the investment strategy at the shortest time possible. To implement the investment strategy, Triodos IM relies on publicly available information communicated by the companies and countries themselves and by third parties. Sustainability risks comprise a.o.
- Climate-related risks (Environmental risk): The performance of the investments in the portfolio may be subject to climate-related risks. Investors should be aware of the fact that climate risks are difficult to assess as they might be distinct from other systematic sources of risk but might affect pre-existing risks (such as market, credit and liquidity risk). Three key areas of risk to financial stability resulting from climate change are:
Physical risk: the risk of losses (realised and unrealised) as a result of direct physical impact of climate change, including impacts on insurance liabilities and the value of financial assets that arise from climate- and weather-related events such as rising sea levels, forest fires, heat waves, floods and storms that damage property or disrupt trade or production. Physical risk may affect companies both directly through damage or loss of assets and indirectly through its effects on supply chains.
Transition risk: the financial risks that could result from the process of adjustment towards a lower carbon economy. Sudden or disorderly changes in policy, technology and physical risks could prompt a reassessment of the value of a large range of assets (i.e. re-pricing risk, stranded assets) as costs and opportunities become apparent.
Litigation risk: the impact that could arise in the future if parties that have suffered loss or damage from the effects of climate change seek compensation from those they hold responsible. These types of claims are likely to impact most severely on carbon extractors and emitters, and their insurers.
The climate-related risks have potentially high impact to the return of the investment. However through an integration and monitoring of the sustainability risk in the investment decision and the investment process, the climate risk in the portfolio is limited and consequently its financial impact is also limited.
The approach to climate risk may evolve and develop over time, also due to legal and regulatory requirements. Furthermore, historical data are of limited use for analysing climate risk since they neither include realisations of extreme climate change effects nor the types of (government) policies that could emerge going forward. Also, physical and transition risk could interact in a myriad of ways. For example, a rapid transition could result in increased transition risk but reduced physical risk, while unanticipated realisations of physical risk could go hand in hand with greater transition risk. The key for Triodos IM is to identify companies that conduct their business with best practice climate policies, and to encourage laggards to align their operations with ‘science based’ emissions reduction targets, in line with the goal of the Paris Climate Agreement, as a way to mitigate potential impact. This means that Triodos IM manages climate transition risks, such as re-pricing risk and stranded assets, and litigation risk, in the pre-investment phase in order to minimise the exposure to climate-related risks. Hereby, Triodos IM selects investments which tend to be more resilient to climate-related risks. Triodos IM continues to minimise these risks throughout the investment lifecycle by means of continuous monitoring and active engagement with investee companies. As a result of their investment strategy, the indirect contribution of the portfolio is limited.
- Labour right-related risks (Social risk): This risk includes the probability of incidents related to the violation of health and safety standards in the workplace, discrimination, forced labour in the company where the money is invested or in its supply chain. Such risks impact the profitability of the investment. This type of risk appears high in certain industries related to manufacturing and material. Nevertheless, with the integration of the sustainable assessment in the investment process, the labour right-related risks in the portfolio are limited.
- Violation of legislation-related risks (Governance risk): This is the risk that a company in the investment portfolio violates international, national or regional regulation and legislation. For instance this could be legislation related to the patent rights of a product in the healthcare industry. The violation of legislation may cause financial loss to a company because of a fine and/or bad reputation. However, by applying the minimum standards in the investment process, the companies invested in have limited risk of violation of legislation.
People, Planet and Profit
The strategy for selecting companies and UCITS or UCIs eligible for investment is determined by the integrated analysis of the factors “People”, “Planet” and “Profit” taking strict minimum criteria into account for the factors “People” and “Planet”. The final decision relating to selection of investee companies for investment is based on the integrated analysis of the factors “People”, “Planet” and “Profit”, in combination with the top-down investment outlook and portfolio construction.