In November 2018, Peter Hofbauer, Head of Hermes Infrastructure, was interviewed by PEI Media. Peter talks through Hermes’ approach to sustainability, the benefits it provides investors and why the asset class requires a different mindset
Q: Hermes is one of the founding signatories of the United Nations-supported Principles for Responsible Investment. How would you define responsible investment?
PH: From an infrastructure perspective, we recognise that the assets we invest in provide essential services – they’re critical infrastructure required to enable the functioning of a community. And that often means investing in assets that not are not only critical to people in their everyday lives, but are intergenerational and have very, very long lives. So, we need to be responsible in how we act as a steward, as an owner of those assets, and we need to respect the fact that these assets have multiple stakeholders involved, not just investors.
Q: What effect does this approach have on your investments?
PH: It impacts everything we do from the macro to the micro level. It affects how we approach our investment decisions and how we interact and engage with stakeholders once we own an asset. That includes communicating to the management, regulators, government, employees and fellow shareholders that we’re truly adopting a long-term view on our ownership and that the decisions we make today need to be made in a way which is appropriate for the long-term, intergenerational nature of those assets. It touches everything that we do, and it means that we need to be prudent, responsible and recognise the importance of the assets we’re investing in.
Q: Can you give a specific example of how you go about ensuring that long-term sustainability?
PH: One thing we know is that there are likely to be issues in the future that may be beyond the working careers of the individuals involved in making the initial investment. So, what does that mean from a governance perspective? It means we’d like to see a robust, fit-for-purpose governance framework that clearly differentiates between the rights of shareholders and the board. We like to see the board as the primary vehicle for managing the business. We like to see that board populated on a merit basis with appropriate diversity and regularly assessed to ensure it is fit for purpose as circumstances, including business, environmental and social considerations and opportunities evolve over time. We believe one of the key tasks of the board is to find best-in-class management and to mentor and challenge that management for the benefit of the company – not just for the benefit of investors, but to be mindful there’s a range of other long-term stakeholders.
Q: How do you measure something like ESG and ensure it’s not just a box-ticking exercise?
PH: We have a range of metrics we apply and regularly measure across our portfolio, but we also go through external validation. We have been validated by the PRI, who assess signatories on their implementation of the principles, every year since 2014 when we were first assessed. This year we’ve been rated A+, which if you look at the distribution of managers, is probably in the top 5 percent of all managers in terms of integrated ESG approach and philosophy.
We’ve also been validated by GRESB and were ranked in the top 5 of all the European diversified fund managers participating last year. We put ourselves through their assessment and validation and we’re very pleased that they feel what we’re doing is best in class.
Q: People often say that sustainable investment comes – or should come – more naturally to the infrastructure world. Where do you stand on this?
PH: Infrastructure has a social purpose to provide public service and as I said we’re often talking about intergenerational assets with long, useful lives. This makes them attractive to pension schemes on two counts: the well-understood long-investment horizon, which is important for providing appropriate financial returns; and the potential for the investment to influence pensioners’ quality of life for the better. The intersection of both is a growing area of focus, with institutional investors recognising infrastructure can have a positive impact while achieving an appropriate, risk-adjusted financial return. And that’s certainly how we approach it.
On the financial side, we recognise that infrastructure assets, by their nature, are often monopolies. Therefore, there is limited choice for the end user, which ties into the social contract. As an investor, you need to have a clear understanding of what you are entitled to, and that is a fair return for the risks accepted. But it’s not a windfall return, it’s not private equity-style return; it’s a fair return for the risks taken over a longer period of time, while also making an impact on the quality-of life-of-the beneficiaries.
Q: Have you ever ruled out an investment because of sustainability?
PH: We don’t have a screening system based on ESG, but we integrate E, S and G considerations into our decision making and consider the overall sustainability of our investment in light of our long-term investment horizon. There are some sectors that we have not invested in because we don’t feel they have positive investment characteristics over a long period of time. For example, areas where government has a policy to reduce usage, such as coal-fired power stations – we wouldn’t see that as sustainable. We would also find it difficult to consider any potential investment where the governance framework and quality of information provision would make it impossible for us to engage and positively influence long-term sustainable performance over time.
Q: How much of your sustainable-investment approach comes from Hermes and how much of it is dictated by investors and their concerns?
PH: We were an early signatory to the PRI and have always seen our sustainable-investment approach as an important aspect of our role. We are seeing increasing interest and sophistication amongst the broader investor community in relation to sustainability. We hope to continue to engage with investors constructively and influence their thinking and I believe we’ve been at the forefront of this for a long time. We’re very pleased to see that sustainability is getting greater and greater positive attention and recognition by institutional investors, as something that needs to be considered across all asset classes.
Q: What would you say have been the greatest changes in this this area in the last few years?
PH: I think it’s been getting clarity around the fact that sustainable investing isn’t necessarily inconsistent with achieving a fair return on investment. The two are not mutually exclusive – you can make sustainable investments that have a positive impact on the environment and the quality of life of beneficiaries and still achieve an appropriate return. Before, some parts of the investment-management industry were treating the two as mutually exclusive. There’s greater recognition now that that’s not the case.
Secondly, from an infrastructure perspective, I think there’s a growing recognition that the private-equity model, which is really what the infrastructure world initially adopted to aggregate capital and promote itself to potential investors, is less fit for purpose than it was. The private-equity model is more about transition capital and maximising returns, minimising costs and delivering short-term financial performance to investors. We’ve been arguing for a long time that critical infrastructure assets are just not suitable to this type of approach, because there are important public-service elements to infrastructure businesses that, some argue, are equal in importance to pure financial returns.