Sustainability – a key component of our fundamental investment framework


Northstar’s fundamental analysis has always considered sustainability in its broadest sense as an integral component in our valuations. We discuss the trends driving socially responsible investing, unpack the different approaches and explain why we believe our method best serves investors in our funds.

The significantly increased focus on socially responsible investing (SRI) or environmental, social and governance (ESG) factors in investing over the past few years is often dismissed as “greenwashing” or a simple marketing exercise. As determined long-term investors, Northstar has always considered sustainability in its broadest sense as an integral component of our fundamental analysis of any potential investment, affording us the ability to develop a deeper understanding of both risk and return.

Effective approaches to ESG investing

ESG investing has evolved considerably since the days when investors followed their consciences by excluding investments in certain industries on moral grounds, often in so-called “sin stocks” such as alcohol, tobacco, gambling, or defense companies.

Exclusion or screening the investment universe to identify and avoid exposure to controversial products or practices is arguably the bluntest form of SRI and is often confronted with a relative morality test.

The extent to which exclusion places values over value also has the potential to compromise investment returns, as it foregoes participation in the growth of companies with strong economics (at least in the short term) but questionable products or practices.

There is also the strong likelihood that, through an exclusionary approach, investors overlook changes in company practices, such as an improvement in governance, that result in a rerating, often the most powerful driver in share price returns.

Many investors have therefore chosen to approach SRI from a “best-in-class” point of view, adopting a systematic approach to scoring companies on ESG-related factors to derive some sort of ranking. A bit like buying the best house in a bad neighborhood, placing you at the mercy of time.

From exclusion to engagement and everything in between

With the ever-broadening definition of SRI and given a deeper appreciation of the importance of sustainability to long-term business performance, the inadequacies of a checklist approach become apparent. More so when one considers the need for a more holistic or nuanced approach arising from a shift in focus from narrow shareholder to broader stakeholder interests.

The increased popularity of SRI has coincided with a rise in related forms of investing, such as impact and sustainable investing, which arguably fall under the SRI umbrella, along with responsible investing, active ownership, and stewardship.

With impact investing, the objectives are most clear – generally an intention to generate a measurable social or environmental benefit alongside a financial return. Sustainable and responsible investing, on the other hand, are slightly more nebulous and overlapping concepts.

As long-term investors and stewards of our clients’ savings, we feel the area within the broader SRI group of activities where we can be most effective is active ownership. This is not to be confused with activism, often associated with aggressive tactics employed by hedge fund managers to achieve relatively short-term goals.

Rather, active ownership requires engagement between investors and the companies they are invested in to achieve sustainable, long-term outcomes in the best interest of both shareholders and wider stakeholders.

Active ownership and the role of the asset manager

The recent rise in SRI is not a function of a newfound sense of collective altruism by the asset management industry, but rather at the insistence of clients and asset owners or in response to competitive pressures. In a survey published by the CFA Institute in ESG Issues in Investing: A Guide for Investment Professionals, 44% of respondents said they considered ESG issues in their investment decision making because clients demanded it.

Nevertheless, one measure of the commitment asset managers are making to integrating ESG considerations into their investment processes is the growth in the number of signatories to the United Nations Principles for Responsible Investing (UNPRI)1, which passed 4,000 signatories in July, accounting for over $121 trillion in assets under management.

Northstar has been a signatory for several years now and has adopted the PRI’s six principles:

Principle 1: Incorporate ESG issues into investment analysis and decision-making processes.
Principle 2: Be active owners and incorporate ESG issues into our ownership policies and practices.
Principle 3: Seek appropriate disclosure on ESG issues by the entities in which we invest.
Principle 4: Promote acceptance and implementation of the Principles within the industry.
Principle 5: Work together to enhance our effectiveness in implementing the Principles.
Principle 6: Report on our activities and progress towards implementing the Principles.

Despite this obvious commitment, meaningful differences exist in approach, notably between passive or index tracking managers, which have seen a significant increase in demand for rules-based ESG products2, and truly active managers with a long-term disposition and an ownership mindset.

Northstar’s approach to sustainability

In addition to adopting and incorporating the PRI Principles outlined above, Northstar has fully integrated Sustainability into our investment analysis by establishing it as a fourth pillar in our fundamental investment framework, alongside Industry Landscape, Competitive Advantage and Management. Previously, consideration was given to ESG issues as part of our analysis of the other three pillars.

As such, any company promoted to our Equity Buy List is given a score reflecting our assessment of its Sustainability practices, including Social and Human Capital, Environment and Governance factors. Taken with the scores for the other three pillars, we derive a Fundamental Risk Rating that directly informs Maximum Position Size. In this way, Sustainability, directly impacts whether we consider a company investable or not, as well as governing how much exposure portfolio managers are able to take when constructing portfolios, neatly linking fundamental risk with expected return.

However, as committed long-term investors, the real work generally begins once we have established an ownership position. While our Responsible Investing Policy sets out our general approach to Sustainability, along the lines of the PRI’s six Principles, our Active Ownership and Proxy Voting Policies outline our approach to engaging company management teams on behalf of our investors.

We have committed to submitting a proxy vote on every resolution at the AGMs of each company we hold. In addition, our investment team routinely meets with company management, engaging on all aspects of their businesses and industries, including sustainability-related topics. Contentious issues, often related to Governance and Remuneration, receive particular attention and our Engagement Logs are made available to clients and prospective clients upon request.

An active approach promotes effective outcomes

Approaches to SRI, ESG and sustainability have all evolved meaningfully over the past number of years. The growth in industry-wide assets under management in dedicated ESG or sustainability-related products over that period has been very strong, particularly in passive strategies.

While we applaud any initiatives that drive better ESG-related outcomes, we remain skeptical of the effectiveness of a systematic or rules-based approach in achieving these outcomes. “Permanent ownership”, which passive investing effectively represents, cannot trump an active, integrated, and holistic approach to complex and nuanced issues, particularly when this is combined with the willingness to engage companies to bring about improvements in the approach to ESG issues.

A final concern would be the unintended consequence of assessing ESG in isolation from the rest of a company’s fundamentals and valuation, which could redirect the available savings pool and potentially lead to a significant misallocation of capital.